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Terms of Trade Volatility and Precautionary Savings in Developing Economies

Listed author(s):
  • Salim B. Furth

This paper investigates the link between terms of trade volatility and long-term output growth in developing countries. I find that differences in terms of trade volatility account for 25% of the cross-country variation in growth from 1980 to 2007. The magnitude is arresting: a two-standard-deviation difference in terms of trade volatility between two countries is associated in the data with a 32-percentage-point difference in overall output growth. A decomposition of output growth distinguishes the dynamic effects of productivity growth from pure factor accumulation. The data show that precautionary savings in the 1970’s and 80’s took the form of high domestic investment, which was replaced in the 2000’s by investment in foreign assets. The reallocation of precautionary savings from domestic to foreign assets led to falling output in countries with volatile terms of trade. A neoclassical capital accumulation model has significant precautionary savings associated with terms of trade risk. Opening foreign bond markets in the model induces a shift away from capital and a fall in output in price-volatile countries, reproducing my finding from the data.

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File URL: http://degit.sam.sdu.dk/papers/degit_15/c015_013.pdf
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Paper provided by DEGIT, Dynamics, Economic Growth, and International Trade in its series DEGIT Conference Papers with number c015_013.

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Length: 30 pages
Date of creation: Sep 2010
Handle: RePEc:deg:conpap:c015_013
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  15. Timothy J. Kehoe & Kim J. Ruhl, 2008. "Are Shocks to the Terms of Trade Shocks to Productivity?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 804-819, October.
  16. Bleaney, Michael & Greenaway, David, 2001. "The impact of terms of trade and real exchange rate volatility on investment and growth in sub-Saharan Africa," Journal of Development Economics, Elsevier, vol. 65(2), pages 491-500, August.
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