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Terms of Trade Volatility and Precautionary Savings in Developing Economies

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  • Salim B. Furth

Abstract

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.

Suggested Citation

  • Salim B. Furth, 2010. "Terms of Trade Volatility and Precautionary Savings in Developing Economies," DEGIT Conference Papers c015_013, DEGIT, Dynamics, Economic Growth, and International Trade.
  • Handle: RePEc:deg:conpap:c015_013
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    File URL: http://degit.sam.sdu.dk/papers/degit_15/c015_013.pdf
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Awel, Ahmed Mohammed, 2012. "Terms of Trade Volatility and Economic Growth in Sub-Saharan Africa," MPRA Paper 45453, University Library of Munich, Germany.
    2. Alessandro Federici & Pierluigi Montalbano, 2012. "Macroeconomic volatility, consumption behaviour and welfare: A cross-country analysis," Working Paper Series 3612, Department of Economics, University of Sussex.
    3. Hakon Tretvoll & Fernando Leibovici & David Kohn, 2017. "Trade in Commodities and Emerging Market Business Cycles," 2017 Meeting Papers 743, Society for Economic Dynamics.

    More about this item

    Keywords

    terms of trade volatility; precautionary savings; GDP growth; developing countries;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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