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Volatility and development

  • Miklos Koren
  • Silvana Tenreyro

Why is GDP growth so much more volatile in poor countries than in rich ones? We identify four possible reasons: (i) poor countries specialize in more volatile sectors; (ii) poor countries specialize in fewer sectors; (iii) poor countries experience more frequent and more severe aggregate shocks (e.g. from macroeconomic policy); and (iv) poor countries' macroeconomic fluctuations are more highly correlated with the shocks of the sectors they specialize in. We show how to decompose volatility into these four sources, quantify their contribution to aggregate volatility, and study how they relate to the stage of development. We document the following regularities. First, as countries develop, their productive structure moves from more volatile to less volatile sectors. Second, the level of specialization declines with development at early stages, and slowly increases at later stages of development. Third, the volatility of country-specific macroeconomic shocks falls with development. Fourth, the covariance between sector-specific and country-specific shocks does not vary systematically with the level of development. We argue that many theories linking volatility and development are not consistent with these findings and suggest new directions for future theoretical work.

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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 3743.

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Length: 50 pages
Date of creation: Nov 2005
Date of revision:
Handle: RePEc:ehl:lserod:3743
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