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Natural disasters and the effect of trade on income: A new panel IV approach

  • Felbermayr, Gabriel
  • Gröschl, Jasmin

Natural disasters affect bilateral trade. We use this fact to generalize the instrumental variables strategy of Frankel and Romer (1999) to a panel setup. This allows revisiting an old question: Does openness cause per capita GDP? We work with a modified gravity framework in which we interact foreign natural disasters with geography. Predicting the exogenous component of bilateral trade flows and aggregating over trade partners, we obtain a time-varying instrument for multilateral openness of a country. Controlling for constant determinants of income (history, geography) by means of fixed effects, we find a robust positive effect of trade on income. Averaging 0.74, the estimated elasticity is substantially smaller than the one obtained in the cross-section. Poor or non-OECD countries feature a larger elasticity.

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Paper provided by University of Munich, Department of Economics in its series Munich Reprints in Economics with number 20590.

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Date of creation: 2013
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Publication status: Published in European Economic Review 58(2013): pp. 18-30
Handle: RePEc:lmu:muenar:20590
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