Openness, specialization, and the external vulnerability of developing countries

Abstract

This paper reassesses the sources of macroeconomic fluctuations across a large sample of developing countries. It employs sign restrictions to identify four external structural shocks – demand, supply, monetary and commodity shocks, and relates their impact to countries' policy and structural framework. External shocks account for a small share of the variance of GDP, especially at short horizons. However, their relative contribution has risen in recent decades, as the incidence of domestic shocks has declined. Global monetary shocks have become the leading external source of GDP volatility in developing countries. At short horizons, real and financial openness raise the share of volatility attributable to external shocks. At longer horizons, financial openness helps reduce the volatility contribution of global real shocks, but not that of global monetary shocks, thus augmenting the relative role of the latter. Commodity-intensive countries exhibit higher vulnerability to all types of external shocks, not just commodity shocks.