Medium-term Business Cycles in Developing Countries
Empirical evidence - including the current global crisis - suggests that shocks from advanced countries often have a disproportionate effect on developing economies. Can this account for the fact that aggregate fluctuations are larger and more pers...
Main Authors: | , , , |
---|---|
Format: | Policy Research Working Paper |
Language: | English |
Published: |
2012
|
Subjects: | |
Online Access: | http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20091202115041 http://hdl.handle.net/10986/4338 |
Summary: | Empirical evidence - including the
current global crisis - suggests that shocks from advanced
countries often have a disproportionate effect on developing
economies. Can this account for the fact that aggregate
fluctuations are larger and more persistent in the latter
than in the former economies? And what are the mechanisms at
play? This paper addresses these questions using a model of
an industrial and a developing economy trading goods and
assets, with (i) a product cycle shaping the range of
intermediate goods used to produce new capital in each
country, and (ii) investment adjustment costs in the
developing economy. Innovation by the advanced economy
results in new intermediate goods, at first produced at
home, and eventually transferred to the developing economy
through direct investment. The pace of innovation and
technology transfer is driven by profitability. This process
of technology diffusion creates a medium-term connection
between both economies, over and above the short-term link
through trade. Calibration of the model to match
Mexico-United States trade and foreign direct investment
flows shows that this mechanism can explain why shocks to
the United States economy have a larger effect on Mexico
than on the United States itself, and hence why Mexico shows
higher volatility than the United States; why business
cycles in the United States lead to medium-term fluctuations
in Mexico; and why consumption is not less volatile than
output in Mexico. |
---|