Impacts of External Shocks on Nations’ Policy Responses and Economic growth —World Economic Synchronization

World Economic Synchronization

-External Shocks -Policy Responses -Trade as a ‘gear’

Methodology -External Shock Accounting -Differenced-Data Models -Multiple Linear Dynamic Models -Cointegration Test and Chow Test

Bacha’s model -- for External Shock Accounting Basic form of the model is Changes in Ratio of Current Account Deficit to GDP = + Changes in External Shocks - Changes in Policy Responses + Error Term

Bacha’s Model Derivation Dt  (M t - E t ) + (V t - T t ) (1) D t /Y t = P t mj t C t /Y t + P t mj t I t /Y t + r t F t-1 /Y t + V t /Y t - R t /Y t -P t x x t W t /Y t - T t /Y t (2) d(D t /Y t ) = j t A t /Z t d(r t m) - x t W t /Z t d(r t x) + F t-1 /Y t d(r t ) - X t r t xd(W t /Z t ) + r t d(F t-1 /Y t ) + d(V t /Y t ) - (R t /Y t ) - d(T t /Y t ) + j t  t md(C t /Z t ) + j t  t md(I t /Z t ) +  t mA t /Z t d(j t ) -  t xW t /Z t d(x t ) + ε (3)

Model Components: External Shocks [j s (A s /Z s )dpmt - x s (W s /Z s )dp x t ]…Terms of trade deterioration [ - F s-1 /Y s dr t ]…interest rate shock [- x s p x s d(W t /Z t )]…retardation of world trade growth. [ r s d(F t-1 /Y t )]…burden of debt accumulation [d(V d t /Y t )]…change in net direct investment income to abroad [- d(R t /Y t )]…change in workers' remittances [- d(T t /Y t )]…change in unrequited transfers

Model Components: Policy Responses [ j s p m s d(C t /Z t )]… consumption contraction [ j s p m s d(I t /Z t )]… investment reduction [ p m s (A s /Z s )dj t ]…import replacement [ - p x s (W s /Z s )dx t ]…export penetration [+ ε] …interaction effects and adding-up errors.

External Shocks -- Attribution to LDC Economic Performance

Measured Impact of in External Shocks

Counterintuitive Relationship between External Shocks and GDP Growth

Policy Responses -- Attribution to LDC Economic Performance

Policy Response Roles Synchronization Transmission Mechanism Reducing External Shock Impact by Improving Current Account Balance ↑ measure of adverse external shocks, ↑ favorable impacts of policy responses Policy responses correlate with the cycles in LDC economic growth Policy responses to the shocks might cause future structural adjustments

Policy Response to External Shocks

The primary policy response was export penetration, averaging from 4.1% to 6.4%; The secondary policy response was import substitution, averaging from 2% to 3.9%; The investment reduction was the third and the consumption contraction the fourth; ‘Belt-tightening’ would sacrifice economic growth in both the long-run and short-term; Trade policies, served as a “gear” of economic synchronization.

A comparison of LDC GDP growth of adopting export penetration policy

Tests and Analysis on Policy Responses Methods: -Multiple Linear Dynamic Models -Stability Test and Chow Test

Tests and Analysis on Policy Responses (1) A Test of policy sensitivity to external shocks: (PR i = b i + b i ES i + ,) Statistic measurements provided by policy parameters Export penetration as the primary policy response

A Test of Policy sensitivity to external shocks: PR i = b i + b i ES i + , where PR i = policy responses and ES i = External shocks Export penetration as the primary policy response Regression Model: PR i =      ES +  Constantcoefficient (t-ratio for X coefficient) R Squared Export-penetration on external shocks *0.22 Import-replacement on external shocks Consumption-contraction on external shocks Investment-reduction on external shocks Notes: N = 139; * denotes statistically significant at the 1% level (one tail).

Tests and Analysis on Policy Responses (2) Trend analysis of long-run LDC export- penetration responses to external shocks: (EP i = a + b i ES i +  ) The impacts of export penetration policy on current-account balances were rising; That response tripled to 91% from 32% through the period of , almost doubled from the period of

LDC export-penetration responses to external shocks in long-run? Model: EP i = a + b i ES i +  PeriodConstant (bi ) Coefficient ** (t-ratio)R Squared (-3.04)* (-4.17)* (-2.84)* (-5.46)*0.5 Notes:* denotes statistically significant at the 1% level (one tail); ** Negative sign indicates reactions of domestic policies result in favorable; T he impacts of export penetration policy on current- account balances were rising

Tests and Analysis on Policy Responses (3) Test the Consistency and the Continuity of Export Orientated Policy: Chow Test was used: F = (SSR 2 /df 2 )/(SSR 1 /df 1 ) Result: No presence of structure break

High-Growth LDC versus Low-Growth LDC (1) Export-penetration policy efforts differentiated high-growth LDC (HLDC) from low-growth LDC (LLDC) Export-penetration policy was used more by HLDCs than by LLDCs to offset external shocks.

High-Growth LDC versus Low-Growth LDC (2) HLDC export oriented policy accounted for 55 cents, offsetting every dollar loss caused by external shocks to the current account balance; HLDC export oriented policy measure was 120% greater than the measure of LLDC policy response, accounted for only 25 cents; HLDC experienced three times as much external shock as LLDC did in the period

Why did some LDCs perform better when they were facing more substantial external shocks?

Why..? The greater measures of external shocks that LDCs experienced, the more open their economies were

Why..? The greater measures of external shocks forced those LDCs to make some necessary economic adjustments, especially, adopting export oriented policies to offset the adverse impact of external shocks.

Why…? LLDCs minimized their exposure to external shocks, but also minimized their opportunities. For Instances: –Lacking of foreign direct investment (FDI) means lower current-account deficit –Less Trade results less the shock of terms of trade

Thanks. Questions please. Martin K. Zhu, Ph.D. Senior Economist U.S. Department of Agriculture