Terms-of-trade shock duration and national saving in the developing countries

Abstract

The literature suggests that terms-of-trade (TOT) is a key determinant of the developing countries’ macroeconomic performance, including its likely impact on the level of national saving. The main objective of this paper is to examine the extent to which the TOT behavior contributed to changes in the saving rates across the developing countries. In doing so, the paper analyzes the TOT by conducting an empirical analysis of annual cross-country data for 57 developing countries for the period 1980–2010. We concentrate on the developing countries as problems stemming from fluctuations in TOT are likely to be more severe as the developing economies face restricted access to world financial markets with a greater magnitude than the advanced economies. The core aspect of our empirical analysis is that we utilize TOT shock duration and trend growth measures that have not been considered in the previous empirical literature. The trend growth is calculated using the smoothing procedure of Hodrick-Prescott (HP) filters. The shock duration is measured using the “half-life” of shocks. The empirical results of our models indicate that TOT trend growth and shock duration are important determinants of national saving in developing countries. Our results are robust to alternative estimation methods, time periods, sample construction, alterations in the control variables, sample coverage (e.g., the exclusion of larger exporters where one might fear the TOT are less likely to be exogenous). Our findings provide new evidence that permanent TOT shocks lead to changes in national saving rates. We also find that greater financial development and international financial integration mitigate the impact of TOT on national saving. Our findings add value to the existing empirical literature in terms of this new evidence and raises policy issues for the developing economies that are critical in terms of boosting their saving rates while ensuring stability in the trading environment. As a matter of policy, and to reduce the variability of TOT, developing countries should phase domestic economic reforms ought to be focused on achieving a diversified export structure. Closely allied to this, policy-makers need to formulate policies that improve the operation and facilitate the deepening of the domestic financial markets.