computed the effect of deviations from the trend in trading partners’ GDP on a country’s exports as the product of the estimated coefficient on the importers’ GDP times the annual change in average GDP of each country’s trading partners. Data come from the International Monetary Fund, the World Bank, and the French Centre d'Etudes Prospectives et d'Informations Internationales (CEPII).

For the domestic real-sector shock, we used the deviation from the trend of each country’s consumer price index. Rising inflation is interpreted as domestic demand exceeding the rise in domestic output. CPI data come from the World Bank.

The external financial shock was defined as the deviation from the trend of the product of the United States lending interest rate and the ratio of the country’s foreign debt to Gross National Income, in the previous year. Data come from the International Monetary Fund.

The domestic financial shock is defined as the deviation from the trend of the product between the domestic lending rate and the ratio of domestic credit to the private sector to GDP, in the previous year. Additional results using alternative domestic interest rates, such as deposit rates, are also presented. Data come from the International Monetary Fund.

All explanatory variables were transformed into their transitory components using the same trends that were used to estimate the cyclical component of RTS. That is, when we assumed a linear trend for RTS, we de-trended the explanatory variables using a linear trend; when the root of the linear trend was used for RTS, we used the same for the explanatory variables, and so on. The basic idea is to use a common de-trending approach for both sides of the model.

In addition to the transitory economic fluctuations defined above, we also consider the effects of labor market rigidities. More specifically, we use data from the World Bank Doing Business database on constraints for employers to hire workers on an hourly basis, difficulty using redundancy as a reason to fire workers, and constraints on hiring temporary workers. These indices were averaged from 2004 to 2009. They range between 0 and 100, with higher values indicating more rigid regulation.<sup>21</sup> In addition, we also included the ratio of the minimum wage to the median wage as a proxy of labor market rigidity. Since the econometric models include country fixed effects, these variables were multiplied by the external real shock, and estimated coefficients can be interpreted as the effects of these labor-market features on the impact of the shock on the transitory component of RTS within countries.

# _5.1 Cyclical Components of RTS and Real External Shocks in Latin America_

In this section we present the results on the relationship between the cyclical RTS and external shocks. The main result is the direct relationship between RTS and the external real shock. When (contemporaneous or lagged) foreign demand increases over its trend, returns to schooling also increase. This means that an increase in exports widens the wage differential between skilled and regional trade agreements of the WTO members, but only covered those agreements that have been notified to the WTO and are in force.

> 21 For details about these indices see www.doingbusiness.org.

13