WPS3733

**Comments welcome**

# **DOES OPENNESS IMPLY GREATER EXPOSURE?***

**César Calderón Norman Loayza Klaus Schmidt-Hebbel**** The World Bank The World Bank Central Bank of Chile

## Abstract

External exposure can be measured by the sensitivity of first and second moments of economic growth to openness and foreign shocks. This paper provides an empirical evaluation of external exposure using panel data methods for a worldwide sample of countries. Controlling for domestic conditions, the paper examines the growth and volatility effects of outcome measures of trade and financial integration as well as four types of foreign shocks: terms of trade changes, trading partners' growth rates, international real interest rate changes, and net regional capital inflows. The paper analyzes the possibility of non-linearities by allowing the growth and volatility effects of openness to vary with the general level of economic development and by letting the effects of foreign shocks depend on the degree of trade and financial integration. The findings point toward strong non-monotonic effects of openness and external shocks on growth and volatility. Moreover, all in all, the results contradict the view that international integration increases external vulnerability by hurting growth and increasing volatility or by amplifying the adverse effect of external shocks.

**Key Words:** External Shocks, Openness, Volatility, Growth, Non-linearities **JEL Classification:** F36, F41, F43

## World Bank Policy Research Working Paper 3733, October 2005

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org._

* For useful comments and discussion we thank Pierre-Richard Agénor, Ricardo Caballero, Luis Felipe Céspedes, William Easterly, Linda Kaltani, Mauricio Larraín, Claudio Raddatz, Luis Servén, Raimundo Soto, and participants at the IFPRI/Cornell Conference on Threshold Effects and Non-Linearities in Growth and Development, the Annual Conference of the Central Bank of Chile, the Econometric Society World Congress, the Latin American Meetings of the Econometric Society, the Annual Meetings of the Chilean Society of Economics, and seminars at the Bank of International Settlements, Catholic University of Chile, University of Chile, University of La Plata, and Central Bank of Portugal.

** Calderón: The World Bank. Address: 1818 H St. N.W., Washington, DC 20433. Email: ccalderon@worldbank.org. Loayza: The World Bank. Address: 1818 H St. N.W., Washington, DC 20433. Email: nloayza@worldbank.org. Schmidt-Hebbel: Central Bank of Chile, Economic Research Division. Address: Agustinas 1180, Santiago de Chile. E-mail: kschmidt@bcentral.cl.