Export Instability and the External Balance in Developing Countries


WP/94/8-EA

Export Instability and the External Balance in Developing Countries by
Atish Ghosh and Jonathan Ostry

Export instability, that is uncertainty about the export earnings
accruing to a country, is an important source of macroeconomic uncertainty
in developing countries. Moreover, the relevance of this issue has
increased recently, as policymakers in a number of developing countries have
turned their attention to the problems associated with, on the one hand, the
sharp decline in commodity prices since the mid-1980s, and, on the other,
the steady increase in the volatility of commodity prices over the past two
decades.

How should the various agents in an economy respond to greater
uncertainty about the prices of a principal export, and the resulting
volatility in real export earnings and real incomes? One answer is provided
by the theory of precautionary savings, which hitherto has been used to
explain household responses to uncertainty in labor incomes. This theory
suggests that in response to an increase in the volatility of household
labor income, arising, say, out of an increase in the probability of being
unemployed, households should increase their savings in order to insure
themselves against the greater probability of a large negative income shock
in the future. The hypothesis that is tested here is that, in response to
increased uncertainty about export earnings, countries need to save more in
order to insure themself against potentially greater income shocks in the
future. Moreover, in an open economy, these greater savings should show up,
in the aggregate, in the external current account balance, which measures
national savings net of investment.

The results suggest that, in general, there is evidence that developing
countries have increased their savings (and external current account
balances) in response to increases in export instability over the past two
decades. Moreover, these savings have not been insignificant, amounting--
for example--to about 3 1/2 percent of average imports for the nonfuel
primary commodity exporters, and substantially more for the fuel exporters.
There are, however, interesting regional differences, with countries that
had difficulty achieving even subsistence consumption levels finding it
difficult to maintain precautionary balances when export uncertainty
increased.