Trade Openness and Volatility

This paper examines the mechanisms through which trade openness affects output volatility using an industry-level panel dataset of manufacturing production and trade. The main results are threefold. First, sectors more open to international trade are more volatile. Second, trade leads to increased specialization. These two forces act to increase aggregate volatility. Third, sectors which are more open to trade are less correlated with the rest of the economy, an effect that acts to reduce overall volatility. The point estimates indicate that each of the three effects has an appreciable impact on aggregate volatility. Added together they imply that the overall e®ect of trade openness is positive and economically signi¯cant. This impact also varies a great deal with country characteristics. We estimate that the same increase in openness raises aggregate volatility five times more in developing countries compared to developed ones. Finally, we find that the marginal impact of openness on volatility roughly doubled in the last thirty years, implying that trade exerts a larger influence on volatility over time.