Flexibility of Adjustment to Shocks: Economic Growth and Volatility of Middle-Income Countries Before and After the Global Financial Crisis of 2008

ABSTRACT

Our analysis shows that the associations of growth level, growth volatility, shocks, institutions, and macroeconomic fundamentals have changed in important ways after the 2008 global financial crisis. Economic growth across countries has become more dependent on external factors, including global growth, global oil prices, and global financial volatility. After accounting for the effects global shocks, we find that several factors facilitate adjustment to shocks in middle-income countries. Educational attainment, share of manufacturing output in gross domestic product, and exchange rate stability increase the level of economic growth; although, exchange rate flexibility, education attainment, and lack of political polarization reduce the volatility of economic growth.

KEY WORDS:

• growth
• institutions
• middle-income
• shocks
• volatility

Acknowledgments

Donghyun Park provided overall guidance for the article. Ilkin Huseynov provided able assistance with the data. Akiko Terada-Hagiwara and participants at the Asian Development Bank Workshop on Transcending the Middle-Income Challenge provided useful comments and suggestions. Any errors are ours. The views expressed herein are those of the authors and do not necessarily reflect the views of their respective institutions.

Notes

^1. Ramey and Ramey (1995) failed to detect a negative association of macro volatility to investment. Aizenman and Marion (1999) noted that Ramey and Ramey (1995) reflect their focus on aggregate investment, but there is a robust negative association of macro volatility and private investment.

^2. These results are in sharp contrast to Lucas (1987), who showed, in a calibrated model, that the cost of business cycle volatility is of second-order magnitude. Lucas’ results reflected his presumption that the economic growth is independent from business cycle volatility, a presumption that is not supported by the data.