Export instability and economic growth in asian developing countries

VIETNAMESE- DUTCH PROJECT FOR M.A. PROGRAMME IN
DEVELOPMENT ECONOMICS

EXPORT INSTABILITY AND ECONOMIC GROWTH
IN ASIAN DEVELOPING COUNTRIES

TONG MINH TUAN
September 2003


CERTIFICATE
I certify that the substance of this dissertation has not already been submitted
for any degree and is not being currently submitted for any other degree.
I certify that to the best of my knowledge, any help received in preparing this
dissertation, and all sources used, have been acknowledged in this
dissertation.

Tong Minh Tuan
Date: September 91h, 2003

ii


ACKNOWLEDGEMENT
This thesis IS done under the Vietnamese-Dutch Project for Development
Economics. The author would like to thank the Netherlands for her Aid and
Scholarship.
A lot of praise goes to Dr Gabrielle Berman and Dr. Youdi Schipper for their
comments for my thesis. I also would like to thank Dr. Haroon Akram-Lodhi and
Dr. Karel Jansen for their worthy academic teaching and methodology in doing
thesis.

Many thanks are also given to all project teachers and staff in HoChiMinh city,
especially Mr. Tran Vo Hung Son, Michael Palmer, Ms. Nguyet, Ms. Chi and Ms
Dieu for their helping during the time I studied at the project.
I am deeply indebted to my supervisor, Dr. Nguyen Khac Minh, who gave me
instructions and comments during the writing of this thesis. I also thank to Dr. Vu
Thieu for his help in providing me a good source of references from VietnameseDutch Project library in Hanoi.
I have benefited from the discussions with many people and friends, especially my
best friends Mr. Nguyen Xuan Nam, Dang Tai An Trang, who gave me many
supports in doing the thesis. I also would like to thank to World Bank's staffs, who
helped me in searching and collecting necessary documents in WB library in Hanoi.
Finally, I wish to express my gratitude and my love to my dad and mum for their
spiritual encouragement and material support, they encourage me very much
whenever I have difficulties in doing thesis.

iii

a


ABSTRACT
EXPORT INSTABILITY AND ECONOMIC GROWTH IN
ASIAN DEVELOPING COUNTRIES

TONG MINH TUAN
HCM Economic University ·
September 2002

In this study, we look at the relationship between export stability and
economic growth in Asian developing countries using panel data analysis. The
database includes annual data for seventeen Asian developing countries over

the 1986- 2000 period. In theory, this effect is ambiguous, and it is thought
that there are no unique and systematic relationships in the causes or effects of
export instability. Our result found in the case of Asian developing countries
is that there is a negative effect of real export instability on the growth.
Specifically studying in composition of export commodity give us the
conclusion that the biggest negative impact falls on countries which export
manufacturing products and are relatively heavily concentrated in capitalintensive sectors, rather than on countries which mainly export primary
products. The impact of export instability on Investment is also examined, and
found negative but ambiguous. This result will bring some supports for the
hypothesis that the negative effect of instability mainly works through
reducing the export productivity of capital stock, rather than the level of
investment.

iv


TABLE OF CONTENTS
CHAPTER 1:

INTRODUCTION .................................................................. !

1.1 PROBLEM STATEMENT .......................................................................... 1
1.2 SCOPE OF THE THESIS AND LIMITATION .......................................... 3
1.3 OBJECTIVES OF THE STUDY ................................................................. 4
1.4 METHODOLOGY AND DATA COLLECTION ....................................... 5
1.5 THE STRUCTURE OF THE THESIS ........................................................ 6

CHAPTER 2:

LITERATURE REVIEW ...................................................... 7

2.1 THEORETICAL BACKGROUND OF EXPORT INSTABILITY ............ 8
2.1.1

EFFECTS OF EXPORT ON ECONOMIC GROWTH ................................... 8
2.1.1.1

Export is one of the sources of economic growth ........................... 8

2.1.1.2

Effects of Primary and manufactured export in Developing
countries ........................................................................................ 10

2.1.1.3

Empirical studies ........................................................................... 12

2.1.2 THE ECONOMIC CONSEQUENCES OF EXPORT INSTABILITY IN
DEVELOPING COUNTRIES ........................................................................ 12
2.1.2.1

Macroeconomic consequences ofExport earnings instability ...... 14

2.1.2.2

Micro consequences of Export earnings instability ...................... 22

2.2 EMPIRICAL ANALYSIS ......................................................................... 25

CHAPTER 3:
3.1

MODEL SPECIFICATION AND DATA BASE .............. 29

SOME SELECTED MODELS .............................................................. 30
3.1.1

FOSU MODEL ............................................................................................... 30

3.1.2 OZLER MODEL ............................................................................................. 32

v


3.1.3 JAME LOVE AND SINHA'S MEASUREMENT OF INSTABILITY ......... 33

3.2 MODEL SPECIFICATION ....................................................................... 35
3.2.1 INDEX OF EXPORT INSTABILITY ............................................................ 35
3.2.2 MODELING ................................................................................................... 35

3.3 DATA DESCRIPTION .............................................................................. 39

CHAPTER 4:

THE EMPIRICAL RESULTS ............................................ 43

4.2 DESCRIPTIVE ANALYSIS ..................................................................... 43

4.2 THE ESTIMATED RESULTS OF THE MODEL .................................... 47

4.3.1 EXPORT INSTABILITY AND GDP GROWTH ......................................... .47
4.3.2. EXPORT INSTABILITY AND INVESTMENT ........................................... 51

CHAPTER 5: CONCLUSIONS ........................... ~ .......................................... 54

vi


LIST OF TABLES

TABLE 1. SUMMARY OF THE EFFECTS OF VARIABLES IN THE MODELS .................. 37
TABLE 2. SUMMARY STATISTICS OF REGRESSION VARIABLES .............................. 44
TABLE 3. CORRELATION COEFFICIENTS OF REGRESSION VARIABLES, 249
OBSERVATION ........................................................................................ 45
TABLE 3. REGRESSION RESULTS: THE IMPACT OF EXPORT INSTABILITY ON
GROWTH - SPECIFICATION 1 .............................................................. :.. 48
TABLE 4. REGRESSION RESULTS: THE IMPACT OF EXPORT INSTABILITY ON
GROWTH - SPECIFICATION 2 ................................................................. 50
TABLE 5. REGRESSION RESULTS: THE IMPACT OF EXPORT INSTABILITY ON
INVESTMENT- SPECIFICATION 1 ........................................................... 51
TABLE 6. REGRESSION RESULTS: THE IMPACT OF EXPORT INSTABILITY ON
INVESTMENT- SPECIFICATION 2 ........................................................... 52

. LIST OF FIGURE
FIGURE 1. .......... PLOTS OF SOME PAIRS OF VARIABLES APPEAR IN A SCATTERPLOT
MATRIX .................................................................................................. 46

vii

Chapter 1: INTRODUCTION
1.1

Problem statement

The issue of export instability m developing countries and less-developed
countries has· always been a great field for theoretical and empirical studies.
Recent events have put the problem of export instability in an important
concern. Some economists even consider instability as a major item affecting
growth in several countries. In the past two decades, many development
economists have been concerned about the negative effect that instability in
export may have on the growth of developing countries (Koomsup, 1978). The
sudden change of oil prices by the OPEC countries in 1973-74 causing balance
of payments difficulties in most non-oil producing countries was an example.
Hence the issue of export instability has increased its important in international
forums such as UNCT AD IV and the Conference of International Economic
Cooperation (Koomsup, 1978:5).
A major concern of developing countries is the problem of instability in their
export of products (Begg, 1991 ). Many countries in Asia are developing
countries, in which Vietnam is one. It is often said that export instability in
developing countries is more severe than in developed countries, because many
developing countries are usually exporters of primary products which are
traded in a very volatile and unpredictable world market (Massell, 1964).
Primary products also have a tendency to decline in term of international price
with increasing fluctuation in price over time (Begg, 1991 :636). Whether
export instability has a negative effect on development in these developing
countries? In addition, some countries have achieved high average ratio of
export

over

GDP

(Malaysia( 57%),

Thailand(25%),

HongKong(111 %),

Korea(30%) in 1970-1994) (Ba,1996). So instability in export may lead to
instability in GDP, and thus, in GDP growth in these countries. James
Love(1992) undertook his study on export instability in developing countries
and his conclusion was that Export instability increased between two periods of


1960-1971 and 1972-1984. Whether such mcrease m Export instability
deteriorates GDP growth in these countries?
Because Vietnam is one of Asian developing countries which export lots of
primary products, then what would be drawn for these countries in studying of
export instability could also be useful for Vietnam. Furthermore, the adverse
effects of export instability may be worse than for Vietnam than a developed
economy since like a developing country, Vietnam lacks necessary tools and
ability to deal the problem effectively. If the damage of instability could be
easily recognized in Asian developing countries as well as in Vietnam,
governments can reduce or eliminate the problem by doing something such as
diversifying their export commodities, or reducing their dependence on a few
markets. Some developing countries can also reduce the adverse effects of
export instability on key economic variables by separating domestic price from
fluctuations in world prices. Recently Vietnamese government has followed a
strategy of export-oriented in order to achieve the high economic growth rate

like some successful NICs,(Ba, 1996), so this makes export play a more
important role in developing the economy. Hence there is a need to know what
the relationship between export instability and economic growth is.
Export instability creates the uncertainty about the export eaming, and
according to Keynes (1938), it has a negative impact on investment decisions
and technological improvements. On the contrary, Friedman (1954) say that
Export instability may lead to a decline in consumption and then, an increase in
savings, thus economic growth may be higher. Previous empirical studies so far
also give different results: some studies find a positive relationship between
export instability and economic growth, some other studies find a negative
relationship between export instability and economic growth while some other
studies find no relationship between export instability and economic growth
(Sinha, 1999). While there is no consensus in generally finding of export
instability effects on economic growth, it is therefore interesting to study this
issue in Asian developing countries. The result obtained for Asian developing

2


countries will help us to know (i) first: what is the relationship between export
instability and economic growth in countries which export lots of primary
commodities like Asian developing countries, (ii) if is found that export
instability does have a negative impact on economic growth, so we will know
the significance of export, and the government has to follow a policy whereby
such fluctuations can be smoothed out, (iii) which theoretical school is
appropriate for the case of Asian developing countries. Therefore beside all of
empirical studies listed above we need more research to know exactly the
relationship in Vietnam and Asian developing countries.
1.2

Scope of the thesis and limitation

Empirical studies have also checked the existence of a negative relationship
between export instability and economic growth, and some have provided
support for a positive relationship. Almost all previous studies have used a
cross-countries approach alone, though in some studies researchers have relied
on time-series approach. In this study we use an instability index that varies
over time as well as across countries. We then investigate the impact of export
instability on GDP growth by employing annual data for seventeen Asian
developing countries over the period 1986- 2000. This research will focus on
Asian developing countries and estimate over period of 1986-2000 to conclude
that there is a negative effect which is sufficiently large for export instability to
be a serious problem for developing countries.
Our study will then rely on panel data of 17 developing countries over the most
recent period of 1986-2000. The study uses mostly secondary data collected
from Word Bank or IMF statistics. On general problem with cross-country
appro11ch is that it estimates average relationship and does not provide much
information on

th~

specific countries. The result of the study, therefore, will

give only the general and common relationship which can be apply for Asian
developing countries instead of a specific relationship in a given country like
Vietnam. It may be a limitation of this study. However, it is reason to believe
that the conclusions drawn in our study may provide general guidelines of

3

some use in development planning by generating a better understanding of
certain fundamental economic relationship. Furthermore it is still necessary to
study because export performance of Vietnam is rather similar to those of some
Asian developing countries in the early period (Ba,1996).
1.3

Objectives of the study

It is the relationship between export instability and economic growth in Asian

developing countries that this study seeks to examine. The purpose for this is to
know and compare the result from the case of Asian developing countries to
that of other countries. The research on Asian developing countries is
particularly interesting because there have been considerable primary products
in export of these countries
The results from previous studies on export instability and economic growth
are so far conflicting. They are different from study to study. Glezakos (1973)
conclude that instabilities in export earnings are harmful to growth and income
when studying in LDC's, but MacBean (1966), Coppock (1977) and Knudsen
& Pams (1975) do not find any empirical evidence that there is a significant

relation between export instability and such economic variables as investment,
national income, and economic growth rate. Moran (1983) uses cross-section
data for 30 countries (18 of them in Lantin America) to study the relationship
between export fluctuation and economic growth. Using several measures of
export instability, he finds that the results are very sensitive and no general
conclusions can be reached
Hence, while there are no homogenous conclusion m prevtous empirical
studies, our research will study the characteristics of expmi m Asian

developing countries, by investigating the relationship between export
instability and economic growth in Asian developing countries.

4


Our research needs to answer the following important question:
Research question:

1. What is the relationship between the percentage of absolute value of the
deviations of actual export earning from five-year moving average of export
earnings and GDP growth in Asian developing countries in the period of
1986-2000?
2. What is the relationship between the percentage of absolute value of the
deviations of actual export earning from five-year moving average of export
earnings and Capital formation growth in Asian developing countries in the
period of 1986-2000?
In our study we use the percentage of absolute value of the deviations of actual
export earning from jive-year moving average of export earnings as an index to

measure export instability.
Research hypothesis

In many Asian developing countries, export of primary goods has still played
an important role in developing economy in some countries (Berg, 1991).
Instability in price of primary good may lead to volatile export earnings and
fluctuation in GDP growth in these countries. We may expect that export
instability indeed have a negative influence on economic growth. Many
empirical studies in developing countries also bring in this result. So we
formulate following hypotheses:

'An increase in the percentage of absolute value of the deviations of actual
export earning from five-year moving average of export earnings lead to a
decrease in GDP growth in Asian developing countries'.
1.4

Methodology and Data Collection

To find the impact of export instability on growth we first measure export
instability as the percentage deviation of export earnings from its five-year
moving average, so this instability index varies over time for each country. We

5


will investigate the impact of export instability on econom1c m Asian
developing growth by pooling across 17 countries and over time of period
1986-2000. Regression on neoclassical production function will be estimated
with instability as an explanatory variable. The ordinary least square (OLS)
method is a suitable tool for running regressions because we are investigating
the economic growth and its influential factors among which expmi instability
1s one.
The data used for this study are secondary data and come from the International
Financial Statistics of the International Monetary Fund (IMF). All data are
expressed in relative terms to correct for country size. Sample size is about 300
observations obtained from panel data of 20 countries and 16 years (19862000).

1.5

The structure of the thesis

The thesis will consists of five chapters:

Chapter two is concerned with the theoretical framework of instability. The
chapter presents some literature review and empirical studies about expmi
instability. The chapter will discuss about the effects of export, and then export
instability, directly or indirectly impacting on growth. The chapter also reviews
some empirical research finding the relationship between export instability and
economic growth.

Chapter three introduce models and data sources for the research
Chapter four is the main one, which presents the empirical results of model
estimation through descriptive analysis and econometric regression.

Chapter five presents the Conclusion. The chapter concludes by summarizing
the thesis and suggesting some policies that would reduce the harmful effect of
export instability.

6


Chapter 2: LITERATURE REVIEW
The issue of export instability in developing countries and less-developed
countries has always been a fertile ground for theoretical and empirical
investigation (Koomsup, 1978). But what is meant by instability? We will first
make clear some basic concepts involving export instability before presenting
the theoretical and empirical issues.

Definition of instability
The issues of the choice of index raised by researchers relate directly to the
question of defining what is meant by "instability". Many researchers have

focused on separating out trend earnings from deviations around the trend. This
approach regards deviations from trend as comprising instability (Love, 1992).
The trend value here can be viewed as 'normal' or 'anticipated' path of
earnmgs.
James Love(1992) as well as most of researchers regarded 'deviations from
trends' as comprising 'instability'
Coppock ( 1977) argued that instability means "excessive departure from some
normal level", and several authors have found to be more specific about the
definition of the "excessive" components of deviations from "normal".
On a different way, Knudsen and Parnes (1975), based on the Friedman's
hypothesis of permanent income, argued that unforeseen and temporary in
export earnings embrace the concept of uncertainty, thus they comprise
instability. Hence, by adaptation of Friedman's permanent income hypothesis
Knudsen and Parnes define instability as being caused by unforeseen
components in the future.
Although there has been no consensus on definition of instability, the choice of
instability indices based on each definition does not matter. (Love, 1992). A
number of authors such as Coppock, Masse! and Glezakos found that there
were high degrees of correlation among estimates of instability obtained using
different indices. Through some studies of many researchers using different

7


indices in their estimating instability, results often give the same answer (Love,
1992).
In this study, we will use the definition of instability as James Love do:
instability is regarded as "deviation from trend". It is chosen because it was
most widely used by many authors. In addition, we chose this definition in
order to be appropriate with the measure of instability which will be presented

in next chapters.
As a result of this export instability can be considered as determining the
deviation of actual export earning around its trend.

2.1

THEORETICAL BACKGROUND OF EXPORT INSTABILITY

We will first discuss the impact of export on economic growth theoretically
before we can go further. This reason is due to the fact that export has
gradually become an important factor, and people often consider it an input in
neoclassical production function. Today countries in the world are more open,
trading between them then becomes indispensable. Balassa (197), Kreuger
(1993) and Hughes (1990) argued that openness to trade was a crucial source of
East Asia's rapid growth and that government's principle contribution was to
limit protection and ensure that incentives were largely neutral. And in such a
region of open trade, according to the study by World Bank (1993), rapid
export growth played an important role in permitting East Asian economies to
avoid foreign exchange constrains. Therefore the study suggests that exports
and export policies played a crucial role in stimulating growth. It seems to be
reasonable that today export may be seen a new input in ·neoclassical
production function.

2.1.1
2.1.1.1

Effects of Export on economic growth
Export is one of the sources of economic growth

According to Neoclassical trade theory, the two countries can benefit from each

other through International Trade. Because of the opportunity cost, the two
countries will use its resources efficiently by producing and exchanging goods
to which they have relative advantages. Because now each country specializes

8


m its own comparative advantage product, each country can use the most
abundant resources to produce, so they can get higher output and can import
many other goods at relatively lower price. Each country tries to use most of
the abundant resources to make it have comparative advantage (B.erg, 1991). In
free trade both countries can enjoy more goods than they produce and enjoy
without trade. Early many economists studied the gains from trade in the view
of economic growth such as: Adam Smith, Ricardo, and many economists
furthered later such as Balassa, Ram, Gillis. They all agreed about the
significant and positive effects of trade on economic growth (Robert, 1999).
Through studies in development, economists found that economic growth was
caused by following factors: (i) the increase in the factor inputs, (ii) the
increase in the productivity or efficiency. How to increase growth also means
how to increase these factors. Quality of inputs between countries can be
improved by reallocating resources effectively. But the process of reallocating
resources between countries can be taken place through export and import
(Robert, 1999). Productivity can also be increased by greater specialization in
each country. If it is possible to exchange, a country can specialize on
producing commodities to which it has relative advantage. Therefore export,
which also means exchange, has contribution to economic growth (Ba, 1996).
Productivity in each country involves much in the development of its
technologies. But export is a channel for learning and technological
advancement. Export is also an effective means of introducing new
technologies both to the exporting firm in particular and to the rest of the

economy For some new industrializing countries (NICs), exporting of
manufactured goods was very successful and it stimulated much economic
growth through the enhancement of productivity, reallocation of resource,
economics of scale, better specialization (Ba, 1996). Many studies of export
which leads to rapid growth were carried out by Balassa, Feder, Kruger. In the
early 1970's Balassa (1971) and others began exploring the links between trade
and growth. Over the next twenty years, a large number of studies found that

9


export growth and export level were highly

correl~ted

with GNP growth

(Edwards, 1992).
2.1.1.2

Effects ofPrimary and manufactured export in Developing countries

For developing countries, early the export consisted almost entirely of primary
commodities while the share of manufactured exports in total export was very
small (Ba, 1996). From 1970, export expansion has been taken place,
especially at manufactured export. The rapid development of Asian NICs and
ASEAN might be due to their outward-looking and market-oriented economic
policies. The growth rate of expoti was very high for these countries. For
example, in 1982-1983 the average ratio of exports to GDP in NICs and
ASEAN was over 50%, while the ratios of Unites and some other developed

countries were 8%. Developing countries merchandise exports· in 1999,
according to WTO News 2000 Press releases, expanded by 8.5%- about twice
as fast as the global average. Remarkably, the growth of export was increasing
in relation to the growth of income in these countries. It is why we will
examine effects of primary and manufactured export in developing countries
(Ba, 1996).
According to Hecksher-Ohlin, less developed countries can also export to
developed countries. In contrast with Ricardo, who just based his theory on
labor opportunity cost, Hecksher-Ohlin bases on differences in factor
endowments of countries and explains the participation of countries in
international trade (Edward, 1995). By his theory, less developed countries can
exchange their labor-intensive products for capital-intensive products from
developed countries. If a country has relatively abundant supply of the factors
used in a commodity production then it can be said that this country has
comparative advantage in the commodity. Hecscher-Ohlin theory seems to
focus on export from less developed countries to developed countries.
Obviously it expanded the application of comparative advantage theory,
explaining that even a less developed countries can export to developed
countries. Because of it's higher ratio of labor relative to other factor, less
developed or developing country will export goods that use their abundant
10


factors such as labor intensive products and natural resources intensive
products intensively (Edward, 1995).
Although it explains why less developed countries can trade with developed
countries, one of the weaknesses of Hecksher-Ohlin theory is that it deals only
with demand-side factor. The relative prices would not only be depended on
supply side, but also on demand side.
Export affects on growth through productivity gain from technology transfer.

In the global trade, from 1970 to now, the trend of growth rate of manufactured
exports increased much rapidly than that of primary commodity. The
significant demand of manufactured products make them able to be exported
from a developing country to other developing one, and from a developing one
to developed one as well. Export in manufactures has grown fastest between
advanced industrialized countries (Ba, 1996). According to Linder (1961 ), for
countries with similar factor endowments, trade can take place because of
different varieties of products. Raymond Vernon (1966) when discussing about
technology gap argued that some corporations taking advantage of cheaper
labor cost in developing countries might come there to invest and operate. The
kind of this activity is normally known as Foreign Direct Investment (FDI).
Through this the host developing countries can get gains of more productivity
from technology transfer through FDI. NICs and ASEAN countries, for
instance, could attract and absorb relevant technique in export sectors to make
them able to export their products to other developed countries. Therefore, by
gains of foreign capital, foreign technology, foreign skill and foreign
management from FDI in export sectors, domestic economic growth will be
enhanced due to "endogenous technical change" (Karel Jansen, 1995).
Export also affect on growth through investment. When FDI comes to host
country, it will stimulate investment and consumer demand. One of the most
significant contributions of FDI is that it provides capital stock and
technological progress to invest in host country, thus it will enhance domestic
investment (Sundrum, 1994). According to R.M Sundrum (1994), growth of

11


export in domestic country will create more opportunities to invest. He also
found positive relationship between growth of export and growth of investment
in developing countries in the 1960s. Export growth also in other way increases

the efficiency of investment, resulting in a lower incremental capital output
ratio (ICOR). Higher rate of export growth will stimulate investor to upgrade
their techniques in order to compete with the world market.

2.1.1.3

Empirical studies

There are many empirical studies have been conducted to the role of exports in
economic growth. A large number of studies found that expmi growth and
export levels were highly correlated with GNP growth (Edward, 1992). R.M
Sundrum(1994) uses data for 41 less developed countries (LDCs) and runs
regression of the role of export. He found that the relationship between export
growth and economic growth is strong positive. Choong Chee Keong (2003)
studies the case of Malaysia, choosing six variables which according to author
are reasonable affect economic output, and finds that most of the explanatory
variables, including export growth variable, are statistically significant and
have positive coefficients. Robert (1999) examines the case of Japan and
Korea, and finds that lower tariffs and higher import volumes would have been
particularly beneficial for Japan during the period 1964 to 1973. His result also
leads to the conclusion that Japanese export were a particularly impmiant
source of productivity growth, this suggests that further liberalization by Japan
and other ASEAN countries may result in future dynamic gains. Hence, export
expanston is indeed a part of national products that directly adds to GDP
growth.
2.1.2 The Economic consequences of Export instability in Developing
countries
The issue of export instability

The issue of export instability m less developed countries (LDC's) and

developing countries has always been a fertile ground for theoretical and
empirical investigations. Recently, due to some .bad events such as the

12


downward tendency of primary products, the oil shocks which have happened
to export sectors in developing countries, the issue of export instability has
assumed increasing importance in international conferences (Koomsup, 1978).
Export instability, at first glance, seems to be detrimental to the economies of
most LDC's and developing countries because of their primary exports which
are traded in volatile and unpredictable world market. Because it is argued that
export earnings are a major source of income in most LDC's and some
developing countries, export instabilities adversely affect their ability to import
essential capital goods, domestic investment, national income, and government
revenue and expenditure (Ozier, 1988:18). Furthermore, because of lack
appropriate tools in LDC's and developing countries, export instability is
expected to cause more damage in LDC's and developing countries than in
developed countries. Some factors such as the concentration on a small number
of export commodities and export market, the high proportion of primary
products in their export, the low income price elasticity of demand and supply
in export commodities and the small economic size are the causes of export
. instabilities in LDC's (Koomsup, 1978). Today there are two international
organizations which were designed to reduce the adverse impacts of short-term
instabilities in export earnings of LDC's. One of them is IMF organization
which provides necessary financing facilities to compensate for shortfalls in
export earnings for circumstances beyond the control of the country. The other
organization is STABEX, which was set up by European Economic
Community to some LDC's in Africa. Countries in this organization will be
helped to stabilize their earnings by compensating and reimbursing for the

difference between actual export earnings and the average of their export
earnings over the past four years (Koomsup 1978).
While the trend of price of primary products was fluctuated very much, the
price of manufactured was more stable. According o Maizel's calculation, there
exists a decline in term of trade of primary export relative to manufactures
imported during the period of 1980-1991 (Maizel, 1968). And according to
Singer (1991) and Matthias Lutz's (1994) studies, volatility of terms of trade
13


has a significantly negative effect on growth. John Cuddington (1989) studied
for all developing countries, and found that the terms of trade fluctuate
considerably during the period of 1954-1988, so it creates instability in export
earning. Observation suggests that earning instability may severely harm these
countries.
Export instability can affect economic growth through a number of ways.
Theoretically, we will examine the macroeconomic consequences of export
instability, first in the short term by discussing the Dutch Disease framework
and some other analysis, and second its effects on growth in the long term. We
then examine the effects of instability from a microeconomic point of view.

2.1.2.1

Macroeconomic consequences ofExport earnings instability

2.1.2.1.1 Traditional development theories:
International Economic theory argues that developing countries benefit from
specializing in producing primary goods due to their endowment of factors
(Berg, 1991 ). The comparative advantage of this endowment of factors may
promote foreign direct investment flows. But this opinion which implies a high

commodity dependence is criticized by some development economists who
argue that such specialization would lead these countries to be much more
affected by export earning instability (Araujo, 1999). In their view export
instability does have a negative effect on economic development in developing
countries. One of the negative effects is that instability may create the
uncertainty related to the cost of commodity prices unpredictability and may
lead to unforeseen losses and gains. Instability in price will lead to
macroeconomic fluctuations which are normally expressed as the national
income instability and thus may hatm the economic growth (Araujo, 1999).
The traditional economic development theories strengthen the negative effect
of macroeconomic instability. Myrdal (1958) argued that in the short term
export instability could create inflation thus lead to a sluggish downward
reaction of price. As the result of this, fiscal deficit will emerge. Myrdal also
believed that commodity price instability was central in explaining developed

14


country inflation. Hence, there exists a positive correlation between fiscal
deficits and exports instability. In the long term, according to Nurkse (1962),
and particularly, to Keynes (1936), export instability creates uncertainty and
thus it has a negative effect on investment ·decision and technological
improvements. But the concept of "uncertainty" may be difficult to calculate in
scientific meaning.
Keynes dearly saw an important role for uncertainty in his General Theory. He
argued that uncertainty actually has a major economic impact. People want to
store their wealth to be stable returns, and thus they increase their demand for
cash and decrease the demand for investments. But it is just one impact of
uncertainty on investment. The other impact is that in uncertainty environment,
the increased demand for cash leads to higher interest rates and hence people

are driven out of investment into bonds. Thus investment may be deteriorated
further because of uncertainty (Keynes, 1936).
Briefly, Myrdal (1958) and Keynes (1936) emphasized the negative effect of
export instability on factors of development such as inflation and investment.
The restriction of their argument is that Myrdal analyzed this effect of
instability just in the short term, while Keynes argued just for the long tem1. In
addition, in his discussion about instability, Keynes thought that uncertainty is
true where there is no scientific basis to which uncertainty can be calculated
(Araujo, 1999). He said : ".. By uncertain knowledge, I do not mean merely to

distinguish what is known for certain from what is only probable. For example
European war is uncertain, or the price of copper and the rate of interest
twenty years hence ... About these matters there is no scientific basis on which
to form any calculable probability whatever. We simply do not know ... "
(Keynes, 1937). However, few contemporaries agreed with him, and they
nearly clear the distinction between risk and uncertainty. Many economists
argued that uncertainty is economically impotent. It only has effect in
conjunction with some other feature of models. These conc1usions of Keynes

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might be right, but if so they can be justified without reference to Keynesian
uncertainty (Shapiro, 1997).
On the contrary, Friedman (1954) argued that instability could lead to a
reduction in consumption, according to his theory of permanent income. His
hypothesis originates from the basic intuition that individuals would wish to
smooth consumption and not let it fluctuate with short run fluctuations in
income. Friedman argued that individuals base their consumption on a longer
term considering about lifetime wealth or wealth over a reasonably long

horizon. Friedman's hypothesis thus can explain why income, in fact, is more
volatile than consumption and why the long run propensity to consume out of
income is higher than the short run one. In this case the intuition for
precautionary motives for saving may arise. Therefore instability may lead to
an increase in saving rate. Because people worry about their future, they want
to save more to be secure in the future. By increases in savings for precaution,
instability thus can stimulate economic growth (Meghir, 1999).
The ideal of positive effect of instability was also reinforced by Hirschman
(1958). He argued that in the short term, shortcuts in exports earnings would
restrain manufactured import, thus promote domestic production.
Briefly, the permanent income hypothesis has been regarded as the most
important theory on consumption decisions. In Friedman's argument there
might be a positive effect of export instability on economic growth through
further saving. But his argument based completely on his permanent income
hypothesis, which in itself has some limits. The lifetime of a household may
not be infinite while his hypothesis bases on infinitely lived household
assumption. The loose definition of permanent income leaves open the question
of its measurement. On the other hand, the permanent income hypothesis as
stated by Friedman did not take a vety firm view on the appropriate horizon for
consumer choice. Although it provides a flexible framework for the study of
consumption and savings, it is this flexibility that make hard to define the
theoretical basis of the model, and thus its is hard to make more detailed

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statements about policy (Meghir, 1999). Friedman thought that permanent
income which determines people decisions rather than current income, so it is
also his limit. Furthermore saving is just one of factor determining growth.
Besides saving technological progress is also important determining of growth.

In Hirschman's (1958) argument, instability may generate positive benefits
from import substitution strategies on economic growth. But this phenomenon,
in fact, appears to be highly improbable.
2.1. 2.1.2 Recent developments of economic theories on export instability

In this part we will discuss the effects of export earnings instability in the short
term and the long term respectively. In the short term, the discussion stresses
the link between primary export instability and competitiveness, mentioning
The Dutch Disease analysis. In the long term, export instability does have an
impact on economic growth.
Short term effects

a. The Dutch disease
When a small, dependent economy has an unexpected and temporary increase
in primary export earnings, its competitiveness of manufactured goods may be
deteriorated. Therefore, natural resources, contrary to what common sense
would indicate, may be not a blessing for rich endowed countries. This economic
phenomenon is known as the Dutch disease (Wikstrom, 2003).
The name of this phenomenon is obtained from the experience that followed a
sharp rise in Holland's in nature gas exports in 1970 (Davis 1995). The Dutch
manufacturing experienced a loss of competitiveness, particularly for export
sectors, because of appreciated currency due to booming in primary exports. To
explain the Dutch disease, it is important to consider the distortion created by
primary export booming. We can outline some responds from an export boom
in a developing country:
There exists an income effect: Originally, more inflows of foreign currency
cause exchange rate to appreciate.


primary exports boots the national income and domestic demand. Labor

demand increases and then wages, maybe leading to inflation. Thus the
combination of an appreciation of nominal exchange rate and domestic
price inflation result in a rise in the real exchange rate, which reduces the
country's competitiveness.
There exists a resource effect: labor will flow from the traditional tradable
goods, such as manufactured goods and agricultural products, to the nontradable goods, such as construction and services, and to booming sector.
Because while wages increases, it will reduce profits in the traditional
exports sector. In addition, the real exchange rate appreciation tends to
reduce relative prices of tradable goods relative to prices of non-tradable
goods. Therefore, the negative consequences of spending effect is
reinforced by the resource effect, thus the Dutch Disease show a definite deindustrialization effect after the export boom (Davis, 1995).
Export of manufactured commodity decline and import mcreases. The
increase in imports and the decline in manufactured exports are often
adjusted by Govemment, with imposing import restrictions and subsidizing
exports. Hut it will create more distotiions by attracting investment to highcost production. Higher manufactured goods prices deteriorate agriculture
and further reduce the competitiveness of tradable goods in the expoti
markets (Davis, 1995).
Briefly, the Dutch Disease theory was originally used to describe the negative
effect of natural gas discoveries on Dutch manufacturing in the 1960s. Hence,
it has been also applied to other countries and other periods of time to explain
the negative effects on country's competitiveness. But it still contains some
limitations: it only concems a temporary increase in expoti eamings, in the
short term. In addition, the mechanism that explain the adverse effect on
manufacturing have not been clear when the model is applied to empirical
cases. Corden (1984) states that the true Dutch Disease in the Netherlands was
not the adverse effects on manufacturing of real appreciation but rather the use

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