WP 1q9L POLICY RESEARCH WORKING PAPER 1948 C omp arativ e Advantage Business cycles are different in rich and poor countries - and the Cross-Section of because the industries in Business Cycls 1which each group of Business Cycles . countries specialize respond differently to domestic and Aart Kraay foreign shocks. Jaume Ventura The World Bank Development Research Department Macroeconomics and Growth H July 1998 POLIcy RESEARCH WORKING PAPER 1948 Summary findings Business cycles are less volatile in rich countries than in different countries specialize. Kraay and Ventura focus poor ones. They are also more synchronized with the on two such asymmetries. world cycle. Kraay and Ventura develop two alternative The first, which they label the "competition bias" but noncompeting explanations for those facts. hypothesis, is based on the idea that cross-country Both explanations proceed from the observation that differences in production costs are more prevalent in the law of comparative advantage causes rich and poor high-tech industries, sheltering producers from foreign countries to specialize in the production of different conmpetition and therefore making them large suppliers commodities. In particular, rich countries specialize in in the markets for their products. high-tech products produced by skilled workers and poor The second, which they label the "cyclical bias" countries specialize in low-tech products produced by hypothesis, is based on the idea that production costs in unskilled workers. low-tech industries may be more sensitive to the shocks Cross-country differences in business cycles then arise that drive business cycles. as a result of asymmetries among the industries in which This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to study open-economy macroeconomics. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Aart Kraay, room MC3-369, telephone 202-473-5756, fax 202-522-3518, Internet address akraay@worldbank.org. July 1998. (45 pages) 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 autbors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Produced by the Policy Research Dissemination Center Comparative Advantage and the Cross-section of Business Cycles Aart Kraay Jaume Ventura The World Bank M.I.T. Comments are welcome at akraay@worldbank.org (Kraay) and jaume@mit.edu (Ventura). Business cycles are different in rich and poor countries. In the top panel of Figure 1, we have plotted the standard deviation of per capita GDP growth against the log-level of per capita income for a large sample of countries. We refer to this relationship as the Volatility Graph and note that it is downward-sloping, meaning that fluctuations in per capita income growth are smaller in rich countries than in poor ones. In the bottom panel of Figure 1, we have plotted the correlation of per capita income growth rates with world average per capita income growth (excluding the country in question) against the log-level of per capita income for the same set of countries. We refer to this relationship as the Comovement Graph and note that it is upward-sloping, meaning that fluctuations in per capita income growth are more synchronized with the world cycle in rich countries than in poor ones. Table 1, which is self-explanatory, shows that these facts are quite robust. ' Here we develop two alternative but non-competing explanations for these facts. Both explanations rely on the notion that the law of comparative advantage causes rich countries to specialize in "high-tech" industries that require sophisticated technologies operated by skilled workers, while poor countries specialize in "low- tech" industries that require traditional technologies operated by unskilled workers. This pattem of specialization opens up the possibility that cross-country differences in business cycles are due to asymmetries between high-tech and low-tech industries. For instance, assume that production in high-tech industries is more sensitive to foreign shocks and less sensitive to domestic shocks than in low-tech ones. It follows immediately that production in high-tech industries, and therefore in rich countries, would be more synchronized with the world cycle than in low-tech ones. Moreover, to the extent that foreign shocks are an average of the domestic shocks of many other countries, it is reasonable to expect that foreign shocks are less volatile than domestic shocks. As a result, production in high-tech industries, and therefore in rich countries, would also be less volatile than in low-tech ones. ' Acemoglu and Zilibotti (1997) also present the Volatility graph. We are unaware of any previous reference to the Comovement graph. 1 One explanation of why industries react differently to shocks is based on the idea that producers in high-tech industries enjoy more market power than producers in low-tech industries. We refer to this asymmetry among industries as the "competition bias" hypothesis. This bias would occur, for instance, if differences in production costs among firms are more prevalent in high-tech industries. These cost differences shelter technological leaders from their competitors and make them large suppliers in international markets. This competition bias has implications for how industries react to domestic and foreign shocks. Consider the effects of a favourable domestic shock that reduces unit costs in all industries. Since producers in high-tech industries are large suppliers in international markets, increases in their production lower prices, moderating the effects of the shock. Since producers in low-tech industries are small suppliers in world markets, increases in their production have little or no effect on their prices. To the extent that the competition bias is important, one would therefore expect that high-tech industries are less sensitive to domestic shocks than low-tech industries. Consider next the effects of a foreign shock that raises production and income abroad and, as a result, increases demand in all industries. Since producers in high-tech industries are large suppliers in international markets, this shock is translated into a large shift in their industry demand which leads to large increases in production and prices. Since producers in low-tech industries are small suppliers in international markets, this shock has a negligible effect on their industry demand as most of the increase in world demand is met by increases in production abroad. To the extent that the competition bias is important, one would therefore expect that high-tech industries are more sensitive to foreign shocks than low-tech industries. Another explanation for why industries react differently to shocks is based on the idea that unit costs in low-tech industries might be more sensitive to the shocks that drive business cycles than in high-tech industries. We refer to this asymmetry among industries as the "cyclical bias" hypothesis. If business cycles are driven by productivity shocks, this bias would occur if industry productivity is more volatile in low-tech industries. If business cycles are driven by monetary shocks, this bias might 2 arise if cash-in-advance constraints are more prevalent for firms in low-tech industries. This cyclical bias also has implications for how industries react to domestic and foreign shocks. Almost by assumption, the cyclical bias implies that favourable domestic shocks reduce unit costs in low-tech industries more than in high-tech industries, leading to larger increases in production in the former than in the latter. This is how the cyclical bias explains why high-tech industries are less sensitive to domestic shocks than low-tech industries. Less obviously, the cyclical bias also implies that high-tech industries are more sensitive to foreign shocks than low-tech industries. To see this, consider the effects of a favourable shock that raises production and income abroad. The cyclical bias implies that worldwide production of low-tech products increases relative to that of high-tech products, raising the relative price of high-tech products. From the perspective of the domestic economy, this constitutes a favourable shock for producers of high-tech products and an adverse one for low-tech producers. As a result, high-tech industries are more sensitive to foreign shocks than low-tech industries. To analyze these issues we construct a stylized world equilibrium model of the cross-section of business cycles. Inspired by the work of Davis (1995), we consider a world in which differences in both factor endowments a la Heckscher- Ohlin and industry technologies a la Ricardo combine to determine a country's comparative advantage and, therefore, the patterns of specialization and trade. We subject this world economy to both the sort of productivity fluctuations that have been emphasized by Kydland and Prescott (1982), and also to monetary shocks that have real effects since firms face cash-in-advance constraints. We then characterize the cross-section of business cycles and find conditions under which the competition and cyclical biases can be used to explain the evidence in Figure 1. The model is simple enough that we obtain closed-form solutions for all the expressions of interest. We also find that our results hold even in the presence of trade frictions, modelled here as "iceberg" transport costs, provided that these frictions are not so large as to alter the pattem of trade. Also, we find that reductions in transport costs 3 (globalization?) magnify cross-country differences in business cycles. Finally, we show that the two hypotheses under consideration have different implications for the cyclical properties of the terms of trade. In principle, these properties can be used to distinguish between the two hypotheses. In practice, however, a first look at the data yields conflicting evidence. The research presented here is related to the large literature on open- economy real business cycle models, surveyed by Backus, Kehoe and Kydland (1995) and Baxter (1995), that explores how productivity shocks are transmitted across countries. Our work also relates to recent work by Obsffeld and Rogoff (1995, 1998) and Corsetti and Pesenti (1998) that analyzes the international transmission of monetary shocks. We differ from these lines of research in two ways. Instead of emphasizing the aspects in which business cycles are similar across countries, we focus on those aspects in which they are different. Instead of focusing primarily on the implications of international lending, risk-sharing and factor movements for the transmission of business cycles, we emphasize the role of commodity trade. 2 The paper is organized as follows. Section 1 develops the basic model. Section 2 explores the properties of a cross-section of business cycles in the basic model. Section 3 extends the model by introducing money. Section 4 further extends the model by introducing transport costs. Section 5 examines some implications of the model for cyclical properties of the terms of trade. Section 6 concludes. 2 Previous literature on business cycles in open economies typically assumes that either (a) there is a single commodity, so that there is no commodity trade whatsoever, or (b) that countries are completely specialized in the production of differentiated products. Whether such models provide a good description of observed trade pattems has not been a major concem for this literature. In contrast, the model presented here is empirically consistent with the main features of observed trade patterns: (a) a large volume of trade among rich countries in products with similar factor intensity (intraindustry trade); (b) substantial trade among rich and poor countries in products with different factor intensities (interindustry trade); and (c) little trade among poor countries. 4 1. A Simple Model of Trade and Business Cycles We consider a world with a continuum of countries with mass one; two industries, which we refer to as the a- and 1-industries; and two factors of production, skilled and unskilled workers. Countries differ in their technologies, their endowments of skilled and unskilled workers and their level of productivity. In particular, each country is defined by a triplet (g,8,7r), where ,u is a measure of how advanced the technology of the country is, 8 is the fraction of the population that is skilled, and rc is an index of productivity. We assume that workers cannot migrate and that cross-country differences in technology are stable, so that ,u and 8 are constant. We generate business cycles by allowing the productivity index r to fluctuate randomly. The a- and 13-industries each contain a continuum of differentiated products of measure one which can be traded at zero cost. Firms in the a-industry use sophisticated technologies that require skilled labour, while firms in the 3-industry use traditional technologies that can be operated by both skilled and unskilled workers. Not surprisingly, we shall find that rich countres that have better technologies and a high proportion of skilled workers export mainly a-products, while poor countries that have worse technologies and a high proportion of unskilled workers export mainly ,B-products. To emphasize the role of commodity trade, we rule out trade in financial instruments. To simplify the problem further, we also rule out investment. Jointly, these assumptions imply that countries do not save. 3 The model presented here is related to Kraay and Ventura (1997). 5 Preferences Each country is populated by a continuum of consumers who differ in their level of skills and their personal opportunity cost of work, or reservation wage. We index consumers by iE [1/y,oe) and assume that this index is distributed according to this Pareto distribution: P(i) = 1- (y i)-, with X>O, y>O. A consumer with index i maximizes the following expected utility: E|U({[a( )] .[10 - ] (i) .t .dt (1) where U(.) is any well-behaved function; I(i) is an indicator function that takes value 1 if the consumer works and 0 otherwise; and c (l) and c,(i) are the following consumption indices of a- and g-products: 1 6-1 @-1 -1 1 -0-1 c [c (i) = fccz,i)6 dz c,() = |cO(zji)e* dz (2) where c.(z,i) and c,(z,i) are consumer i's consumption of variety z of the a- and J- industries, respectively. The elasticity of substitution between industries is one, while the elasticity of substitution between any two varieties within an industry is 0, with 0>1. The solution to the consumer's problem is quite straighfforward. Consumers spend a fraction v of their income on a-products and a fraction 1-v on ,-products. Moreover, the ratio of spending on any two a-products z and z' is given by F( p(z) 1i8 pPa( () j ; and the ratio of spending on any two 13-products z and z' is 6 p[(z') J , where p.(z) and p,(z) denote the price of variety z of the a- and ,B- products, respectively. Finally, consumers work if and only if the applicable wage (skilled or unskilled) exceeds a reservation wage of i '. We express all prices in terms of the ideal consumer price index, i.e. v 1-v &fPo ((Z)1e .dzl (Z)be *dzl = 1. Let r(I,8,7t) and w(p4A,7r) be the wages of skilled and unskilled workers in a (g.,8,nc)-country. Also, define s(V,8,2r) and u(g.,8,n) to be the measure of skilled and unskilled workers that are employed. Under the assumption that the distribution of skills and reservation wages are independent, we have that S= Y (3) (Y ) Equations (3)-(4) show that the fraction of skilled and unskilled workers that are x (N. employed are (-) and , respectively. If the wage of any type of worker reaches y, the entire labour force of that type is employed and the labour supply for that type of workers becomes vertical. Throughout, we shall assume that y is large enough so that this never happens. Finally, we note that the wage-elasticity of the labour supplies, A, is the same for both types of workers since it only depends on the dispersion of reservation wages. 7 Firms and Technology The a-industry uses sophisticated production processes that are not available to all countries and that require skilled workers. Let e .a * dz (sX>O) be the "best-practice" unit labour requirements to produce one unit of a given small set of a-products of measure dz. Let (1 + 'I) * e-6axff * dz (rn>Q) be the "second-best' technology available to produce one unit of a given small set of a-products of measure dz. Let ,u be the measure of a-products in which a firm located in a (p.,8,)- country owns the best-practice technology. We can interpret ,u a natural indicator of how advanced the technology of a country is. Assume further that the set of a- products in which two or more firms share best-practice technology has measure i 1 zero. Jointly, these assumptions imply that 1 = f J *. dF(1i,8), where F(p.,8) is the 00 time-invariant joint distribution function of ,u and 8. We shall assume throughout that ',n is large enough so that the firms that have the best-practice technology are 'de facto' monopolists in the market for their products. Therefore, their optimal pricing policy is to set a markup over their unit cost. Symmetry ensures that that all firms in the a-industry of a (g,8,it)-country set the same price, p.(g,8,i): 0() P. = a. r. e-E (5) 0 -i The n-industry uses traditional technologies that are available in all countries and can be operated by both skilled and unskilled workers. In particular, e a = . dz (s=>O) workers of any kind are required to produce one unit of a given small set of 3- products of measure dz. Since all firms have access to the same technologies, the 3-industry is competitive and prices are equal to costs. We shall assume throughout that in equilibrium skilled wages are high enough that only unskilled workers produce 8 3-products.' Symmetry ensures that all firms in the 3-industry of a (g,8,3r)-country set the same price, p(g,,7r): po = w e (6) Two features of this representation of technology play an important role throughout the paper. First, the elasticity of substitution among varieties 0 regulates the extent to which the competition bias is important. If 0 is low (high), a-products are perceived as different (similar) by consumers and, as a result, firms in the a- industry face weak (strong) competition from producers of other varieties of a- products. As 0-4o, the degree of competition in the a-industry increases and the competition bias disappears. Second, the parameters Ea and s5 regulate the importance of the cyclical bias. If e.p), unit costs in the n-industry (a- industry) are more sensitive to fluctuations in productivity. As e, the cyclical bias disappears. Productivity Fluctuations We generate business cycles by assuming that the productivity index fluctuates randomly. In particular, we assume that ic consists of the sum of a global component, rl, and a country-specific component, 7r-I. We assume that the global and country-specific components are independent, and moreover that the country- specific components are independent across countries. Both the global and country-specific components of productivity are reflected Brownian motions on the interval with zero drift and instantaneous variances aCdt and (1 -a).dt respectively, where 7E is a positive constant and 0< cy<1 . These assumptions imply 4This is the case K the share of spending on a-products not too small, i.e. v>>O. 9 that the productivity index ir follows a Brownian motion with zero drift and unit variance reflected on the interval [nI' - 2l + 2]. This interval itself fluctuates over time as the global component of productivity changes. Finally, it is a well-known result of the theory of reflected Brownian motion that the invariant distributions of the global and country-specific components of productivity, G( n) and G(2-fI), are uniform on the interval [- 2 ' 2 We assume that the initial cross-sectional distribution of the country-specific component of productivity is equal to the invariant distribution and hence does not change over time. From the perspective of a (g,8,7t)-country, we can refer to changes in 7 and ri as as domestic and foreign productivity shocks. It is straighfforward to show that the instantaneous correlation between these shocks is V_G.8 That is, the parameter a regulates the extent to which the variation in domestic productivity is due to the global or country-specific components, i.e. whether it comes from d Fl or d(ir-11). Figure 2 shows possible sample paths of 7t under three different assumptions regarding a. In the first panel, we assume that a=Q, so that rI is constant and all the variation in 7i is country-specific. The second panel shows the case in which a=1. Then, dnr=drl and all the variation in 7 is global, i.e. changes in it are perfectly correlated with changes in global productivity, rI. The third panel shows the case in which O, high productivity is associated with high (low) relative prices for a-products as the world supply of 1-products is high (low) relative to that of a-products. As a

v import them. As a share of income, these exports and imports are v-x and x-v, respectively. This kind of trade is usually referred to as interindustry trade or factor-proportions trade. As a result, the model captures in a stylized manner three broad empirical regularities regarding the patterns of trade: (a) 8 n particular, iv * X = . 1 JfJ(-o)e *dl=(p, 8) * dG(iT - rl) . I1-cv c 00 To derive Equation (8), we equate the ratio of spending in both industries to the ratio of worldwide production of both industries and then use Equations (3)-(7) to solve for p. 12 a large volume of intraindustry trade among rich countries, (b) substantial inter- industry trade between rich and poor countries, and (c) little trade among poor countries. 13 2. The Cross-section of Business Cycles In the world economy described in the previous section, countries are subject to two kinds of shocks. On the one hand, domestic productivity shocks shift industry supplies. On the other hand, foreign productivity shocks shift industry demands. In the presence of the competition bias or the cyclical bias, these shocks have different effects in high-tech and low-tech industries. As a result, the aggregate response to similar shocks differs across economies with different industrial structures. In other words, the properties of the business cycles that countries experience depend on the determinants of their industral structure, that is, on their factor endowments and technology. Domestic and Foreign Shocks as a Source of Business Cycles The (demeaned) growth rate of income in a (gi,8,n)-country can be written as a linear combination of domestic and foreign shocks: 9 dIny - E[dIny] = 4r * dn + dtr * dll (10) The functions Q,(18,it) and t.(18,7r) measure the sensitivity of a country's growth rate to domestic and foreign shocks, and are given by: in = ( + A) - [X - a 1B + (1 - x) eco (1 1 ) =(1+x) -X a +(x-V) (Ea-e)P (12) 9To see this, apply Ito's lemma to the definition of income and use the expressions for equilibrium factor prices and supplies in Equations (3)-(9). 14 Equations (1 0)-(1 2) provide a complete characterization of the business cycles experienced by a (t,S,r)-country. Moreover, they show how business cycles differ across countries, since the sensitivity of growth rates to domestic and foreign shocks depends on the share in production of high-tech products, x. Finally, we note the detrended growth rate of world average income, Y, is given by dinY -E[dInY] = or - drl (13) where the sensitivity of the world growth rate to innovations in the global component of productivity is given by: xn = (1+X).(v*a +(1-v) P) (14) Let V(g,8,n) denote the standard deviation of the growth rate of a ( g,8,7r)- country, and let C(p.,8,nr) denote the correlation of its growth rate with wodd average income growth. These are the theoretical analogs to the Volatility and Comovement graphs in Figure 1. Using Equations (1 0)-(1 4) and the properties of the shocks, we defive the following result: 10 ' The proof is simple, since we have closed-form solutions for both the volatility and comovement statistics: V=4 (1-o).2+a (41 + H)2 andC= ( ) . Since 4,+4. 1(1 - a), 2 + a. (4 + ir)2 does not depend on x, V (C) will be downward (upward) sloping if and only if E, is decreasing in x. The proposition describes the sign of 7c for different parameter values. 15 PROPOSITION 1: The functions C and V depend, at most, on x. Moreover: (i) If E{= = =a *O- then TX = ax = 0 for all x; (ii) If E >Ea 00 x then a <0 and -C >0 for all x; and 0 + ), ax ~ ax (iii) If sp < a * then V>0 -and C< oforallx. O+X ax ax This is the first of a series of results that relate a country's industrial structure, as measured by x, to the properties of its business cycles. Proposition 1 says that the theoretical Volatility and Comovement graphs have the same slopes as their empirical counterparts if the competition bias (low 0) and/or the cyclical bias (e5>Qa) are strong enough. Equations (11)-(1 2) show that this same parameter restriction implies that rich countries are less sensitive to domestic shocks (i.e. ,, is decreasing with x), but more sensitive to foreign shocks (i.e. ; is increasing with x). In the remainder of this section we provide intuition for this result. Why Are Rich Countries Less Sensitive To Domestic Shocks? Domestic shocks shift industry supplies. When these shocks are positive, they raise production, wages and employment in both industries. When negative, they lower production, wages and employment. However, to the extent that the competition bias and the cyclical bias are important, these effects are larger in the 1- industry than the a-industry. It is useful to start with a benchmark case in which 0-oo and so that neither the competition bias nor the cyclical bias are present. A favourable productivity shock results in an increase in productivity of magnitude C*dn in both industries, and has two familiar effects. Holding constant employment, increased productivity directly raises production and hence income. This is nothing but the 16 celebrated Solow residual and consists of the sum of the growth rates of productivity of both sectors, weighted by their shares in production, i.e. E.dn. Increased factor productivity also raises the wages of skilled and unskilled workers and, as a result, employment, output and income rse further. This contribution of employment growth to the growth rate of income is measured by Xs-sd7t, and its strength depends on the elasticity of the labour supply to changes in wages, X. Favourable domestic shocks therefore raise growth rates in all countries by the same magnitude, i.e. (1+ X) E-dt. To see how the competition bias determines how a country reacts to domestic shocks, assume that 6 is finite and se=sfi=. As in the benchmark case, favourable domestic shocks raise productivity equally in the a- and ,-industries, raising wages, employment and output. This is captured by the term (1 + X) c-dn as before. However, since the country is large in the markets for its a-products, increases in the supply of a-products are met with reductions in prices that lower production and income. This stabilizing effect of prices is measured by the term -x. (1+ ) ) s dr. The more inelastic is the demand faced by each a-product (the lower is 0) and the larger is the share of the a-industry (the larger is x), the more important is this stabilizing role of prices. Since rich countries have larger a- industries, domestic shocks have smaller effects on their growth rates, i.e. ( ) (~ O+X) To see how the cyclical bias determines how a country responds to domestic shocks, assume that 0--oo and s, the converse will be true. To sum up, in all countries domestic productivity shocks shift outwards the supplies of a- and ,8-products. Since rich countries produce mainly high-tech products, they face inelastic industry demands (i.e. the competition bias) and experience relatively small shifts in supplies (i.e. the cyclical bias). As a result, the effects of domestic shocks on income are small in rich countries. Poor countries, by virtue of producing primarily low-tech products, face elastic industry demands and experience relatively large shifts in supplies. This is why the effects on income of domestic shocks are large in poor countries. Why Are Rich Countries More Sensitive to Foreign Shocks? Foreign shocks shift industry demands. For instance, positive shocks raise production and income in the rest of the world, increasing demand for all products. Whether this leads to an increase in the demand for the domestic industry depends on the extent to which the increase in demand is met by an increase in production abroad. To the extent that the competition bias and the cyclical bias are important, the increase in the demand for the a-industry is always larger than that of the ,B- industry. It is useful to start again with the benchmark case in which neither the competition bias nor the cyclical bias are present, i.e. 0e- and sa=s=s. A favourable foreign shock consists of an increase in average productivity abroad of magnitude *drl in both industries and therefore raises worldwide demand and production of both a- and 1-products. However, it follows from Equation (12) that this has no effect in the domestic economy. The reason is simple and follows from three assumptions. First, the assumption of homothetic preferences ensures that, at given prices, the relative demands for both types of products are unaltered as income grows. Second, 18 the assumption that Sa=S ensures that, at given prices, the relative supplies of both industries are unaltered as productivity grows. Third, our assumption that 0-+o ensures that consumers are very willing to switch their consumption expenditures over different varieties of products. The first two assumptions mean that the increases in the foreign supplies of both industries match exactly the increase in demands for both industries. This is why p does not change (recall Equation (9)). The third assumption means that despite the change in relative supplies of different varieties of a-products, there are no changes in their relative prices. To see how the competition bias affects how a country reacts to foreign shocks, assume that 0 is finite and = It is still true that after a favourable foreign shock the increases in the foreign supplies of both industries match exactly the increase in demands at the industry level. As a result p is not affected. However, since the increase in demand for domestic a-products is not matched by increased production abroad, the price of these varieties increases. This stimulates wages, employment and production in the a-industry. This effect is measured by x (1+X-- . * di, and is larger the more inelastic is the demand faced by each a- product (the lower is 0) and the larger is the share of the a-industry (the larger is x). Since rich countries have larger a-industries, foreign shocks have larger effects on their growth rates. To see how the cyclical bias determines how a country react s to foreign shocks, assume that 0.-* and s,K.. Finally, a straighfforward extension of the arguments in Section 1 can be used to show that Equation (8) is still valid, while Equations (7) and (9) must be replaced by: 14 p. = -P p1-v ) e (17) Equations (1 5)-(18) are natural generalizations of Equations (5), (6), (7) and (9). As the cash-in-advance constraints become less important, i.e. KO-+O and Kp+O, this model converges to the model without money presented in Section 1. 14 The constants X and ir are now given by: x fI+ . f fX dF(p, 8). dG(n -II) dH(K -I) -c-00 00 vI+x e+x v .(,E ( | +|(1) e dF(u, 8). dG(- I) dH(i -I) l-v 2 -c -00 24 Properties of Business Cycles With the addition of interest rate shocks, income growth in the (t,8,it,t)- country is given by this generalization of Equation (10): tS diny-E[dIny]=t. d7r+t11 drl- . dt-tI -dI (19) where j,8,u;t) and M0(,8,it,) are still defined by Equations (11)-(1 2) and ,(,u,t) and ,(A,8,n,t), which measure the sensitivity of income growth to domestic and foreign interest rate shocks, are given by: ~t1= X XKa + (1-X) K] (20) AI=X{X.Ka + 3+ (X-V) (15 Ka)j (21) Equations (1 1)-(12) and (19)-(21) provide a complete characterization of the business cycles of a (g,8,7,tL)-country. As Kac.*0 and ic-*0, we have that k,+0 and t,-40 and business cycles are driven only by productivity shocks. As -+X0 and s,-+O, we have that E O0 and n-+O and business cycles are driven only by interest rate shocks. In the general case, however business cycles result from the interaction of both type of shocks. A comparison of (20)-(21) with (1 1)-(12) reveals that the effects of domestic and foreign monetary shocks are very similar to those of productivity shocks. As mentioned earlier, differences in the prevalence of cash-in-advance constraints provide an altemative source of cyclical bias, i.e. ia and iN play the same role in (20) and (21) as Ea and Pe, do in (11) and (12). In contrast to productivity shocks, however, '5 To compute income, remember that financing costs are not really a cost for the economy as a whole but a transfer from firms to consumers via the govemment. 25 monetary shocks only have indirect effects on production through their effects on wages and labour supplies. Therefore, the sensitivity of income growth to monetary shocks is smaller, i.e. the term (1 +X) which premultiplies (11) and (12) is replaced with X. Since we now have two sources of business cycles, world average growth is given by: dInY - E[dlnY] = (Odndl - o) dl (22) where co, is still defined by Equation (14) while co, is given by: 'I =IX[V ' K + (1 - V) Kp] (23) 26 If productivity shocks are negligible, i.e. c,=s,=0, we have the following result:'6 PROPOSITION 2: The functions C and V depend, at most, on x. Moreover: o-i av ac (i) If KP, =I --I then -=- = 0 for all x; ~~+X ax ax (ii) If cp > Ka 0 , then - < 0 and -C > 0 for all x; and O+X, ax ~~ax (ii) If KP, 0 and a- <0 forallx. aO+X, ax ax Proposition 2 is the natural analog to Proposition 1 in a world in which business cycles are driven only by interest rate shocks. The competition and cyclical biases cause cross-country differences in business cycles, regardless of whether the cycles are driven by productivity shocks or interest rate shocks. The intuition of why the competition bias and the cyclical bias generate these pattems in a cross-section of business cycles has been discussed at length in Section 2 and need not be repeated here. Instead, we generalize Propositions 1 and 2 to the case where both productivity shocks and interest rate shocks drive business cycles, as follows: " '6 Notethatinthiscase V = I(, t) + a. (t+1)2 and C= (2 I)+. )2 The proof is analogous to that of Proposition 1. '7 Note that V = (,_ + - O 2 2 I5C0l 't +n) +0'@ '(t +0-t L41)n C= ,(r l) -(4 i) . Since neither | co2 + 0 -)2 ((2 - ) t2 + a (f1: + trl)2 + (I _ 0). t2 + 0. (it + 41)2) E_+t. nor ,+ depend on x, V (C) is downward (upward) sloping if and only if (1- a) 2 + (1- -) t2 is decreasing (increasing) in x. The proposition describes the sign of a-((1- ) -L- (1- 0 )for different parameter values. 27 PROPOSITION 3: The functions C and V depend, at most, on x. Moreover, if aV <0 ( aV > 0), then aC >0 ( ac < 0). Define: TX a-x ax ax A = (1-_ r) * (1 + ),)2 * ( 1 * 8 - + (1 _ *2 * Ka * 0-X - IC ). O A=(1_ C). (1 +X)2{c- o J.X2+( 0K IKK1c3 Then, (i) If A>0, aV > 0 for all x; ax (ii) if -B0, a <0 ( a- >0) if x<- A (x- A ); and ax a X B Bg (iii) if A<-B, then 'V < 0 for all x. Proposition 3 provides a set of necessary and sufficient conditions for the functions V and C to exhibit the same slopes than their empirical counterparts. Let.x* be the highest value for x in a cross-section of countries. Then, a necessary and sufficient condition for business cycles to be less volatile and more synchronized with the world cycle in rich countries is that A+B- x*<0. This condition is always satisfied if both types of shocks generate industry responses with the right biases, i.e. > ,, * 0 X and KO >Ka * i X . But this is not a necessary condition. For instance, it might be that the a-industry is more sensitive to domestic productivity (interest rate) shocks and less sensitive to foreign productivity (interest rate) shocks than the 13-industry, S- < sa * o X (K < Ka * 0 - ), yet still business cycles are +X 0+ X less volatile and more synchronized with the world cycle in rich countries. This naturally requires that the a-industry be less sensitive to domestic interest rate (productivity) shocks and more sensitive to foreign interest rate (productivity) shocks, 0-1 0-1 KO >Ka - O+X (e0 > -a +2 28 4. Trade Integration The postwar period has seen large reductions in both physical and policy barriers to commodity trade. Here we do not attempt to explain these changes but instead explore how parametric reductions in transport costs affect the cross-section of business cycles. Throughout, we assume that transport costs are small enough relative to cross-country differences in factor endowments that all countries are either net importers or net exporters of the ,8-product, for any value of their domestic productivity and interest rates, and for all possible equilibrium prices. Moreover, we assume that transport costs are small enough relative to cross-country differences in technology in the a-industry that every a-product continues to be produced in only one country. These assumptions ensure that the pattern of trade is unchanged by the introduction of transport costs, although the volume of trade is negatively related to the size of transport costs. Remember that the main theme of this paper is that the nature of business cycles a country experiences depends on its industrial structure. As transport costs decline, the prices of products in which a country has comparative advantage increase and, as a result, the share in production of these industries increases. A natural conclusion of this argument is that one should expect that reductions in transport costs (globalization?) increase the cross-country variation in the properties of business cycles. We confirm this intuition here. The Model with Transport Costs We generalize the model with money by assuming that trade incurs transport costs of the "iceberg" variety, i.e. if r>1 units of output are shipped across borders, only one unit arrives at the destination while r-1 units "melt' in transit. Let p.(z) and p,(z) now denote the f.o.b. or intemational price of variety z of the a-products and of 29 the 3-products, respectively. We use the same normalization rule as before in terms of these international prices, and define p as as the average f.o.b. price of a- products relative to f-products. The presence of transport costs implies that the c.i.f. or domestic product prices vary across countries. In each country, the c.i.f. prices of imports and import-competing products are higher than the f.o.b. prices while the c.i.f. prices of exports are equal to the f.o.b. prices. Since countries import all the varieties of a-products they do not produce, the c.i.f. price of all but the infinitesimal measure , of domestically-produced a-products is t* pA(z). Similarly, the c.i.f. price of f3-products is c-p,(z) if the country is a net importer of 1-products, and p,(z) otherwise. Note that the consumer continues to allocate consumption expenditures (evaluated at c.i.f. prices) over commodities exactly as before. The consumers labour supply decision is also unchanged: consumers work if and only if the applicable wage, expressed in terms of a unit of consumption, exceeds their reservation wage. However, since consumers located in different countries face different c.i.f. prices, the price of a unit of consumption now varies across countries. Let pc(g,8,ir,t) denote the ideal price index of consumption in a ( g,8,7r,t)-country. This index is given by X if the country is a net importer of the 13-product, and V otherwise.18 Therefore, we need to replace Equations (3)-(4) by the following generalizations: Y Pc .t r ) (24) u= ( (25) 8 To see this, use the nomnalization rule and recall that all countries import all but the infinitesmal number of a-products produced domestically, and so incurr the transport-cost on (almost) their entire consumption of a-products, which constitute a fraction v of total expenditure. In addition, consumers in counrites that are net importers of ,-products face a c.i.f. price of T-p, for their remaining expenditure on P-products. 30 Since a-products are exported in all countries, producers face identical c.i.f. and f.o.b. prices and, as a result, Equation (15) is still valid. However, Equation (16) is only valid in countries that export 3-products. In countries that import ,-products, the producer price of these products is T-p", and, as a result, Equation (16) has to be replaced by: X. pp =w.e' -+KPl (26) Straightforward but somewhat tedious algebra reveals that the expressions for equilibrium prices in Equations (8), (17) and (18) still hold, provided that we replace 8 and 1-8 with 6. T- and X * (1- 8) if the country is a net importer of 1- products, and with 8 -. fv and (1- 8) *, - 9otherwise. 19 While trade patterns are unchanged, the world economy with transport costs exhibits less cross-country variation in industrial structures than the world economy with free trade. The higher the transport costs are, the lower is the price of those industries in which the country has comparative advantage. That is, the lower is the price of a-products (3-products) in rich (poor) countries. For the reasons mentioned '9To derive the analog to Equation (17), we can equate the ratio of world expenditure on the (sum of all) a-products in any two countries to the ratio of the value of productions as before. Using the new expressions for wages in the expressions for factor supplies results in , XO+A - Xs) a( Pa' = Pa . eo+21 . Inserting this in the ideal price index for the a-industry yields the appropriate modification of Equation (17). Equation (8) is simply a consequence of our unchanged normalization rule. To obtain the analog to Equation (18), note first that the presence of transport costs implies that the market -clearing conditions in the a- and ,-industries can now be expressed as equating the value of world production at producer prices to the value of world consumption at consumer prices for all a- and ,8-products. Then, using the analog to Equation (17), the new expressions for factor prices, and the factor supplies we can equate the ratio of expenditure in both industries to the ratio of productions at producer prices to obtain the appropriate modification of (18). 31 before, this leads to an reduction in the share of the a-industry (,3-industry) in rich (poor) countries.20 Business Cycles and Transport Costs The (demeaned) growth rate of income is still given by Equations (1 1)-(12) and (19)-(21). Consequently, Proposition 3 relating the properties of business cycles to a country's industrial structure still holds. However, transport costs reduce the volume of trade and, as a result, the cross-sectional dispersion in x. This implies that the cross-section of business cycles exhibits less variation in the model with transport costs than in the free-trade model. A process of parametric reductions in transport costs has opposite effects on the business cycles of rich and poor countries. If the competition and cyclical biases are important, we know that the Volatility and Comovement graphs are downward and upward sloping with x, respectively. Therefore, reductions in transport costs lower the volatility of business cycles in rich countries (as their x increases) and raise volatility in poor countries (as their x decreases). Similarly, reductions in transport costs make business cycles more synchronized with the world cycle in rich countries (as their x increases) and less synchronized with the world cycle in poor countries (as their x decreases). 20 It is straightforward to verify this by substituting the expressions for equilibrium wages and employment into the definition of x and differentiating with respect to r. 32 5. Terms of Trade Shocks In this section, we develop implications of the theory for the cross-section of the (growth of the) terms of trade. Often, changes in the terms of trade are assumed to be exogenous to the model, as part of the description of the "shocks" to the system. The advantage of a world equilibrium model is that it removes this degree of freedom by determining the behavior of the tenms of trade in terms of more primitive sources of fluctuations. We exploit this feature here to show that the competition and cyclical bias hypothesis have different implications for how the volatility and comovement of the (growth rate of the) terms of trade vary with the industrial structure of a country. Although in principle these implications could be used to empirically distinguish between our two hypotheses, a first look at the data yields somewhat inconclusive results. Properties of the Terms of Trade Let T(g,8,ir,-) denote the terms of trade of a (g,8,ir,t)-country, defined as the ideal price index of production relative to the ideal price index of consumption. We refer to the (detrended) growth rate in the terms of trade of a country as its terms of trade shock. 21 Using the expressions for prices in Equations (8) and (1 9)-(20), this is given by: dinT - E[dInTj = eT *d +h *dr -_ * d- * dI (27) 21 It is straighfforward to show that the growth rate of T in (27) is equivalent to the growth rate in the ideal price index for exports, weighted by the share of exports in income, less the growth rate of the ideal price index for imports weighted by the share of imports in income. We use this altemative formulation when we turn to the data. 33 where ,T(,7, and tnT(g,j,g,,t) measure the sensitivity of the growth in the terms of trade to domestic and foreign productivity shocks, while T(g1,8,n,) and tT(lt,8,7,) measure the sensitivity to domestic and foreign monetary shocks, and are given by c =-x-a * +X (28) tT 1+X fI =X * +a(x-vHFaE -a) (29) tt =XKa 0+>X (30) I =X -K -ex+(X-V)-(K -K,)- 1+x(31) The intuitions for these expressions should be familiar. Increases in domestic productivity (decreases in domestic interest rates) raise the supply of domestically- produced varieties of the a-products. If the competition bias is present, this leads to a decline in their price as countries are "large" suppliers in their export markets, constituting an adverse terms of trade shock for the domestic economy. This is captured by Equations (28) and (30), which vanish as O-*o and the competition effect disappears. Increases in foreign productivity (decreases in foreign interest rates) raise the demand for a-products in all countries and provided that 0 is finite, raise their price as well (See Equation (17)). This constitutes a favourable terms of trade shock for all countries, and is larger the richer is a country (the larger is its share of a-products in production). In addition, provided that %v (x>e, and c<<1ca, the country as a whole might not exhibit a strong cyclical bias and yet E could be quite large. Proposition 4 also shows that the Comovement graph for the terms of trade is upward-sloping if M>O and downward-sloping if MO, changes in the terms of trade are positively correlated with the world cycle in rich countries, and negatively in poor countries. If M>c. and ic,<>Ka. Turning to the data, Figure 3 plots the volatility and comovement of the growth rate of the terms of trade against the log-level of income for a subset of countries we used to construct Figure 1 (See also Table 2). Figure 3 suggests that changes in the terms of trade are less volatile in rich countries than in poor ones, and that changes in the terms of trade are more or less equally correlated with the world cycle in rich and poor countries. If one is willing to assume that the theory is approximately correct, one could read the top panel of Figure 3 as indicating that E>>D, while the lower panel would show that M =0. These restrictions are consistent with the notion that the cyclical biases are large (E>>D) but go in different directions for different shocks (M =0). However, this neither rules out nor confirms whether the cyclical bias is more important than the competition bias in shaping the cross-section of business cycles. 36 On the one hand, one could point to the condition that E>>D to support the view that the cyclical bias is more important than the competition bias. On the other hand, one could stress that E>>D does not necessarily mean that D is small in absolute value, and use the condition M=O to argue that the competition bias is more important than the cyclical bias. In any case, given our very crude measures of the terms of trade, we are reluctant to use Figure 3 to draw sharp conclusions regarding the relative importance of our two hypotheses. 37 6. Concluding Remarks We have developed two altemative explanations of the main features of the cross-section of business cycles. Both explanations rely on the observation that the law of comparative advantage leads rich countries to specialize in "high-tech" products produced by skilled workers, while poor countries specialize in "low-tech" products produced by unskilled workers. To the extent that "high-tech" and "low- tech" industries respond differently to domestic and foreign shocks, business cycles depend on the industrial structure of a country and, as a result, have different properties in rich and poor countries. We have focused on two such asymmetries: the competition bias and the cyclical bias. Our work suggests some natural avenues for further research. On the empirical front, the theory developed here provides a rich set of testable predictions regarding the connection between the industrial structure of a country and the nature of the business cycles that it experiences. To investigate the empirical validity of these predictions, one would have to first identify asymmetries in how industries react to domestic and foreign shocks. With this evidence in hand, it would then be possible to quantify the extent to which cross-country differences in industry structure contribute to cross-country differences in the properties of business cycles. On the theoretical front, it is natural to ask how the possibility of cross-border trade in financial instruments affects the shape of the cross-section of business cycles. In the models presented here, the price of consumption in different dates and states of nature varies across countries, creating an incentive for the establishment of an intemational financial market that redistributes consumption across dates and states. However, since neither factor supplies nor their productivities depend on consumption, a redistribution of the latter cannot affect output, although it certainly would affect consumption. If we want to construct an argument relating financial integration to the shape of a cross-section of business 38 cycles, we need to link factor supplies and their productivities to consumption. One way achieve this is to modify preferences so as to introduce income effects on the labour supply. In our opinion, a preferred option would be to allow workers and firms to invest in skills and technology, and then study how trade in financial instruments, by affecting these investments, combines with commodity trade in shaping the cross-section of business cycles. 39 References Acemoglu, D. and F. Zilibotfi (1997) 'Was Prometheus Unbound by Chance? Risk, Diversification and Growth," Joumal of Political Economy 105: 709-751. Backus, D., P. Kehoe and Kydland (1995), "International Business Cycles: Theory and Evidence" in T.F.Cooley (ed.) Frontiers of Business Cycle Research, Princeton University Press. Baxter, M. (1995), "Intemational Trade and Business Cycles" in G.M. Grossman and K. Rogoff (eds.) Handbook of Intemational Economics, Volume 3, North-Holland. Christiano, L., M. Eichenbaum and C. Evans (1997), "Sticky Price and Limited Participation Models of Money: A Comparison", mimeo. Corsetti, G and P. Pesenti (1998), 'Welfare and Macroeconomic Interdependence", mimeo. Davis, D. (1995), "Intraindustry Trade: A Heckscher-Ohlin-Ricardo Approach," Journal of International Economics 39: 201-226 Harrison, J.M. (1990), Brownian Motion and Stochastic Flow Systems, Krieger. Kraay, A and J. Ventura (1997), 'Trade and Fluctuations", mimeo. Obsffeld and Rogoff (1995), "Exchange Rate Dynamics Redux," Joumal of Political Economy 103 (June):624-660. Obsffeld, M. and K. Rogoff (1998), "Risk and Exchange Rates", mimeo. 40 Figure 1: Volatility and Comovement Volatility 0.16 0.14 0.12 * 4 0.1 1 0.08 0.06 0.02 0 l l l l l l I 6 6.5 7 7.5 8 8.5 9 9.5 10 Iny Comovement 0.8 U gS0.2- '* ''*/ ;, q,5 7 7.5 a s.sr 9 9.s 1 0 -0.2 . * * -0.4 Iny The top panel plots the standard deviation of the grovwth rate of real per capita GDP (diny) over the period 1960-1994 against the log-level of average per capita GDP in 1985 PPP dollars over the same period (Iny), for a sample of 88 counteies. The bottom panel plots the correlation ot real per capita GDP growth with world average per capita GDP growth. excluding the country in question (dInY) over the period 1960- 1994 against the log-level of average per capita GDP over the same period. All data are at annual frequenoy. The sample consists of all non-OPEC market eoonomies with at least 30 observations on per capita income (RGDPCH) beginning in 1960 in the Penn World Tables Version 5.6, extended to 1994 using constant price local ourrency growth rates from the World Bank World Tables. Figure 2: Sample Paths of the Productivity Index Country-Specific Variation Only (0=0) [I+2>F 2 Global Variation Only A Time IW VY IIII 2~~~ Both Country-Specific and Global Variation t ~~~~~~~~~~~~~~Time 7- - 2 Figure 3: Volatility and Comovement of Terms of Trade Volatility 0.2 0.18 - 0.16 0.14 ,0.12 : 0.1 - 0.08-.. 0.06- 0.04 0.02 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 Iny Comovement 0.6 0.5 0.4 0.3 4 * * * 0.2 . t 0.1 . * * * Z5 * 6 c.. 0 * I * ' 1 ' '. II -0.1 , i.5 7 7.5 8 8.5 9. * 9.5 10 -0.21 * ~ ~~~ 4 -0.2 -0.3 - -0.4 Iny The top panel plots the standard deviation of the growth rate of terms of trade (dInT) over the period 1960- 1994 against the log-level of average per capita GDP in 1985 PPP dollars over the same period (Iny), for a sample of 63 countries. The bottom panel plots the correlation of the growth rate of the terms of trade with world average per capita GDP growth excluding the country in question (dInY) over the period 1960-1994 against the log-level of average per capita GDP over the same period. All data are at annual frequency. Terms of trade growth is defined as the growth rate of the national accounts local currency export deflator times the share of exports in GDP at constant local currency prices, less the growth rate of the corresponding import deflator times the share of imports in GDP. The sample consists of all countries with complete time series on these variables in the World Bank World Tables over the period 1960-1994. Five countries for which terms of trade volatility was more than two standard deviations above the mean for all countries were dropped from the sample (Argentina, Zambia, Israel, Bolivia and Nicaragua). Table 1: Volatility and Comovement Volatility Comovement (Standard deviation of real (Correlation of real per per capita GDP Growth) capita GDP growth with world average excluding country in question) Average Correlation Average Correlation with ln(per with ln(per capita GDP) capita GDP) Full Sample .051 -.621 .240 .627 (88 countries, 1960-94) Full Sample, Non-Oil .050 -.624 .264 .539 Shock years (88 countries, 1960-72, 1976-78,1982-94) Full Sample, using -- -- .259 .440 unweighted world average growth Full Sample, using .097 -.431 .525 .428 deviations from linear trend instead of growth rates Top Quartile by Income .031 -.573 .496 .425 Second Quartile .050 -.407 .260 .430 Third Quartile .051 -.094 .140 .297 Bottom Quartile .074 -.144 .066 .238 Note: See notes to Figure 1. Table 2: Volatility and Comovement of the Terms of Trade Volatility Comovement (Standard deviation of (Correlation of terms of terms of trade growth) trade growth with world average excluding country in question) Average Correlation Average Correlation with ln(per with ln(per capita GDP) capita GDP) Full Sample .054 -.420 .054 .095 (63 countries, 1960-92) Full Sample, Non-Oil .051 -.416 .044 -.257 Shock years (63 countries, 1960-72, 1976-78,1982-92) Full Sample, using -- -- .072 -.338 unweighted world average growth Full Sample, using .066 -.387 .211 -.330 deviations from linear trend instead of growth rates* Top Quartile by Income .015 -.153 .072 -.563 Second Quartile .068 -.299 .074 .202 Third Quartile .069 .238 .053 -.263 Bottom Quartile .074 -.048 .006 .038 Note: See notes to Figure 3. * For this row only, the level of the termns of trade is defined as a geometric average of the import and export deflators, using the export and import shares in GDP as weights. Policy Research Working Paper Series Contact Title Author Date for paper WPS1925 Half a Century of Development Jean Waelbroeck May 1998 J. Sweeney Economics: A Review Based on 31021 the Handbook of Development Economics WPS1926 Do Budgets Really Matter? Emmanuel Ablo June 1998 K. Rivera Evidence from Public Spending Ritva Reinikka 34141 on Education and Health in Uganda WPS1927 Revenue-productive Income Tax Fareed M. A. Hassan June 1998 A. Panton Structures and Tax Reforms in 85433 Emerging Market Economies: Evidence from Bulgaria WPS1928 Combining Census and Survey Data Jesko Hentschel June 1998 P. Lanjouw to Study Spatial Dimensions Jean Olson Lanjouw 34529 of Poverty Peter Lanjouw Javier Poggi WPS1929 A Database of World Infrastructure David Canning June 1998 A. Abuzid Stocks, 1950-95 33348 WPS1930 The Main Determinants of Inflation in ilker Domac June 1998 F. Lewis Albania Carlos Elbrit 82979 WPS1931 The Cost and Performance of Paid Ariel Dinar June 1998 F. Toppin Agricultural Extenion Services: The Gabriel Keynan 30450 Case of Agricultural Technology Transfer in Nicaragua WPS1932 Air Pollution and Health Effects: Bart D. Ostro June 1998 C Bernardo A Study of Respiratory Illness Gunnar S. Eskeland 31148 Among Children in Santiago, Chile Tarhan Feyzioglu Jose Miguel Sanchez WPS1933 The 1997 Pension Reform in Mexico Gloria Grandolini June 1998 C. Zappala Luis Cerda 87945 WPS1934 WTO Accession for Countries Constantine Michalopoulos June 1998 L. Tabada in Transition 36896 WPS1935 Explaining the Increase in Inequality Branko Milanovic June 1998 G. Evans during the Transition 85734 WPS1936 Determinants of Transient and Jyotsna Jalan June 1998 P. Sader Chronic Poverty: Evidence from Martin Ravallion 33902 Rural China WPS1937 Aid, the Incentive Regime, and Craig Burnside June 1998 E. Khine Poverty Reduction David Dollar 37471 Policy Research Working Paper Series Contact Title Author Date for paper WPS1938 What Explains the Success David Dollar June 1998 E. Khine or Failure of Structural Adjustment Jakob Svensson 37471 Programs? WPS1939 Second Thoughts on Second Arturo J. Galindo June 1998 M. Cervantes Moments: Panel Evidence on William F. Maloney 37794 Asset-Based Models of Currency Crises WPS1940 The Structure of Labor Markets in William F. Maloney June 1998 M. Cervantes Developing Countries: Time Series 37794 Evidence on Competing Views WPS1941 Are Labor Markets in Developing William F. Maloney June 1998 M. Cervantes Countries Dualistic? 37794 WPS1942 Poverty Correlates and Indicator- Christiaan Grootaert July 1998 G. Ochieng Based Targeting in Eastern Europe Jeanine Braithwaite 31123 and the Former Soviet Union WPS1943 The Implications of Hyperbolic Maureen Cropper July 1998 A. Maranon Discounting for Project Evaluation David Laibson 39074 WPS1944 Detecting Price Links in the World John Baffes July 1998 J. Baffes Cotton Market 81880 WPS1 945 Evaluating a Targeted Social Martin Ravallion July 1998 P. Sader Program When Placement Is Quentin Wodon 33902 Decentralized WPS1946 Estonia: The Challenge of Financial Carlos Cavalcanti July 1998 L. Osborne Integration Daniel Oks 38482 WPS1 947 Patterns of Economic Growth: Hills, Lant Pritchett July 1998 S. Fallon Plateaus, Mountains, and Plains 38009