Volatility and Development

Why is GDP growth so much more volatile in poor countries than in rich ones? We identify three possible reasons: (i) poor countries specialize in fewer and more volatile sectors, (ii) poor countries experience more frequent and more severe aggregate domestic shocks, and (iii) poor countries macroeconomic fluctuations are more highly correlated with the shocks affecting the sectors they specialize in. We show how to decompose volatility into these three sources, quantify their contribution to aggregate volatility, and study how they relate to the stage of development. We find that, as countries develop, their productive structure moves from more volatile to less volatile sectors and the volatility of country-specific macroeconomic shocks declines. There is also evidence that the level of specialization follows a U-shaped curve with respect to development; the higher specialization at later stages, however, occurs in low-volatility sectors. We argue that many theories linking volatility and development are not consistent with these findings, and suggest new directions for future theoretical work.