Terms-of-Trade Effects of Productivity Shocks in Developing Economies

This paper studies the terms-of-trade effects from economy-specific shocks to productivity with a focus on developing economies using a panel vector autoregression model with interactive fixed effects and the “maxshare” approach. We find that the terms of trade in developing economies show insignificant dynamics after such shocks. The analysis of a more detailed classification of developing economies reveals a finding of critical importance: a positive economy-specific productivity shock results in a significant improvement in the terms of trade in the developing economies with a high degree of export diversification, indicating a clear violation of the small-country assumption for these economies.