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Trade Openness, Country Size and Economic Volatility: The Compensation Hypothesis Revisited

Published online by Cambridge University Press:  20 January 2017

Ian Down
Ian Down*
Affiliation:
University of Tennessee, Knoxville
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Abstract

A prominent variant of the compensation hypothesis rests on the premise that increased trade exposure heightens domestic economic volatility, prompting demands for compensation via generous systems of transfers and services. Economic theory suggests that because the expansion of international trade entails integration into larger, deeper, more stable markets, and may entail risk diversification, it may actually promote rather than reduce stability. By the same token, however, economic theory also suggests that smaller economies should experience greater levels of volatility than larger economies, and thus also greater levels of insecurity. The evidence presented here suggests that the level of domestic economic volatility in the developed economies, during the latter half of the twentieth century, may indeed have been driven by the size and depth of markets. And critically, for these countries international trade integration may have eased rather than accentuated domestic economic volatility.

Keywords

tradevolatilitycountry size
Type
Article
Information
Business and Politics , Volume 9 , Issue 2 , August 2007 , pp. 1 - 20
Copyright
Copyright © V.K. Aggarwal 2007 and published under exclusive license to Cambridge University Press 

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