liberalization on wage volatility and its welfare consequences. Koren and Tenreyro (2006)
use industry-level data to provide an interesting decomposition of aggregate volatility into
several subcomponents, and describe their features. Our paper is unique in its emphasis
on trade and its use of trade data along with production. Thus, its contribution is in the
comprehensive empirical exploration of multiple channels of the trade-volatility link.
The rest of the paper is organized as follows. Section 2 describes the empirical strategy
and the data. Section 3 presents the regression results, while section 4 discusses what these
imply about the impact of the three channels on aggregate volatility. Section 5 concludes.
2 Empirical Strategy and Data
2.1 Empirical Strategy
In an economy comprised of I sectors, the volatility of aggregate output growth σA2 can be
written as follows:
I II
σA2 = ai2σi2 + aiajσij , (1)
i=1 i=1 j=1
j6=i
where ai is the share of sector i in total output, σi2 is the variance of output growth in
sector i, and σij is the covariance between sectors i and j . Trade can affect overall volatility
through changing the variance of each sector separately (σi2), through changing the covari-
ance properties between the sectors (σij), or through changing the production structure of
the economy (ai). This paper analyzes each of these mechanisms in turn.
In particular, using our sector-level panel dataset on production and trade, it is straight-
forward to estimate the relationship between trade in a sector and the volatility of output
in that sector, σi2 . We call this the Sector Volatility Effect. Our main empirical specification
is:
Volatilityict = α0 + α1Outputict + βTradeict + uict + εict, (2)
where i denotes sector, c denotes country, and t denotes time. The left-hand side, Volatilityict ,
is the log variance of the annual growth rate of output per worker. In the cross-sectional
specifications, the variance is computed over the entire sample period, 1970-99. In panel
specifications, the volatility is computed over non-overlapping ten year periods: 1970-79,
1980-89, 1990-99. Tradeict is imports plus exports divided by output within a sector. The
openness measure is the average for the same time periods over which the left-hand side
variables are computed, and is always in logs. We proxy for sector-specific, time-varying
productivity by including the log of the beginning-of-period output per worker, Outputict,
as one of the regressors. We experiment with various configurations of fixed effects uict . The