How Big are the Benefits of Economic Diversification?: Evidence from Earthquakes
International Monetary Fund, 2005 - Consumption (Economics) - 32 pages
Economic activity is risky. Returns across economic sectors can be highly variable, potentially causing costly adjustments to consumption. However, when returns are imperfectly correlated across sectors and insurance is unavailable, diversification can reduce the economic impact of shocks. Therefore, despite the well-known efficiency benefits from specialization, the risks of too little diversification have long been acknowledged. But how big are the benefits of diversification? This paper exploits the exogeneity and randomness of earthquakes to address this question. There is robust evidence that more specialized economies experience larger declines in consumption when earthquakes occur, and consistent with the insurance channel, the cost of specialization is smaller in more financially developed economies.
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capita income Change in Final change in household Coefficient of Variation consumption cost consumption impact cost of earthquakes cost of shocks country level definition and sources Dependant Variable Deviation Theil Index Earthquake Magnitude economic specialization errors in parenthesis Final Consumption Expenditures financial depth Gini Log Mean Household Final Expenditures Huber White robust impact of earthquakes impact of specialization indicate significance invariant factors Labor Specialization level of financial Log Mean Deviation log of population Magnitude and Specialization Mean Deviation Theil Mean Log Deviation median level omitted variable bias percent levels respectively percent of GDP percentage point decline Polity IV population density Regression residual terms Richter scale robust standard errors scale measure specialization measures specialization patterns specialization point estimates standard deviation increase Table 18a terms are clustered Theil Index Coefficient UNIDO White robust standard World Bank 2003 Yes Fixed Effects Yes Yes Fixed Yes Yes Yes