Understanding Policy Responses to External Shocks in Developing Countries

Abstract

This paper shows that trade patterns can be crucual in explaining different policy responses to external shocks, such as the contraction of foreign capital inflows faced by developing countries since 1982. Based on the hypothesis that the same simple political economy explains commercial policy in any developing country, I show that a particular country's policy response to a contraction of foreign capital inflows can be explained as rational choice under the assumed general policy constraint, given the country's comparative advantages in international trade. The main implication is that, contrary to common practice in the development literature, more attention should be paid to structural differences, and less to political idiosyncracies, in order to understand policy behavior in developing countries.