On the Economic Vulnerability of Low-Income Countries

Abstract

This paper examines the relevance of the concept of economic vulnerability for low income countries, a topic of recent concern in several international bodies. It first proposes some conceptual clarifications and a method to build an internationally comparable indicator. Three factors of vulnerability are identified: shocks, exposure and resilience or capacity to react (the first two ones being more structural, the third one more related to policy). To measure the two main kinds of shocks (natural and external), proposed proxies are respectively the instability of agricultural production and the instability of the purchasing power of exports, while the (smallness of) the population size can be used as a proxy for (structural) exposure. To aggregate the various possible indicators of shocks and exposure in a composite index of structural economic vulnerability, weights can be drawn from their estimated impact on growth. Then selected issues related to the impact of vulnerability on growth are considered: "primary" instabilities (natural events, terms of trade, political troubles) are found to slow growth, more by their effect on the total factor productivity growth than on the rate of investment, to do so through "intermediate" instabilities (of the rate of investment and of the real exchange rate), and in agricultural economies through their impact at the farmer level. Besides its negative effects on growth, vulnerability is assumed to increase aid effectiveness: the more the recipient country is vulnerable the more aid contributes to growth. Implications are drawn for aid allocation and aid design.aid., growth, productivity, instabilities, resilience, exposure, shocks, Economic vulnerability