Export instability, that is uncertainty about the export earnings accruing to a country, is an important source of macroeconomic uncertainty in developing countries. Moreover, the relevance of this issue has increased recently, as policymakers in a number of developing countries have turned their attention to the problems associated with, on the one hand, the sharp decline in commodity prices since the mid-1980s, and, on the other, the steady increase in the volatility of commodity prices over the past two decades.
How should the various agents in an economy respond to greater uncertainty about the prices of a principal export, and the resulting volatility in real export earnings and real incomes? One answer is provided by the theory of precautionary savings, which hitherto has been used to explain household responses to uncertainty in labor incomes. This theory suggests that in response to an increase in the volatility of household labor income, arising, say, out of an increase in the probability of being unemployed, households should increase their savings in order to insure themselves against the greater probability of a large negative income shock in the future. The hypothesis that is tested here is that, in response to increased uncertainty about export earnings, countries need to save more in order to insure themself against potentially greater income shocks in the future. Moreover, in an open economy, these greater savings should show up, in the aggregate, in the external current account balance, which measures national savings net of investment.
The results suggest that, in general, there is evidence that developing countries have increased their savings (and external current account balances) in response to increases in export instability over the past two decades. Moreover, these savings have not been insignificant, amounting--for example--to about 3 1/2 percent of average imports for the nonfuel primary commodity exporters, and substantially more for the fuel exporters. There are, however, interesting regional differences, with countries that had difficulty achieving even subsistence consumption levels finding it difficult to maintain precautionary balances when export uncertainty increased.