Export diversification and macroeconomic shocks

This research explores how export diversification interacts with macroeconomic shocks by investigating how a country's response to aggregate shocks is impacted by its level of export diversification. This is done through the lens of a version of the Melitz (Econometrica, 2003, 71, 1695) model, which is calibrated to five European countries and is solved quantitatively. The welfare effect of shocks to the balance of payments, production fixed costs and domestic productivity is amplified by export diversification, whilst the effect of shocks to trade costs, foreign population, entry fixed costs and foreign productivity is dampened by export diversification. The amplification of shocks, in particular, is a novel finding as the literature generally finds export diversification reduces macroeconomic volatility. The channel for it is how firms' reallocation of sales between domestic and export markets in response to the shock interacts with export diversification.