Does openness to trade make countries more vulnerable to sudden stops, or less? Using gravity to establish causality

Openness to trade is one factor that has been identified as determining whether a country is prone to sudden stops in capital inflows. Several authors have offered empirical evidence that having a large tradable sector reduces the contraction necessary to adjust to a given cut-off in funding. Such studies may, however, be subject to the problem that trade is endogenous. We use the gravity instrument for trade openness, which is constructed from geographical determinants of bilateral trade. We find that openness indeed makes countries less vulnerable to crises, and that the relationship is even stronger when correcting for the endogeneity of trade. (C) 2007 Elsevier Ltd. All rights reserved.