For most countries in the world, this is not a financial crisis – it is a trade crisis. In 2009, for the first time since 1982, global trade flows will not grow. The latest IMF projections expect global trade in goods and services to drop by 11% this year and stagnate next year. This collapse in trade has spread the global recession far beyond the relatively few nations whose banks were involved in the financial wizardry that sparked the crisis.
The size and synchronicity of the trade collapse raises new and pressing questions concerning the relationship between banking crises and exports growth (Freund 2009a).
- Are the supply shocks stemming from the banking system and credit markets responsible for the export decline?
- Or, is what we observe completely attributable to the demand side, where we have also observed unprecedented drops, particularly in developed countries?
This chapter tackles these questions from the perspective of historical crises that occurred between 1980 and 2000.
Supply-side effects of credit crunches on exporters
Financial constraints that arise during periods of banking crises are important for all producers, but they are particularly relevant for exporters who, in addition to production costs, have to face the additional expense of penetrating foreign markets – a fact well documented by various firm-level studies (Roberts and Tybout 1997, Iacovone and Javorcik 2008, Muuls 2008). Additionally, exporters are likely to be more exposed to financial shocks than domestic companies because international transactions normally involve higher working capital requirements and default risks (Auboin 2007).
Previous industry-level studies have shown that countries with more developed financial systems can develop comparative advantages in industries that rely more on external finance, or tend to have lower shares of tangible assets (Manova 2008, Beck 2003). The latter matters. When financial markets are not sufficiently developed, industries with above-normal shares of tangible assets tend to have an advantage in accessing finance. At the same time, it has been shown that – in countries with less developed financial systems – sectors that rely more on trade finance (as opposed to bank finance) tend to grow relatively faster (Fisman and Love 2003).
Evidence from recent banking crises
To extend and update these analyses, we put together a database on 23 past banking crises episodes that occurred in developed and developing countries from 1980 to 2000.
We view the banking crisis as an adverse shock to financial development that reduces the availability of finance from private banks to firms in the affected country. The spotlight is on how firms’ export growth is affected by the crisis and how changes in export growth are related to firm characteristics. The key characteristics are the firms’ ability to finance their operations through internal cash flow, their ownership of assets that could be used as collateral, and their sector’s overall dependence on external finance.
We expect that growth in industries that are highly dependent on finance will fall when a crisis strikes, while the growth of other firms will be relatively unaffected.
There are two main lines-of-argument behind this a priori expectation that exporters will be more heavily affected in sectors with greater dependence on external finance. This first depends upon the general need for working capital. For any given exporter, financing production-related variable costs becomes increasingly difficult in a banking crisis period. The second is specifically related to exporting. New exports must pay a sunk cost in order to penetrate foreign markets. Thus the credit crunch may deter some firms that would have otherwise become exporters, or expanded the range of products export and range of destination markets. This reasoning also suggests that a firm’s ability to provide collateral could become more important during a crisis. (See the original study, Iacovone and Zavacka 2009, for details.)
The results in Iacovone and Zavacka (2009) confirm that this is exactly what happened during the 23 banking crises under investigation. Specifically, the results show that during a crisis:
- The export growth of a sector with a relatively high reliance on external finance, such as electric machinery, is reduced on average by 4%, compared to a sector like footwear, whose dependence is relatively low.
- The exports of industries that tend to have more tangible assets grow relatively faster during a banking crisis; this confirms the hypothesis regarding the importance of collateral.
- Using a proxy for trade-credit dependence (Fisman and Love, 2003), we show that exports of industries that are relatively more reliant on inter-firm finance are less affected by a banking crisis.
A potential explanation for this finding is that some exporters may still be able to access trade credit, or favourable payment conditions, through their foreign counterparties, who, being located abroad, are probably less affected by the crisis (we look at country-specific crises – most of which affected only a handful of nations at most). The interpretation is that the inter-firm credit channel does not ‘dry up’ when a banking crisis strikes the exporting country.
The importance of demand shocks during a financial crisis
Even though banks were not adverseky hit in all countries, the current crisis affected import demand in most nations. For this reason it is important to also evaluate the effect of demand shocks.
In our study, we evaluate the demand channel by analysing how exports respond to GDP changes in export markets. We find evidence that demand shocks operate independently of, and in addition to, the financial channel.1
In fact, when a banking crisis is simultaneously accompanied by a drop in demand, the exporters are hit twice. Based on our results, Figure 1 simulates a situation in which a country simultaneously faces a banking crisis and a recession in its only importer. The drop of 2.8% that we choose for our simulation corresponds to the IMF projection for the US in 2009.
As the figure shows, the effect of finance is amplified by the demand shock, and the latter is particularly pronounced in sectors producing durable goods (e.g. automobiles, domestic appliances) whose growth drops by as much as 10%. Our finding is in line with the recent Vox column by Caroline Freund (2009b), which concludes that the impact of demand shocks on trade are particularly important in the context of global downturns.
Figure 1. Export collapse in response to financial and demand shocks
Source: Authors’ calculations.
Crises are not the same: Some countries are hit harder
It is important to mention two additional results, partly because they go some way towards confirming our hypothesis, and partly because of the potential implications with respect to the current crisis.
- The first result is that not all crises are the same; deeper crises have more profound consequences.
We use the GDP loss during the crisis as a measure of the deepness of the shock, and confirm that the deeper the crisis the more adversely exporters who rely on banking finance are affected.
- Additionally, we find that countries with a less developed financial system (generally the poorer countries) suffer more during a financial crisis.
The results show differential impacts for sectors that are highly dependent on finance, relative to those able to finance investments with internal funds, amongst countries with different levels of financial development. The impact on countries with less developed financial systems is clearly more negative than on countries with more developed financial systems.
Implications for the 2008-2009 crisis
Before discussing the implications that can be derived from our study for the 2008-2009 crisis, it is important to mention some caveats.
- First, our analysis focuses only on manufacturing industries; our results do not translate directly into conclusions regarding the effect of the crisis on trade flows of agricultural products or natural resources.
- Second, our analysis focuses on the “relative” impact of the crisis on sectors that are relatively more dependent on finance. Therefore our results do not have immediate implications for aggregate trade.
In fact, focusing on aggregate trade volumes, Freund (2009) finds that countries that had a banking crisis during past global downturns have not seen their exports decline by more than what was observed globally. This could be explained both by relative price changes, due to exchange rate movements, as well as by relative sectoral composition. In aggregate, therefore, the effect is not clear and is crucially dependent on the sectoral composition, as well as on external demand conditions surrounding the crisis.
Notwithstanding these limitations, there are several informative conclusions that can be derived from our study in order to help explain the sudden drop in trade that was initiated in the final quarter of 2008.
- First, the financial crisis that preceded the trade collapse can certainly be considered a systemic crisis in various countries; it reduced the confidence of financial institutions and sparked a severe credit crunch.
Despite the reduced availability of data to confirm the findings of our study, we expect that those sectors characterised by a high dependence on external finance, or those sectors with lower shares of tangible assets, are the ones more exposed to the crisis.
Recent work by Bricongne et al (2009) on the very latest data lends support to this conjecture. Specifically, they show that French firms in sectors that are more dependent on external finance have been hurt more.
Based on the evidence from Bricongne et al (2009), the latter adjustment at the extensive margin seems to be particularly relevant in the case of French firms. One possible reason, but with limited evidence, for the impact of the financial crisis on entry, could be due to the limited time-span of the data. In fact, it is likely that the fixed costs to enter export markets are paid more than one year before becoming an exporter, therefore suggesting that 2009 data are too premature to detect this effect.2
- Second, our results suggest that the inter-firm financial channel does not dry up in a crisis for exporters; we argue that is a consequence of the fact that importers were not affected simultaneously in the historical crises we studied. The financial crises were isolated events affecting one country, or a small group of countries at a time.
In such crises exporters – particularly those involved in international production chains – could rely at least partially on credit from trading partners abroad – as long as these did not face a crisis themselves (Kyotaki and Moore 1997).
The situation in 2008-2009, however, is different. The credit crunch was planetary; even normally deep-pocketed firms experienced a credit crunch, limiting their ability to support the rest of the supply chain.
However, the importance of trade credit as a channel affecting the current crisis has also been put under discussion by a recent study by Levchenko et al (2009). This paper analysed disaggregated US trade data in order to shed light on the anatomy of the recent trade collapse. It concluded that no support sectors that were dependent on trade finance, defined similarly as in our study, were more adversely affected during the recent crisis.
- Third, a key characteristic of the current crisis has been a sharp drop in demand, particularly in the US.
Our results show that demand shocks not only affect sectors more dependent on external finance, but more broadly have a negative impact on all sectors, and in particular, those producing durable goods.
This result may be important in understanding why almost all industries experienced trade collapses in the current crisis. The credit crunch amplified the demand drop in finance-intensive sectors, but demand drop hit all sectors. This is also consistent with Freund (2009), who points out that during global downturns sectors that produce durable goods have typically suffered the most.
A similar pattern has been confirmed by the preliminary analysis based on monthly data analysed in the “World Bank Trade Watch” by Freund and Horenstein (2009). These results show that in the US and Japan – for which high-frequency sectoral trade data are available – the main adverse effect has been observed in industries such as transportation and metals where external finance matters. Food products, by contrast, have been little affected. Bricongne et al (2009) find a similar pattern in the French firm-level data; the most affected sectors are investment goods and automobiles.
Our research on historical crises shows that demand shocks have amplified the effects of the financial crunch, producing particularly adverse effects on durable-goods sectors.
Although the data is so far scarce when it comes to the current trade collapse, we conjecture that the same combination of factors (financial constraints coupled with a demand slump) have been central to the great trade collapse – but this time it is operating on a vastly larger scale.
The global drop in demand has affected all industries, with very few exceptions, but it has been particularly harsh on sectors that produce capital goods and durables. In the current crisis the effect from finance and lack of demand has been most likely magnified by the presence of supply chains, thus deepening the impact on the global trade drop. Under a global financial shock, when financial constraints affect several, if not all firms along the production chain, shocks become easily transmitted and can potentially pull down the entire supply chain.
It is, however, difficult to evaluate whether the supply chain effects have primarily propagated through the financial or the demand side. In fact, many durable goods, such as cars or electronic appliances, are produced within global supply chains involving several countries. Therefore, under an adverse demand shock, when the demand for the final-durable good decreases, so does the demand for all intermediates, thereby substantially reducing global trade flows. Future research is needed in order to clarify the relative importance of these factors.
1 We build a “demand shock index” for each individual country at sectoral level equal to the weighted sum of GDP changes in export markets where the weights are equal to the relative exports share (for more details see Iacovone and Zavacka, 2009).
2 The existence of a preparation of period spanning more than one year before entering export markets is confirmed by Iacovone and Javorcik (2009).
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