The provision of subsidized credit to domestic firms is an important policy goal for many governments around the world. One of the main justifications for these subsidies is that they help local industries overcome capital market failures, especially in developing countries where such market imperfections are common. Yet, there is little empirical evidence showing how effective these subsidies are in improving the real outcomes of firms, or how efficiently these subsidies are allocated across targeted firms that is, are more capital-constrained firms allocated a greater share?
Credit subsidies for firms operating in export markets are particularly widespread. The "miracle" growth of East Asian economies is often attributed to the extremely rapid export expansion achieved by these countries, which was accompanied by significant government involvement in supporting exports. Some free-trade advocates, however, question the contribution that export subsidies made in improving the output of East Asian firms, and argue that the dramatic increase in exports was realized primarily because of favorable macroeconomic conditions, stable exchange rates, and a strong physical infrastructure (Panagariya, 2000; Little, 1996).
Measuring the direct effects of subsidies on firm-level outcomes is hampered by such identification concerns, and rigorous empirical work on this question is lacking. The literature on exporting sectors instead focuses on the broader question of whether export subsidies enhance economic welfare, and provides inconclusive theoretical predictions in terms of cross-country macro gains and losses.
This paper estimates the causal impact of credit subsidies on the real outcomes of exporting firms. This estimation is made possible by using a detailed export loan and output dataset from Pakistan for a panel of five years. The Central Bank of Pakistan provides subsidized loans through the commercial banking sector to domestic firms that export an eligible set of commodities. I exploit an exogenous change in eligibility that resulted in the subsidies being discontinued for a specific commodity ( i.e., cotton yarn), and compare outcomes before and after the policy change for yarn and non-yarn textile firms. The results show a large and statistically significant effect of the removal of export credit subsidies on yarn firms: following the policy change, these firms are unable to replace their subsidized credit with market-rate loans, and their exports fall sharply.
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The Effectiveness and Allocation of Subsidized Credit: Evidence from Export Loans
