Ebook Financial Crises and International Trade: the Long Way to Recovery
The growing number of financial crises during the nineties has generated an important economic literature. Most of it focuses on the determinants of crises, explains why financial crises happens, and tries to predict their occurrence. These papers have widely studied the role of international trade in explaining financial crises, showing in particular the significant role of trade linkages in facilitating the contagion of crises, or more generally testing the importance of trade links on the probability of occurrence of financial crises. A fewer number of authors have shown the implications of such events, by looking generally at the crises’ impacts in terms of output variation. Among others, Gutpa and al. (2004), Noy and Neuberger (2002), Dooley (2000) and Hong and Tornell (2005) study the effects of currency, banking and twin crises on output, and describe the necessary conditions for the output cost to be minimum.
Surprisingly, very little work has been done on the impact of financial crises on international trade, the latter being usually considered as obvious or traditional. Theoretically, a currency crisis may lead to a decrease in imports, and to an increase in exports because of a J-curve effect : the nominal devaluation usually implies a real devaluation, at least to the extent that relative prices do not adjust by the same amount as the nominal exchange rate; this competitiveness gain, by leading to a switch of demand toward home produced goods, may improve the trade balance. On the other hand, a banking crisis, by decreasing the total financing capacity of the economy, may have a recessive impact; this should imply a drop of both exports and imports.
However, the few authors who tried to test the effect of crises on trade generally found unclear results, in contradiction with the apparently simple theoretical effects. A fast look to some recent stylized facts emphasizes this fluctuating character of trade’s reaction after currency and banking crises. Trade patterns after crises deeply differs according to the considered country: while in Mexico, total exports increased by 32 percents in 1995, it diminished in Brazil in 1999 and in Thailand in 1998 by almost 6 percent. Since the improvement of the trade balance is one of the main ways to recover from a crisis, it seems important to understand the mechanisms that explain these variable responses.
Fischer (1999) listed strong exports, expansionary domestic policies and stable foreign financial conditions as the key determinants of recovery after a financial crisis. Nevertheless, Hong and Tornell (2005) shows that the share of the export sector was not significant in explaining recent currency crises recoveries. We attempt in this paper to explain this fact by looking more closely at the channels which can affect trade’s reaction to financial crises. We argue that while the exports’ reaction in an important determinant of crises recoveries, some elements may affect negatively exports after such an event, thus preventing trade from having beneficial effects on the country’s recovery.
The lack of robust and general results of previous studies is probably due to missing variables or to an insufficient consideration of the different mechanisms through which crises may affect bilateral imports and exports. Campa (2000) tests the impact of currency crises on South American countries’ exports. The impact appears positive or insignificant, according to the specification, but the empirical methodology he employed suffers from a problem of omitted variables which prevents us to take its results for granted. In particular, it seems that control variables that should capture the effect of demand or prices are missing. In a more recent paper, Ma and Cheng (2003), using a gravity-like equation, test the impact of financial crises - both currency and banking crises - on international trade. Their results are even less clear-cut: currency crises do no seem to have any impact in the short run (or a slightly negative impact), and the sign of the long run impact depends on the considered period. The present paper brings a number of innovations which allow us to find clearer results.
More precisely, the question we address is twofold : is the theoretical impact of crises on trade so simple? And, if not, how can we test empirically the relevance of the different theoretical channels? To answer this question, the present work builds on the the recently growing literature on the links between finance and international trade. Since its first introduction by Kletzer and Bardan (1987), the important role of financial development for international trade’s growth has been widely studied (Beck (2002, 2003), Manova (2005)). More particularly, a special attention has been given to the interactions between financial market imperfections, exchange rate movements and international trade. Finance is especially important for international trade because of the existence of high fixed costs of entry on the export market. If financial imperfections are observed, like foreign currency borrowing or credit constraints, the impact of exchange rate movements on international trade and exports decisions can be modify. On the first hand, Chaney (2005) has shown within a monopolistic competition model with heterogenous firms a la Melitz (2003) that when firms are liquidity constrained, an appreciation of the exchange rate, by facilitating the entry on the export market (because of the increase of the value of firms’ wealth, denominated in home currency), can lead to new firms’ entry, and to an increase in total exports. On the other hand, Berman and Berthou (2005) have studied the impact of exchange rate movements on international trade in presence of foreign currency borrowing.
They show that if firms borrow in foreign currency in order to finance their fixed cost of entry, a devaluation of the home currency can lead to a decrease of the number of exporters (the extensive margin of trade), and to a drop of the export volume of the country. Moreover, they show that the impact of exchange rate movements may be non-linear: while little depreciations lead to the positive, traditional competitiveness effect, large swings have a reversed impact. This last result underlines the specificity of the impact of currency crises in comparison with smaller exchange rate variations.
We build on these various theoretical results to show that the impact of banking and currency crises on trade are likely to be more complex than one can suppose. More precisely, we show that while the effect of currency crises on imports is theoretically negative, the reaction of trade after a banking crisis and the reaction of exports after a currency crisis are not well-defined. To assess the impact of crises, we use a gravity-like equation in which we introduce crises dummies. We use a sectoral database in order to reveal, through sectoral characteristics, the different channels through which trade is affected by financial crises. We are thus able to determine different elements which can improve or worsen the crises’ effect on trade and accelerate countries’ recovery. First, we show that both kinds of events currency and banking crises - have a negative impact on both imports and exports. Trade remains under its natural level during the eight years that follow a currency crisis. Second, the persistent effect of crises on exports is likely to be magnified by the combination of firms’ foreign currency borrowing and high fixed costs of entry, which leads to important balance-sheet problems.
Post-crisis volatility explains a large part of the negative imports’ reaction after currency crises. Finally, we find that the effect of both types of crises on exports depends on the country’s specialization: currency crises have a more positive effect as the country exports goods that are associated with a larger elasticity of substitution, and is specialized in industries that use less external capital in their financing; the impact of banking crises is harder when the country is specialized in industries associated with higher fixed costs of export and larger financial external dependence.
This paper contributes to the existing literature at various levels. First, it provides a theoretical framework which allows a better understanding of the interactions between financial crises and international trade. Second, our results emphasize the specificity of large exchange rate shocks, in comparison with smaller exchange rate movements. Finally, our concludes have important policy implications, since we define some elements that should be able to improve the impact of crises on international trade, thus facilitating the crisis’ recovery.
The reminder of this paper is organized as follow. In the next section, we present the different channels which connect financial crises to international trade. In section 3, we present our methodology, while in section 4 we review the data used in the regressions. In section 5 we present the overall and the sectoral results, before drawing some conclusions and policy implications in section 6.
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