As the financial crisis rocked the global economy in 2008, a trade collapse wasn’t far behind. Between 2008 and 2009, international trade fell 15 percent, while real world GDP dropped by 3.7 percent, according to the IMF Global Data Source. Researchers and experts have disagreed about whether a drop in consumer demand or a decrease in available financing for exporting firms was the main cause of the trade collapse.
A drop in demand is a likely culprit: uncertainty about the economy and employment created more caution among consumers, who focused on saving and paying down debt instead of spending. However, credit shortages caused by the financial crisis could also be responsible. In theory, when the economy suffers, banks cut credit and consequently firms produce less. History supports this idea: some economists argue that the drop in output during the Great Depression is largely attributed to this phenomenon, says Professor Daniel Wolfenzon.
“Banks play a role in amplifying economic fluctuations,” Wolfenzon says. “The question is how much of the trade decline was due to decreased demand versus banks not supplying financing to exporting companies?”
Wolfenzon worked with Professors Daniel Paravisini and Veronica Rappoport, teaming up with Philipp Schnabl of NYU, to answer this question. They focused on exporting firms in Peru because, unlike other countries, Peru provides accessible information about the two types of data the researchers needed: customs data that details highly specific export information for each of the country’s exporting firms including where exports are sold and the prices they are sold for and a credit registry that shows how much each firm has borrowed from each Peruvian bank.
They classified banks into two groups, institutions with significant borrowing from foreign investors that saw big shocks to their funding and banks that mainly borrowed from the domestic market and hence, weren’t as affected by the crisis. Then, the researchers figured out which banks the firms received financing from the most affected banks versus the least affected and how much each firm exported. By comparing the two groups, the researchers were able to isolate the fraction of the trade drop caused by credit shortages.
“The methodology we use essentially compares firms that export the same good to the same country,” Wolfenzon explains. For example, the researchers focused on one firm that exported asparagus to the United States and borrowed from the banks most affected during the recession and compared it to another firm that also sold asparagus to the United States but borrowed from the least affected banks.
“It’s easy to look at the firms borrowing from the most affected banks and realize they exported less because we were in the middle of a financial crisis, and financing was harder to get,” Wolfenzon says. “But all Peruvian firms were exporting less. By comparing the data in this way, it allows us to pinpoint how much of the drop was due to financing and how much was due to a drop in demand.”
Out of the total decline in exports from Peru, only 15 percent was driven by credit shortages. The other 85 percent was due to a drop in consumer demand. “Our 15 percent figure is a lower bound as it refers only to the decline in exports due to lack of finance to exporters. Finance can have a bigger impact as it surely also affects importers at the other end,” Wolfenzon says.While trade is clearly based on supply and demand, it’s important to understand the relative importance of these both forces. To this end, Wolfenzon suggests a general takeaway. “The Peruvian government could not have done much to improve the country’s export performance,” he says. “The problem was a lack of demand from importing countries.”
Daniel Paravisini is the Gary Winnick and Martin Granoff Associate Professor of Business in the Finance and Economics Division at Columbia Business School.
Veronica Rappoport is assistant professor of finance and economics at Columbia Business School.
Daniel Wolfenzon is the Stefan H. Robock Professor of Finance and Economics and research director for the Eugene Lang Entrepreneurship Center at Columbia Business School.