Economic Research Forum (ERF)

Financial vulnerability and export dynamics

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How does the financial vulnerability of many developing economies affect the ability of their firms to participate effectively in export markets? This column summarises research on 34 developing countries between 1997 and 2011. Financial crises in both the exporting and importing countries have a big negative effect on export dynamics.

In a nutshell

The impact of financial crises on export dynamics is less pronounced in exporting countries with relatively open capital accounts.

This suggests that portfolio inflows may be a good substitute for under-developed domestic financial markets, as well as the lack of domestic finance for firms’ investments.

A well-developed banking system in exporting countries can help firms to be more resilient in the face of shocks, with positive consequences for national export performance.

Research in international trade shows that individual firms face substantial barriers to engaging in trading activities. This is particularly true in the developing world, where many countries have limited participation in export markets and a narrow set of export products and destinations. These countries also typically have export sectors that are volatile and less resilient to shocks, with high rates of firm entry and exit, and low rates of firm survival.

One of the factors holding back these countries’ export participation and performance is the lack of access to external finance, which renders them vulnerable in the face of adverse financial shocks. The existence of substantial sunk costs of entry into exporting makes financial vulnerability a major barrier to trade.

In the presence of sunk costs, only more productive firms or firms with a certain level of financial health are able to export effectively. The World Bank Enterprise Surveys show that the percentage of firms identifying access to finance as a major constraint is typically higher in developing countries.

While the impact of financial shocks on export participation is well understood at the aggregate level, it remains relatively unclear through which trade margin this effect works. Is it the result of a reduced number of new exporters, of new products, of new destinations or any combination of the three?

In an ERF study (Jaud et al, 2015), which is forthcoming in World Economy, we use the new World Bank Exporter Dynamics Database, which contains indicators on the micro-structure of exports, together with data on financial crises, to develop a better understanding of how finance affects the different margins of entry into export markets.

We focus on three indicators of export dynamics – rates of firm entry and exit; rates of product entry and exit; and rates of destination entry and exit – for 34 developing countries between 1997 and 2011.

Our results show that financial crises in both the exporting and importing countries have a negative and economically important effect on export dynamics, particularly in industries dependent on external finance. We find that firm, firm/product and firm/destination gross entry rates decrease following shocks, and the corresponding exit rates increase.

Exporting is costly, and firms need access to sufficient financial resources to enter international markets successfully and expand their operations there. This is particularly true for industries that do not generate sufficient cash flow to invest in production, plant and machinery, and thus rely heavily on external financing.

By increasing trading costs, financial shocks in exporting countries (supply-side shocks) limit disproportionately more the ability of firms in financially vulnerable industries than in less vulnerable ones, to enter export markets, as well as the number of products exported and destinations served by firms.

By lowering demand for exporters’ products, financial crises in importing countries (demand-side shocks) also have negative effects on firms’ export performance in the exporting countries, especially for those industries that are most dependent on external financing.

Our approach allows us to differentiate between the effects of supply- and demand-side shocks. The results suggest that supply-side financial shocks are about as disruptive as demand-side shocks for the three dimensions of export dynamics.

Our approach also allows us to examine the timing of the effect of the crises. Our results suggest that the negative impact of both supply- and demand-side financial shocks persists for three years after the start of the crisis.

Furthermore, we find that the impact of financial crises is less pronounced in exporting countries with relatively open capital accounts. This suggests that portfolio inflows may be a good substitute for under-developed domestic financial markets, as well as the lack of domestic finance for firms’ investments.

From a policy perspective, the fact that developing countries are dependent on a narrow set of export products suggests that they have room for upgrading the existing basket of exports.

A well-developed banking system in the exporting country can help firms to be more resilient in the face of shocks, with positive consequences for national export performance as well as the allocation of available resources and economic development.

Alternatively, measures to facilitate portfolio flows may be a second-best option, given that increased capital inflows are good substitutes for domestic funding.

Further reading

Jaud, Melise, Youssouf Kiendrebeogo and Marie-Ange Véganzonès-Varoudakis (2015) ‘Financial Vulnerability and Export Dynamics’, ERF Working Paper No. 948.

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