Abstract
This paper demonstrates theoretically that a financial shock can have highly persistent effects on international trade. Motivation is taken from the aftermath of the dramatic trade collapse in 2008–2009, which, despite a substantial recovery, has left a persistently slower growth rate in trade. We find conditions under which a transitory financial shock significantly reduces the investment by firms in entering the export market, and that this can have long-lasting effects on the range of goods exported and hence overall trade. Important to our mechanism are endogenous capital structure decisions by firms in response to the financial shock, and firm entry investment that requires traded goods. This mechanism provides an example of how firm dynamics can serve as a potent propagation mechanism, generating very long-lasting effects of transitory macroeconomic shocks.
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Notes
While Paravisini et al. (2015) do not find evidence in firm-level data for a direct effect of financial shocks on the extensive margin of trade, this result is conditional on the use of instruments to control for indirect effects on the extensive margin coming from, as they state, changes in the level in export demand, and changes in input costs. They explicitly say that their result does not reject potential explanations where: “a deterioration in credit conditions lowers the equilibrium size and profitability of each export flow, which, in turn, may reduce the probability of entering new markets – as we find when the period of analysis is extended to 2 years (Table 8, Panel 5).” (p353) Consequently, the empirical evidence of Paravisini et al. (2015) does not bear on the mechanism we propose, since we do not specify a direct effect of credit shock on entry, but rather that the credit shock affects entry indirectly through the channels of a rise in input costs for the investment good used for entry, a reduction in expected future export sales and profits, and through capital restructuring.
A well-known disadvantage of using a Cholesky decomposition on the reduced-form residuals is that results can be sensitive to the ordering of variables, calling into question the validity of the restrictions used for identification. In addition, ordering restrictions typically are not derived from a theoretical model. Robustness checks reported in section A of a Supplementary Online Appendix show that our conclusions are robust to alternative orderings.
Appendix also reports results for a panel VAR exercise, in which we redefine the measure of extensive margin to track the number of products rather than the combination of products and country, so that the country dimension is available for use for cross-sectional information. The cross-sectional information does not narrow the confidence bands for the variables of interest, trade, and the extensive margin. See Fig. 15. Only when we reduce the number of estimated parameters in the VAR by reducing the number of variables to 3, are we able to find a statistically significant negative long-run effect of the shock on the extensive margin of trade. This specification also redefines the shock by interacting the Libor rate with a dummy indicating the crisis period after 2008. See Fig. 16.
Given that we need a sunk cost of exporting, we did not want to also model domestic entry, as the presence of two sunk costs could introduce complex issues of option value of paying the domestic sunk in case it becomes optional under some future shock to pay the sunk export entry cost. This option value could greatly complicate the solution method, for reasons that have little bearing on the export entry decision we wish to focus on. Our specification of a constant mass of domestic firms while focusing on export entry follows that in Bergin and Lin (2012) and Ruhl (2008).
We are not unique in studying firm entry when firms are symmetric; see for example Bilbiie et al. (2007, 2012) and Bergin and Corsetti (2008). In general, it is possible to determine the number of exporting firms, even if one cannot identify which of the identical firms is doing the exporting. In the absence of heterogeneity, this identification does not affect the equilibrium. Given the size of overall home country export revenue, only so many home firms can enter before the fraction allocated to each firm is small enough to just barely justify a given entry cost.
Perri and Quadrini (2018) introduce international asset trade in equities in a two-country model with financial shocks and capital restructuring. However, our model differs in introducing non-traded goods, including some goods which are traded in some states and non-traded in others, which prevents us from using the standard modeling of equity trade used in Perri and Quadrini (2018). Further, introducing international financial integration in our model would not confer the benefit it does in their model, whereby it endogenously transmits financial shocks internationally, to make the tightness of the financial constraint co-move perfectly across countries. This is because collateral in our model is specified in terms of equity rather than capital, and the financial shock enters directly in the firm Euler equation.
We assume that death shocks apply to both exporters and non-exporters, since we do not want the decision of whether to become an exporter to be driven by an exogenous and arbitrary distinction that exporters are at greater risk of death shocks. Our specification of death shocks and a constant mass of domestic firms follows Bergin and Lin (2012) and Ruhl (2008). In our context, it is assumed that newly born non-exporting firms inherit the debt position of the dying non-exporting firms they replace.
The idea with financially constrained working capital needs is not new and can be widely seen in the literature, such as in Jermann and Quadrini (2009, 2012). The collateral constraint is not derived from an optimal credit contract. Instead, it may come from the limited enforcement that prevents lenders from collecting more than a certain fraction of the firm’s collateral asset value.
The model implicitly assumes that the debt of exiting non-exporters is inherited by newly born non-exporters. But Eq. (44) implies that the additional debt of exiting exporters relative to non-exporters disappears. The online appendix describes an alternative specification where the extra debt of exporters is passed exogenously on to newly entering exporters. As shown in appendix, our results are almost the same as for the benchmark specification.
See also Bergin and Lin (2012) and Lewis (2009) for discussions of this model feature. Our functional specification of entry costs more closely resembles that in Lewis (2009) in specifying the rise in entry cost as a function of the number of new entrants, motivated in terms of an imperfectly elastic supply of a factor specific to product entry such as advertising. Bergin and Lin (2012) also allow for the possibility of a congestion externality in entry but specifying the rise in entry cost as a function of total number of active firms. Their specification is in line with Berentsen and Waller (2009), which was motivated using a matching externality found in Rocheteau and Wright (2005) and common in monetary search models.
Although the model of Perri and Quadrini (2018) introduces financial integration which links the Lagrange multipliers on the collateral constraint of firms in both counties, they nevertheless need to assume financial shocks that are exogenously perfectly correlated across countries in order to generate international co-movement in financial flows.
In principle, when comparing model predictions to data, it is preferable to use data-consistent variable definitions of model variables, which do not adjust price indexes for availability of new products. See Ghironi and Melitz (2005). While the theoretical impulse responses reported in the main text are utility-consistent definitions from the model section, the corresponding impulse responses for data-consistent definitions are extremely similar, and our conclusions are unaffected. See Supplementary Online Appendix E for details of variable definitions and results.
Supplementary Online Appendix D reports results for an extension of the model that includes an internationally traded bond. Results indicate that a home financial shock has very similar effects on trade volume as in the benchmark model. Some international transmission takes place, as the home financial shock lowers foreign as well as home output, and generates a home current account deficit as home agents try to borrow from the foreign country.
The empirical VAR uses all fluctuations in the Libor rate to help identify financial shocks, not just the large shock of the 2008 crisis.
A slightly different calibration of parameters is needed in this case in order to ensure the existence of a steady state.
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Appendix
Appendix
See Figs. 11, 12, 13, 14, 15, 16 and Table 4.
Impulse responses to national financial conditions index: trade. Note: data are at monthly frequency, based on 6-digit HS disaggregate US export and import flows, running from 2002:1 to 2016:11
Impulse responses to national financial conditions index: exports. Note: data are at monthly frequency, based on 6-digit HS disaggregate US export flows, running from 2002:1 to 2016:11
Impulse responses to national financial conditions index: imports. Note: data are at monthly frequency, based on 6-digit HS disaggregate US import flows, running from 2002:1 to 2016:11
Impulse responses to interbank rate: real effective exchange rate included in the VAR. Note: we order the real effective exchange rate after monetary policy and the interbank rate, indicating that the real effective exchange rate responds contemporaneously to the shock. Our results are robust to alternative orderings. Data are at monthly frequency, based on 6-digit HS disaggregate US export and import flows, running from 2002:1 to 2016:11
Panel VAR with 7 variables. Note: data are at monthly frequency, based on 6-digit HS disaggregate US export and import flows, running from 2002:1 to 2016:11
Panel VAR with 3 variables. Note: data are at monthly frequency, based on 6-digit HS disaggregate US export and import flows, running from 2002:1 to 2016:11
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Bergin, P., Feng, L. & Lin, CY. Financial Frictions and Trade Dynamics. IMF Econ Rev 66, 480–526 (2018). https://doi.org/10.1057/s41308-018-0060-x
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DOI: https://doi.org/10.1057/s41308-018-0060-x