Financial Crises and International Trade: The Long Way to Recovery

Standard theoretical models would predict that a currency depreciation generates an increase in net exports. However, recent emerging market crises, accompanied by sharp exchange rate devaluations, have often been followed by a fall in or a stagnation of exports. This paper provides a simple theoretical framework which shows that a currency crisis affects trade through (i) a competitiveness effect, i.e. a variation in relative prices, that positively influences the intensive margin of trade (the amount of exports by firms); (ii) a balance-sheet effect, i.e. a modification of the fixed cost of exports, which negatively affects the extensive margin of trade (the number of exporters). We derive from our model a gravity-like equation of bilateral sectoral trade which we estimate using data on 27 industries and 32 countries over the period 1976-2002. First, we find that these events have a long-lasting negative impact on exports - which remain below their natural level for five years. We present evidence suggesting that this persistent effect is due to the combination of firms’ foreign currency borrowing and fixed costs of exports, which leads to important balance-sheet problems in the aftermath of the crisis. Second, the net effect of crises on exports largely depends on country specialization: the positive competitiveness effect is magnified by a specialization in high elasticity of substitution’s industries, while negative balance-sheets effects are exacerbated in industries more dependent upon external finance, in which assets are more tangible, or in high fixed costs sectors.