Real effects of banking crises: Imports of capital goods by developing countries

• Author: Andreas Savvides,Nektarios A. Michail
• DOI: http://doi.org/10.1111/rode.12399
• Published date: 01 August 2018
• Date: 01 August 2018

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Real effects of banking crises: Imports of capital

goods by developing countries

Nektarios A. Michail

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Andreas Savvides

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Central Bank of Cyprus and Cyprus

University of Technology, Nicosia,

Cyprus

2

Cyprus University of Technology,

Limmasol, Cyprus

Correspondence

Andreas Savvides, Department of

Financial Economics and Shipping,

Cyprus University of Technology,

Limassol 3603, Cyprus.

Email: andreas.savvides@cut.ac.cy

Abstract

We examine the hypothesis that banking crises have real

effects on developing economies by reducing imports of

capital goods. We test this hypothesis by estimating a

model for the determinants of imports of capital goods by

a panel of developing economies during 1961 to 2010.

Our results suggest that not only do banking crises have

statistically significant and economically important effects

on imports of capital goods, but these effects increase the

longer a banking crisis lasts. Imports of capital goods are

a critical component of the capital stock and the produc-

tion process in developing economies and, thus, our

results highlight one important channel through which

banking crises may hamper the growth prospects of these

economies.

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INTRODUCTION

The causes and economic effects of banking crises have been debated by policy makers and the

academic community alike. Though these issues have long been the subject of study, the late-

2000s global financial crisis and the emergence of banking crises globally have reignited interest

in this area. Beginning with the seminal work of Kaminsky and Reinhart (1999), a large literature

has been devoted to analyzing the factors behind the occurrence of banking crises. This literature

attempts to develop early warning signals of banking crises: Kaminsky and Reinhart identify the

capital account and financial liberalization as the best indicators for predicting crises, followed by

the terms of trade, exports and the real exchange rate. Demirg€

ucß-Kunt and Detragiache (2005) sur-

vey this literature. More recent contributions include Karim, Liadze, Barrell, and Davis (2013)

who find that off-balance sheet exposures and property prices are significant determinan ts of bank-

ing crises while Dattagupta and Cashin (2011) find that very high inflation, highly dollarized bank

deposits and low bank profitability are important.

DOI: 10.1111/rode.12399

Rev Dev Econ. 2018;22:1343–1359. wileyonlinelibrary.com/journal/rode ©2018 John Wiley & Sons Ltd

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Another, but less voluminous literature, investigates the real effects of banking crises. Hutchi-

son and Noy (2005) find that banking crises reduce output by 5 to 8 percent over a 2 to 4-year

period. Others, such as Boyd, Kwak, and Smith (2005), suggest that the effect on real GDP per

capita is dependent on country characteristics. They find that, on average, the present discounted

value of crisis-related output losses ranges from 63 percent to 302 percent of real per capita GDP

in the last year before the onset of the crisis. Joyce and Nabar (2009) estimate that the occurrence

of a banking crisis in developing economies is associated with significant reductions in the share

of gross fixed capital formation in GDP: the long run impact of a banking crisis is a decline in the

ratio by some 3.4 percentage points. Haugh, Ollivaud, and Turner (2009) arrive at similar results;

they show that in addition to output losses, housing and business investment also disproportion-

ately drop.

Our paper contributes to this literature on the real effects of banking crises on developing

economies. Further to our contribution on this realm, one area of research that has been relatively

neglected by the literature is the effect of banking crises on the flow of international trade. Studies

in this area have shown that, in general, banking crises have significant effects on international

trade. However, they are mostly confined to export decisions by firms in developed countries in

times of credit constraints related to banking crises. A study of the effects banking cris es may have

on imports, and especially imports of capital goods, by developing economies has not appe ared.

The need for developing countries to import capital goods is an important consideration in eco-

nomic development because these countries are prevented by technological and production con-

straints from producing their own capital goods and rely, to a very large extent, on imports from

developed economies. Capital imports are a key input in the domestic production process of devel-

oping economies and banking crises may have deleterious effects as they may cut off the supply

of an important productive input. Several studies have suggested that imports of goods that

embody foreign technology raise a country’s output both directly (as inputs into the production

process) and indirectly through reverse engineering of these goods (e.g., Connolly, 2003; Lee,

1995). Moreover, studies have shown that imports of capital goods are more important to the pro-

cess of innovation and imitation in developing countries than other forms of technology diffusion

such as foreign direct investment or intellectual property rights (e.g., Connolly, 2003; Savvides &

Zachariadis, 2005; Schneider, 2005).

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In sum, reductions in capital goods imports have potentially

damaging consequences for both the process of innovation and imitation in developing countries.

The purpose of this paper is to investigate the impact of banking crises on imports of capital

goods by developing economies. Banking crises can result in significant changes to imports of cap-

ital goods through various channels. One is through a reduction in aggregate demand as a result of

the overall deterioration of the macroeconomic environment, while another is via a reduction in

business funding through tightening of bank lending. Consequently, during banking crises firms

tend to reduce investment even more than expected based on macroeconomic developments, in

order to cut costs. Calvo, Izquierdo, and Talvi (2006) elaborate on this point and Kroszner, Lae-

ven, and Klingebiel (2007) also provide supporting evidence of a credit-channel impact of banking

crises.

Our paper makes several contributions. First, we provide an empirical test of the hypothesis that

banking crises have an adverse impact on the growth of imports of capital goods. Second, we look

at imports of several categories of capital goods employing disaggregated international trade data

from the OECD. Third, we provide a general empirical framework to evaluate various determinants

of the import of capital goods by developing countries and examine the main hypotheses with a

panel data set from a wide variety of developing economies during 1961 to 2010. Finally, we pro-

vide several robustness checks of our results.

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MICHAIL AND SAVVIDES