The great trade collapse and Indian firms

• Published date: 01 January 2018
• DOI: http://doi.org/10.1111/twec.12517
• Date: 01 January 2018
• Author: Pavel Chakraborty

ORIGINAL ARTICLE

The great trade collapse and Indian firms

Pavel Chakraborty

Centre for Trade and Development, School of International Studies, Jawaharlal Nehru University, New Delhi, India

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INTRODUCTION

The financial crisis of 2008–09—triggered by the bankruptcy of Lehman Brothers and the virtual

nationalisation of world’s largest insurance company, American Insurance Group, Inc. (AIG)—

soon led to a fall in both demand for goods and supply of credit which catapulted into a global

trade crisis. As Richard Baldwin (2009, pp. 12) writes, “For most nations of the world [...] this is

not a financial crisis –it is a trade crisis.”In the words of Paul Krugman, “world trade acted as a

transmission mechanism”which led even the countries with robust financial systems into economic

distress (Evans, 2009). World Bank (2010) and/or the WTO (2010) estimate that real global output

declined by 2.2%, whereas the real global trade had the same fate, but by more than five times of

the global output. The collapse in global trade by over 17% between the second quarter of 2008

and the second quarter of 2009 is one of the most dramatic features of the recent “Great Reces-

sion.”

Studies concerning the 2008–09 crisis have largely exploited the developed nations’data,

except Paravisini, Rappoport, Schnabl, and Wolfenzon (2014) on Peru and Aisen, 

Alvarez, Sagner,

and Tur

en (2013) on Chile.

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India, an emerging nation, that has its real sector well integrated with

the world trade matrix today (as a result of the liberalisation policies adopted in the 1990s) is no

exception to escape the brunt of the crisis.

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It experiences an overall decline in its gross domestic

product (GDP), trade values (both exports and imports) and other important macroeconomic indi-

cators during the crisis period. Considering the 2008–09 crisis as a natural experiment, I study the

behaviour of Indian manufacturing exporters as a result of possible demand shock(s) from its

major trading partners or importers using a matched data set of the manufacturing firms with the

destination-specific product-level trade flows at the HS (Harmonised System) six-digit level. The

result is clear—Indian manufacturing exporters suffered heavily as a result of the fall in demand

from its major importers, especially the USA, as result of the 2008–09 crisis.

The current research on the likely causes of the Great Trade Collapse (GTC) of 2008–09

mainly highlights the following mechanisms by which the crisis impacts trade: (i) drop in demand

(Baldwin, 2009; Behrens, Corcos, & Mion, 2013; Bems, Johnson, & Yi, 2010; Eaton, Kortum,

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Both the studies investigate how financial constraints, because of 2008–09 crisis, affect performance of the manufacturing

firms.

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However, on the financial side, it is still weakly integrated into the global financial cobweb. Its financial sector, particularly

the mortgage-backed securities, is loosely connected with the global markets (Kumar & Alex, 2009). For example, Indian

banks do not have any direct exposure to the mortgage-backed securities, and their off-sheet activities are also quite limited.

DOI: 10.1111/twec.12517

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©2017 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/twec World Econ. 2018;41:100–125.

Neiman, & Romalis, 2016; Levchenko, Lewis, & Tesar, 2010) and (ii) difficulties in the supply of

finance (Aisen et al., 2013; Amiti & Weinstein, 2011; Auboin, 2009; Bricongne, Fontagn

e, Gau-

lier, Taglioni, & Vicard, 2012; Chor & Manova, 2012; Helbling, Huidrom, Kose, & Otrok, 2011;

Paravisini et al., 2014).

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Other factors, which potentially have also impacted the fall in trade dur-

ing the 2008–09 crisis, are the rising trade barriers (Baldwin & Evenett, 2009; Jacks, Meissner, &

Novy, 2011; Kee, Neagu, & Nicita, 2013) and the behaviour of imported inventories (Alessandria,

Kaboski, & Midrigan, 2010; Altomonte, Mauro, Ottaviano, Rungi, & Vicard, 2013).

Following the literature

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, I aim to investigate how Indian manufacturing exporters adjusted to

external shock(s) during the current financial crisis. In particular, I use the 2008–09 crisis as a nat-

ural experiment to investigate the role of demand (from the major importing partners, namely the

USA and the European Union (EU)) on the intensive margin (amount of exports) of Indian manu-

facturing firms.

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The results show that decline in export flows in case of India as a result of the

2008–09 financial crisis is due to one central issue—the sudden drop in demand (as a result of the

2008–09 crisis) for India’s goods from two of its major trading partners, the USA and the EU.

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The drop in demand may have curtailed the firms’production and export capacities which led to

significant decline in the export earnings of an Indian manufacturing firm.

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I focus primarily on the USA and the EU because of the following two reasons: (i) first, they

are two of the largest trading partners of India and account for around 35% of India’s merchandise

exports (in 2008). In addition, the income elasticity of demand for India’s exports is esti mated to

be the highest in case of the USA, which is 2.5, while for global exports, it is 1.9 (UNCTAD,

2009) and (ii) focusing on the USA and the EU will help me to establish the direct evidence of

the impact of 2008–09 financial crisis on the trade collapse of the Indian exporters, whereas focus-

ing on the world or any other group of countries or regions may not do so (since other regions

were affected as a result of the crisis in the USA and the EU). Although I highlight the role of

demand spillover on the decline in international trade flows (in this case exports), I do not per se

belittle the role of trade friction (increase in trade barriers) or disruptions in supply of trade credit

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in explaining the collapse. These factors may well also be important in accounting for the residual

decline in trade, which my analysis does not capture. However, I control the above-mentioned fac-

tors using interactions of industry fixed effects with the year trends.

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The studies, which pursue the demand-side explanation as the major role behind the fall in trade, use trade data at the coun-

try level rather than at the firm level, except for Behrens et al. (2013). They use Belgian firm-level data to show that the fall

in the demand for tradables, especially durables and capital goods, is the main explanation behind the fall in trade for Bel-

gium.

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Specifically Baldwin (2009), who asserts that the GTC is primarily caused by a demand-side shock, amplified by “composi-

tional”and “synchronicity”effect.

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Current research on 2008–09 crisis shows us that most of the activity happened at the intensive margin (Levchenko et al.,

2010).

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The study that comes closest to this paper is by Bems et al. (2010). They use global input–output framework to quantify

the US and the EU demand spillover during the global recession of 2008–09. They conclude that 20%–30% of the decline

in demand in the USA and the EU is borne by the foreign countries with Asia being hit the hardest. Further, by changing

the demand for all countries simultaneously, they find that demand alone accounts for 70% of the trade collapse.

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The only other study, which highlights the role of demand using firm-level data, is by Behrens et al. (2013). It uses data

for Belgium, a OECD member country. All other studies using firm-level data for both developed and developing nation

find credit channel to be the most important factor. A developing, export-oriented nation like India had a very different kind

of crisis in the sense that the banks and the domestic financial system were not directly hurt as they are not directly inte-

grated into the global system unlike the real sector.

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I use a proxy to explore the role of finance, especially foreign sources of finance (borrowings from foreign banks), along

with demand spillover. But, the benchmark results stay the same.

CHAKRABORTY

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