Sub-Saharan Africa’s low level of financial development meant that African banks were not directly involved in the credit crunch. But this column warns against rejoicing. If the cost of such low development is that African exporters are very dependent on external trade finance, then the real cost of the global crisis on Africa may actually be higher.
The early view during the global crisis was that Africa's low level of financial integration was a blessing in disguise. Indeed, it is certainly the case that the direct wealth effect has been smaller than in other regions such as East Asia, Latin America, and Central and Eastern European countries which are more open to financial flows than African countries.
The early view during the global crisis was that Africa's low level of financial integration was a blessing in disguise. Indeed, it is certainly the case that the direct wealth effect has been smaller than in other regions such as East Asia, Latin America, and Central and Eastern European countries which are more open to financial flows than African countries.
But while the decision by African banks not to buy "toxic" assets provided some shelter, the continent may have been harder hit by other transmission channels, in particular the trade channel. The trade collapse has hit African countries particularly hard (Baldwin 2009, Draper and Biacuana 2009, and Kandiero and Ndikumana 2009).
An indication of this vulnerability is given by US trade statistics between 2008 and 2009. Following the crisis, the fall in US imports from African countries has been much larger than from other countries. This is especially true for African manufacturing exports. This suggests that the fall in African exports is not only a composition effect due to the importance of primary goods and the fall in primary goods prices. This raises the following questions:
What is behind this sharp fall of African exports to the US?
What does it reveal on the vulnerability of African exporters to financial crises in partner countries?
What are the mechanisms through which a financial crisis in a partner country affects African exports?
In a recent paper (Berman and Martin 2010), we attempt to partially answer these questions by analysing the impact of past financial crises on bilateral trade flows. Using sectoral bilateral trade data and for 1976-2002, and a gravity equation approach, we quantify the deviation of exports from their "natural" level generated by financial crises.
We distinguish two mechanisms through which a financial crisis in a country affects the exports of partner countries.
The income effect (financial crisis are typically associated with sharp recessions which lead to a fall in consumption and imports). We find that African exports are more sensitive to large negative income movements in the countries they trade with. This is true both for manufacturing and primary goods exports.
Second, for a given fall in income and demand, African exports may be adversely hit by a financial crisis due to what we call a disruption effect. The disruption effect may take direct or more subtle forms. The most direct effect, one that has been widely discussed in policy circles is the fall in trade credit that makes international trade more costly (see Amiti and Weinstein 2009 and Chor and Manova 2010).
There are however more subtle ways through which the financial crisis may negatively affect trade. In particular, although it is difficult to measure it, risk aversion increases amongst bankers and traders during a financial crisis and this may affect more severely countries or groups of countries which are viewed as more risky.
As shown in Figure 1, we find that the disruption effect on trade is more important (at least 20% larger) and longer lasting for African countries than for exporters of other regions. Again, this disruption effect comes in addition to the fall of exports due to the fall of income and consumption. This sharp difference applies both for primary products and manufactured goods. We also find that for African countries, the largest disruption effect comes when the destination country which is hit by a financial crisis is industrialised.
Figure 1. Exports after financial crisis in partner country, Africa
Note : Figure 1 shows the deviation of Sub-Saharan African exports after a financial crisis that takes place in year t = 0, with respect to the average disruption effect. A positive (negative) excess trade ratio means that the effect of a financial crisis in the partner country on African exports is more positive (negative) than the average effect on exports. Source: Berman and Martin (2010). Finally, we also investigate whether this vulnerability comes from the strong dependence of African countries on trade credit.
The role of trade credit financing
Our results suggest that this dependence exerts a significant role in shaping the reaction of African exports to countries experiencing financial crises. The disruption effect is indeed only found to be negative and significant in African countries which are more dependent on trade finance.
One interpretation is that during a financial crisis when uncertainty is high, trust and liquidity are low, banks and firms in the importer country first cut exposure and credit to particular countries which are seen as more risky. This would in particular affect trade finance through letters of credit where the importer pays the exporting firm in advance. It is also likely that during financial crisis, financial institutions "renationalise" their operations and reduce their exposure to foreign banks and firms.
Exporters in countries with a strong financial system may be able to better resist to such retrenchment of foreign banks. Clearly, for African firms which are more dependent on foreign finance, this option may not be feasible. At this stage, these interpretations of our results are only tentative and more research needs to be done to better understand the origin of the particular fragility of African exports to financial crises in industrialised countries.
Our results can be viewed as contradicting the implicit policy conclusion that came with the early conventional wisdom. The underdevelopment of financial systems in Africa is not a "blessing in disguise" in the current crisis. If the cost of such low development is that African exporters are very dependent on external trade finance, then the real cost of the financial crisis on Africa may actually be higher due to the underdevelopment of financial systems.
References
Amiti, Mary and David Weinstein (2009), "Exports and financial shocks: New evidence from Japan", VoxEU.org, 23 December.
Baldwin, Richard (ed.), The Great Trade Collapse: Causes, Consequences and Prospects, VoxEU.org, 27 November.
Berman, Nicolas and Philippe Martin (2010) “The vulnerability of Sub-Saharan African countries to financial crises: the case of trade”, CEPR Discussion Paper 7765
Davin Chor Kalina Manova (2010), “Off the cliff and back? Credit conditions and international trade during the global financial crisis”, VoxEU.org, 15 February.
Draper, Peter and Gilberto Biacuana (2009), “Africa and the trade crisis”, in Richard Baldwin (ed.), The Great Trade Collapse: Causes, Consequences and Prospects, VoxEU.org, 27 November.
Kandiero, Tonia and Léonce Ndikumana (2009), “Supporting the World Trade Organization Negotiations: Looking Beyond Market Access”, in Richard Baldwin (ed.), The Great Trade Collapse: Causes, Consequences and Prospects, VoxEU.org, 27 November.
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