Financial Crises and International Trade: the Long Way to Recovery

Recent emerging market crises have emphasized the fluctuating character of trade’s reaction after financial crises, in contradiction with the apparently simple theoretical impact of such events on trade, which is essentially described by the well-known J-curve mechanism.. We use a gravity-like equation to assess the impact of these events on bilateral sectoral trade and reveal the elements which can improve their effect and accelerate countries’ recovery. We find that both currency and banking crises have a long-lasting negative impact on trade. Trade remains under its natural level during eight years after a currency crisis. The persistent negative impact of currency crises on exports is magnified by the combination of firms’ foreign currency borrowing and high fixed costs, which leads to important balance-sheet problems. Post-crisis volatility explains a large part of the negative imports’ reaction after currency crises. Finally, the effect of crises on exports largely depends on the country’s specialization: currency crises have a more positive effect as the country exports goods associated with a high elasticity of substitution and a low financial external dependence; specialization biased toward highly differentiated, externally dependent industries magnifies the negative impact of banking crises. JEL classification: F12, F17, F32, F34