The impact of financial crises on industrial growth: lessons from the last 40 years

Summary

Focus

Financial crises have a large impact on economic growth, and recoveries from such episodes can take years. However, assessing the causal effect of financial crises on GDP growth is difficult. This is because of reverse causality – the possibility that shocks to current or expected growth were a cause of the crisis.

Contribution

I focus on the effect of financial crises on manufacturing growth, using panel data from 102 countries and 23 industries. Since manufacturing industries are small and usually outside of financial regulators' responsibility, the model adequately identifies the causal effect of financial crises. I study two channels for the impact of financial crises: their direct effect on all manufacturing industries and through each industry's external finance dependence. I also study the effect on manufacturing industries' growth of the macroprudential policies adopted after the Great Financial Crisis (GFC).

Findings

I find that financial crises reduce manufacturing growth, both in terms of their direct effect on all industries and through industries' dependence on external finance. The direct effect is the most powerful. Banking, currency and sovereign debt crises cause a reduction in total manufacturing growth in the full sample by 2.7%, 6% and 1%, respectively. Considering just the external finance dependence channel, banking, currency and sovereign debt crises cause a reduction in manufacturing growth in the full sample of 0.8%, 1.3% and 0.3%, respectively. Notably, currency crises impact emerging markets and developing economies (EMDEs) more strongly. Sovereign debt crises have stronger effects on advanced economies (AEs). The impact of banking crises was even stronger during the GFC, especially in EMDEs. However, macroprudential policies adopted after the GFC increased manufacturing growth during banking crises in both AEs and EMDEs.

Abstract

This work shows the impact of financial crises across industries and the total manufacturing sector. I find both a direct impact of financial crises on all manufacturing growth and an additional effect through an external finance dependence channel. Externally dependent industries experience lower growth during banking and currency crises, especially in emerging markets and developing economies. Banking, currency and sovereign debt crises cause an average reduction in total manufacturing growth of 2.7%, 6% and 1%, respectively, with the direct effect being the most significant component. Finally, I show that macroprudential policies adopted after the Great Financial Crisis attenuated the fall in growth caused by banking crises.

JEL Classification: E44, G01, O10, O16

Keywords: financial crises, banking crises, growth, external finance dependence, credit frictions