The Vulnerability of sub-Saharan Africa to the Financial Crisis
The Case of Trade
Background paper to the ERD2009
Paper prepared for the Conference on “Financial markets, adverse shocks and policy responses in fragile countries”, organised by the European Report of Development in Accra, Ghana, 21-23 May, 2009.
In the early stages of the crisis, the conventional wisdom was that the financial under-development of the Sub-Saharan African economies may have been a blessing in disguise because it insulated them from the direct effects of the crisis. This paper argues that this may also make African firms, particularly exporters, dangerously more dependent upon foreign finance in the countries to which they export. Motivated by the present dramatic fall in international trade, which has hit Sub-Saharan African countries very strongly, we analyse the channels through which a financial crisis can affect trade. We focus on two channels: the income channel and the disruption channel. Exports to crisis-hit countries fall because demand falls in these countries. In addition to this income effect, trade may be disrupted because trade relations depend on a well-functioning financial system, both in the country of origin and in the country of destination. Using a large sectoral database of bilateral trade and of financial crises, and a gravity equation approach, we quantify the deviation of exports from their gravity determinants. First, we show that African exports are more sensitive to large negative income movements in the countries with which they trade. This is true both for the exportation of both manufacturing and primary goods. We also show that the disruption effect is more important and longer-lasting for African countries than it is for exporters of other regions. As compared with other regions, the disruption effect is greater for African exporters (-35%), aggravates over time and disappears only 4 to 7 years after the crisis. 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. However, we find no evidence of the disruption effect on African imports from crisis-hit countries. Finally, we provide evidence that dependence upon trade credit may explain part of the fragility of African exports to financial crises.