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Lunch Seminar: Fadi Hassan - Banca d'Italia
Wednesday 15 May 2019, 01:00pm - 02:00pm

Trade Shocks and Credit Reallocation (joint with Stefano Federico e Veronica Rappoport)

Abstract:

The effect of trade liberalization on welfare and economic activity remains one of the most important questions in economics. The literature identifies a number of key determinants that reduce the potential gains from trade, by focusing on frictions to labor mobility across regions or sectors. This paper contributes to this debate by exploring a novel channel, namely the reallocation of credit across sectors in the aftermath of a trade shock. Our results suggest that there are endogenous financial frictions that arise from trade liberalization as, given the portfolio of firms they lend to, banks can be negatively affected by a trade shock. Using data from the Italian credit registry, matched with bank and firm level data, we follow the evolution of the bank and firm activities across sectors and regions prior to and after the entry of China into the WTO. We identify the sectors most affected by import competition from China and estimate the transmission of this trade shock from firms to their lending banks, and the consequence of the shock on banks' lending to other firms. We find that, controlling for credit demand, banks exposed to the China shock decrease their lending relative to non-exposed banks. Importantly, this lending is reduced both for firms exposed and those non-exposed to competition from China. The main mechanism is related to the reduction of the core capital of banks, and their resulting funding capacity, through the rise of non-performing loans. We quantify the impact of this effect on real outcomes such as output, investment, and employment. We find relevant aggregate effects such that employment would have been between 1.2 and 3.0 higher if these financial frictions were less binding.  

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