The Impact of the Global Financial Crisis and the Role of External and Internal Factors in Emerging Economies

ABSTRACT

This article assesses the impact of trade, capital openness and institutions on emerging economies’ output loss during the “Great Recession.” The fixed-effect estimates of an unbalanced panel of 122 emerging countries observed from 2008 to 2010 yield three main results. First, trade openness has exacerbated output loss. Second, capital openness can help mitigate the negative impact of an external shock, but this is conditional on the level of financial development. Finally, the results also point out that the interrelations between financial and institutional development affect the crisis’s severity.

KEY WORDS:

• Emerging economies
• financial institutions and governance
• global financial crises
• trade and capital openness

JEL codes:

• F49
• G01
• G20
• P59

Notes

^1. Due to increased globalization, many emerging economies are exposed to external economic shocks (e.g. Kutan 2015). However, what exactly determines the vulnerabilities to global turmoil remains a contentious matter.

^2. It was especially with the collapse of Lehman Brothers (September 2008) that a remarkable global diffusion of the US crisis became much more evident.

^3. The predicted values of national GDP growth rates published in April 2008 by IMF are, obviously, the latest forecasts available for that time and refer to estimations made in the year 2007 or 2006.

^4. The Cronbach Coefficient Alpha assesses how a set of indicators measures a unidimensional concept (OECD 2008). This technique is useful for clustering similar variables. It therefore seems particularly appropriate for the chosen Kaufmann indicators, which are highly correlated.

^5. We also carried out the same exercise with a different threshold, i.e. we used the mean of the institutional indicators to create the two subsamples of interest. These results are not reported here, but are available upon request.

^6. It is worth mentioning that, in order to verify whether the differences observed in the two groups were statistically significant, we carried out a further check. That is, we ran a regression between the variable of interest (i.e. any of the explanatory variables of Equation 1) and the dummy classifying the two groups of countries. If both the variable of interest and the interaction term were statistically significant, it could be concluded that the effect of the selected explanatory variable was different across the two groups (i.e. very low- vs. good-quality institutions), and hence that internal institutions played a major role in determining the severity of the crisis in terms of output loss.

^7. To be noted is that, following the suggestion of an anonymous referee, we have replicated our exercise in three distinct cross-sections, one for each of the years considered (i.e. 2008–2010). The results of our main exercise are qualitatively unaltered. To save space, we do not report them here, but they are available upon request. We thank a referee for suggesting this important robustness check.

^8. To be noted is that, in order to assess the relative importance of financial institutions and financial markets, we have split our sample into bank-based and market-based economies. This has been done following the recent work of Gambacorta, Yang and Tsatsaronis (2014). In line with Levine (2002), Beck and Levine (2002) and Chakraborty and Raybhttp://www.sciencedirect.com/science/article/pii/S0304393205001534—aff2 (2006) we do not find evidence that one system outperforms the other in terms of making countries more resilient to global financial turmoil. To save space we have not reported these results here, but they are available upon request. We are grateful to an anonymous referee for providing this suggestion.

^9. As for the magnitude of the impact of trade openness, although our results are not comparable with others existing in the literature (mainly due to different specifications or periods), it should be highlighted that we find a quite high value of the coefficient (as detailed above).

^10. Differently, Maa (2015) reports that increased financial openness is associated with sharper volatility in the presence of foreign shocks. Consequently, it can aggravate the impact of a crisis.

^11. Although the effect of this variable is not statistically significant, its positive sign and, especially, the (jointly) significant role of capital openness suggest future research on the potential and effective actions of the central banks in emerging economies in crisis times.

^12. In particular, they show that, in the case of developing countries, distorted incentives within the financial sector can increase the likelihood of crises, making such countries more vulnerable.

^13. Although the 2008 financial crisis was the worst since 1929, it should be noted that reforms of “regulatory system and governance” have been—until now—very scarce at both international and national levels. Moreover, on a Keynesian view, it is important to mention that, on the occurrence of a financial crisis, the timing and size of the countercyclical monetary and fiscal policies are fundamental for reducing the magnitude and duration of a recession: for instance, the very different cumulative real impact of the global financial crises in the US and in Europe (especially Eurozone) can be—at least partly—explained by the very different features and timing of the monetary and fiscal policies (e.g. Marelli and Signorelli 2015).

^14. For a study adopting a long-run approach not focused on crisis time, see Bonnala and Yayab (2015) who investigate the relationship among political institutions, trade openness and economic growth using a panel of over 200 countries and eight nonoverlapping 5-year average observations for the period 1975–2010.