Garrick Blalock, Cornell UniversityPaul Gertler, University of California, BerkeleyDavid Levine, University of California, Berkeley

Investment Following a Financial Investment Following a Financial Crisis: Does Foreign Ownership Crisis: Does Foreign Ownership

MatterMatter

2

Financial Crises are Pervasive

• Last decade has had annually: – Mexico– East Asia– Russia– Turkey– Latin America (more than once)

• Two elements: – Large currency devaluations– Financial sector meltdowns

3

Crisis reduces investment for most firms

• Investment falls due to:– Fall in domestic demand – Banking crisis

• Reduced credit supply• Uncertainty about borrowers’ creditworthiness,

value of collateral

4

Both devaluation & credit affect exporter investment• On the one hand: Exporters & those

who compete with imports should invest.

• Bank failures may impede investment.

• Back to the first hand: Foreign affiliates may be able to use internal or foreign credit markets.

5

Foreign Advantages to Credit Access

• Parent company has access to internal funds.– And good information on

creditworthiness of subsidiary.• Western accounting increases

transparency– May raise access to overseas funds.

6

We observe less investment after a crisis.

Question 1: Do liquidity constraints contribute to lower investment?

Question 2: Does foreign ownership avoid the liquidity constraints?

We address these question for the Indonesian financial crisis of 1997-1998

What explains post-crisis investment

7

Prior literature

• Lots of studies show crises lower investment but some competitiveness effects for exporters (Aguiar 2002, Forbes 2002)

• Lots of studies show liquidity constraints sometimes matter (Fazzari, Hubbard & Peterson 1988; Bernanke & Gertler 1989; Hoshi, Kashyap & Scharfstein 1991; Hubbard 1998)

• Not conclusive if liquidity constraints matter in a crisis--as opposed to lower demand (Aghion, Bachetta & Banergee 2000; Aquiar 2002; Bleakley & Cohen 2002; Desai, Foley & Forbes 2003)

8

Presentation Outline

• The institutional setting

• Data and measurement• Empirical strategy• Results• What have we learned?

• Why Indonesia?• Review of crisis

9

Why Indonesia?

• Largest real currency devaluation in recent history• Both a currency crisis and a banking crisis:

– banks closed – new credit issued fell by half

• Crisis unanticipated, even after Thai Baht devaluation

• Time-series data on large number of domestic and foreign manufacturing firms before and after crisis

10

Indonesia suffered massive currency devaluation in 1997-1998

July 1997 Thai Baht floated

August 1997 Rupiah band eliminated, currency plunges

November 1997 16 banks closed, more promised, deposits not guaranteed, initial IMF agreement reached

December 1997 Almost half of all bank deposits withdrawn

January 1998 Indonesia Bank Reconstruction Agency formed, deposits guaranteed

May 1998 New IMF agreement, rioting, Suharto resigns

11

Exchange rate vs. urban prices

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

Jan-97 Jan-98 Jan-99 Jan-00100

120

140

160

180

200

220

Rupiah/$

UrbanCPI

12

Implications for firm investment prospects

Real price of non-tradable inputs falls dramatically: labor-intensive exporters should benefit greatly

Many firms highly leveraged with foreign debt now much more costly to repay

Few were hedged because history of gradual rupiah float

13

Implications for firm borrowing

• Poor transparency and corruption made monitoring of borrowers difficult in crisis

• Suharto resignation devalued many business relationships

• Run on banks sharply reduced available credit• Even state-run banks vulnerable to closing if new

reserve requirements not met

Question: Were foreign affiliates largely exempt from these problems?

14

Presentation Outline

• The institutional setting

• Data and measurement

• Empirical strategy• Results• What have we learned?

15

Indonesian Data

Annual manufacturing census, 1990-2000:– ~20,000 factories with more than 20 workers– Measures of output, capital, labor, materials,

exports, and foreign equity

Price deflators:– WPI for output– Mix of building, machinery, and vehicle prices for

capital

16

Presentation Outline

• The institutional setting• Data and measurement

• Empirical strategy

• Results• What have we learned?

17

Two-stage Identification

• Compare post-crisis outcomes between Indonesian exporters and non-exporters

– H1: Exporters should profit, hire workers, and invest in the absence of constraints

• Compare post-crisis outcomes between Indonesian exporters and foreign exporters

– H2: Both foreign and domestic exporters should expand in absence of liquidity constraints

18

Estimated Outcomes

Value added Labor: variable input relatively easy to finance

through cash flowCapital: land, machinery, vehicles, and other

fixed assets more likely to need external financing

19

Identification Strategy

• Control for firm and industry heterogeneity– Use plant fixed effects– Estimate by industry

• Avoid using 1997 and 1998 data– Reported values hard to interpret with 100%

inflation within the year.– Use 1994-1996 as pre-crisis and 1999-2000 as

post-crisis

20

Identification Strategy• Avoid reliance on first difference in capital

– Difficult to separate changes in capital asset holdings from changes in capital asset valuations

– Use differences in differences model• Control for firm debt leverage

– Denomination of debt to extent possible• Preserve sample size

– Balance sheet information needed to calculate marginal Q available for only a few firms

• Check for time trends and heterogeneous treatment effects

21

Other identification issues

• Sunk cost to becoming an exporter so pre-crisis exporting behavior good predictor of potential devaluation benefit– Less than 2% of pre-crisis non-exporters become exporters

• Many foreign affiliates owned by Asian parents– Many Singaporean and Korean firms– Biases against benefits of foreign ownership

• Political hazards could deter investment– Unclear if severity of hazard varies by ownership– Ethnic-Chinese businesses targeted by riots

22

Specification

On the population of domestic firms

On the population of exporting firms

23

Presentation Outline

• The institutional setting• Data and measurement• Empirical strategy• Results

• What have we learned?

24

Sample size

Firm type N in 1996 share survived until 2000

Domestic non-exporter 16,847 0.70

Domestic exporter 4,036 0.81

Foreign exporter 917 0.88

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Mean values of outcome before & after crisis

Log(VA) Log(labor) Log(capital)

Pre- Post- Pre- Post- Pre- post

Domestic non-exporters

10.6 10.5 3.9 3.6 11.3 11.0

Domestic exporters

12.8 12.8 5.1 5.1 13.2 12.8

Foreign exporters 14.5 14.8 5.7 5.8 14.8 14.3

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Mean capital by firm type

1010.5

1111.5

1212.5

1313.5

1414.5

15

mea

n lo

g(K

) def

late

d

Domestic Non-exportersDomesticExportersForeignexporters

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All Industries: Fixed effect estimation

Log(VA) Log(labor) Log(K)

Exporter*post-crisis 0.203(9.87)

0.123(16.03)

-0.019(1.12)

Foreign*post-crisis 0.339(8.17)

0.154(8.56)

0.088(2.26)

ForLeverage*post-crisis -0.000(0.93)

0.022(2.11)

-0.000(0.21)

0.008(1.76)

-0.001(3.04)

0.023(1.83)

DomLeverage*post-crisis 0.001(1.65)

0.002(2.02)

0.000(0.23)

0.000(0.32)

-0.001(1.30)

-0.001(1.05)

Firm and year f.e. Y Y Y Y Y Y

No. firms 9444 3324 9477 3327 7350 2571.

Green: domestic firms only. Blue: exporters only.

28

Food: fixed effect estimation

Log(VA) Log(labor) Log(K)

Exporter*post-crisis 0.016(0.33)

0.084(4.53)

-0.134(3.57)

Foreign*post-crisis 0.574(4.22)

0.259(3.68)

0.246(2.29)

Firm and year f.e. Y Y Y Y Y Y

No. firms 2188 430 2190 430 1703 332

.

Green: domestic firms only. Blue: exporters only.

29

Textiles: fixed effect estimation

Log(VA) Log(labor) Log(K)

Exporter*post-crisis 0.087(1.72)

0.006(0.31)

0.005(0.12)

Foreign*post-crisis 0.223(2.44)

0.088(2.14)

0.213(2.34)

Firm and year f.e. Y Y Y Y Y Y

No. firms 1181 441 1184 441 895 336

.

Green: domestic firms only. Blue: exporters only.

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Machinery: fixed effect estimation

Log(VA) Log(labor) Log(K)

Exporter*post-crisis 0.087(1.72)

0.006(0.31)

0.005(0.12)

Foreign*post-crisis 0.017(0.16)

0.204(4.94)

0.190(1.63)

Firm and year f.e. Y Y Y Y Y Y

No. firms 1181 356 1184 356 895 286

.

Green: domestic firms only. Blue: exporters only.

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Exporting and Foreign ownership does not affect survival

.

Green: domestic firms only. Blue: exporters only. Year dummies included but not reported. Probit with coefficients expressed as probabilities.

Survived until next year

Exporter 0.001(0.97)

Foreign 0.005(0.80)

ForLeverage -0.000(0.25)

-0.001(2.15)

DomLeverage 0.000(0.47)

0.000(0.87)

Performance 0.008(5.54)

0.007(3.46)

Log(K) 0.005(4.00)

0.007(3.51)

Obs. 24764 7699

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Falsification: As if Crisis in 1993

Log(VA) Log(labor) Log(K)

Exporter*post-”crisis” (94-95)

-0.020(0.56)

-0.046(1.95)

-0.030(1.51)

Foreign*post-”crisis” (1994-95)

0.123(2.71)

0.121(6.17)

-0.004(0.09)

Firm and year f.e. Y Y Y Y Y Y

No. firms 8309 3028 8364 3046 6486 2338

.

Green: domestic firms only. Blue: exporters only.

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Break Points at 93 and 96

Log(VA) Log(labor) Log(K)

Exporter*post-crisis 0.24(9.08)

0.11(10.80)

-0.056(2.48)

Foreign*post-crisis 0.22(4.60)

0.093(4.40)

0.072(1.57)

Exporter*post93 -0.00(-.17)

0.01(1.74)

0.099(5.29)

Foreign*post93 0.19(4.15)

0.118(5.76)

0.058(1.46)

Firm and year f.e. Y Y Y Y Y Y

No. firms 5552 2178 5561 2181 4252 1658.

Green: domestic firms only. Blue: exporters only.

34

Presentation Outline

• The institutional setting• Data and measurement• Empirical strategy• Results• What have we learned? • Domestic firms appear

credit constrained• Implications for policy

makers and managers

35

What have we learned?

• Domestic exporters expanded value added and employment

– Consistent with devaluation effect.• Domestic exporters did not expand capital

– Consistent with liquidity constraints.• Only foreign exporters also expanded

capital– FDI acted like insurances against liquidity

constraints during a financial crisis