Garrick Blalock, Cornell University Paul Gertler, University of California, Berkeley David Levine, University of California, Berkeley

1
Investment Following a Financial Crisis Does
Foreign Ownership Matter
Garrick Blalock, Cornell UniversityPaul Gertler,
University of California, BerkeleyDavid Levine,
University of California, Berkeley
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
What explains post-crisis investment

• 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

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
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 flow
• Capital 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
25
Mean values of outcome before after crisis
Log(VA) Log(VA) Log(labor) Log(labor) Log(capital) 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
26
Mean capital by firm type
27
All Industries Fixed effect estimation
Log(VA) Log(VA) Log(labor) Log(labor) Log(K) Log(K)
Exporterpost-crisis 0.203(9.87) 0.123(16.03) -0.019(1.12)
Foreignpost-crisis 0.339(8.17) 0.154(8.56) 0.088(2.26)
ForLeveragepost-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)
DomLeveragepost-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(VA) Log(labor) Log(labor) Log(K) Log(K)
Exporterpost-crisis 0.016(0.33) 0.084(4.53) -0.134(3.57)
Foreignpost-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(VA) Log(labor) Log(labor) Log(K) Log(K)
Exporterpost-crisis 0.087(1.72) 0.006(0.31) 0.005(0.12)
Foreignpost-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.
30
Machinery fixed effect estimation
Log(VA) Log(VA) Log(labor) Log(labor) Log(K) Log(K)
Exporterpost-crisis 0.087(1.72) 0.006(0.31) 0.005(0.12)
Foreignpost-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.
31
Exporting and Foreign ownership does not affect
survival
Survived until next year 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
.
Green domestic firms only. Blue exporters only.
Year dummies included but not reported. Probit
with coefficients expressed as probabilities.
32
Falsification As if Crisis in 1993
Log(VA) Log(VA) Log(labor) Log(labor) Log(K) Log(K)
Exporterpost-crisis (94-95) -0.020(0.56) -0.046(1.95) -0.030(1.51)
Foreignpost-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.
33
Break Points at 93 and 96
Log(VA) Log(VA) Log(labor) Log(labor) Log(K) Log(K)
Exporterpost-crisis 0.24(9.08) 0.11(10.80) -0.056(2.48)
Foreignpost-crisis 0.22(4.60) 0.093(4.40) 0.072(1.57)
Exporterpost93 -0.00(-.17) 0.01(1.74) 0.099(5.29)
Foreignpost93 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