Investment Following a Financial Crisis: Does Foreign Ownership Matter

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. The institutional setting Data and measurement Empirical strategy Results What have we learned? Why Indonesia? Review of crisis Presentation Outline

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

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. The institutional setting Data and measurement Empirical strategy Results What have we learned? Presentation Outline

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. The institutional setting Data and measurement Empirical strategy Results What have we learned? Presentation Outline

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. The institutional setting Data and measurement Empirical strategy Results What have we learned? Presentation Outline

24. Sample size

25. Mean values of outcome before & after crisis

26. Mean capital by firm type

27. All Industries: Fixed effect estimation . Green: domestic firms only. Blue: exporters only.

28. Food: fixed effect estimation . Green: domestic firms only. Blue: exporters only.

29. Textiles: fixed effect estimation . Green: domestic firms only. Blue: exporters only.

30. Machinery: fixed effect estimation . Green: domestic firms only. Blue: exporters only.

31. 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.

32. Falsification: As if Crisis in 1993 . Green: domestic firms only. Blue: exporters only.

33. Break Points at 93 and 96 . Green: domestic firms only. Blue: exporters only.

34. The institutional setting Data and measurement Empirical strategy Results What have we learned? Domestic firms appear credit constrained Implications for policy makers and managers Presentation Outline

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