Electronic Thesis and Dissertation Repository

Thesis Format

Integrated Article

Degree

Doctor of Philosophy

Program

Economics

Supervisor

Juan Carlos Hatchondo

Abstract

This thesis consists of two main chapters studying the interplay between government policies and firms’ financing, focusing on credit risks.

In Chapter 2, I study the effects of government-backed financing on aggregate productivity by exploiting an expansion of government loans to firms in Korea after 2017. I show that the borrowing cost decreased more for firms eligible for government loans relative to ineligible firms. Eligible firms with higher pre-policy borrowing costs had larger post-policy increases in investment than eligible firms with lower pre-policy borrowing costs. At the same time, the exit rate of low-productivity eligible firms decreased the most following the policy. To quantify the effect on aggregate productivity, I build a heterogeneous-firm model with endogenous entry and exit, borrowing cost, and investment. I find that an expansion of government loans to firms as large as the one observed in Korea decreases aggregate productivity by 0.3% over 10 years, explained by a 0.1% increase coming from higher investment by formally constrained firms and a 0.4% decrease attributed to the reduced exit rates among low-productive firms.

In Chapter 3, I study how the government’s local debt financing influences firms’ access to credit, in turn shaping the response of emerging economies to global financial conditions. Local currency debt allows emerging economies’ governments to avoid currency mismatch, which is expected to insulate them from global financial fluctuation. Using data from 11 emerging economies, I document that this insulation is partial and the degree of the insulation depends on a country’s financial development and debt level. I also find that banks in a country with low financial development relative to its debt level disrupt private credit more significantly when foreign capital exits from the local currency bond market. Low financial development relative to its debt level makes the local economy more exposed to external factors despite a seemingly lowered exposure of government debt, as government debt crowds out credit for firms. To better understand these patterns, I develop a sovereign default model with local currency bonds that can be held by local banks and a heterogeneous set of foreign investors. The model replicates key patterns observed in the data, related to the relationship between an economy’s capacity to maintain private credit during capital outflows, credit risk, and external vulnerability.

Summary for Lay Audience

This thesis explores the relationship between government policies and firms’ financing focusing on the role of credit risks. I investigate how financial frictions stemming from credit risks interact with government interventions to shape firms’ financing decisions. Specifically, the research examines two key aspects: the direct impact of government-backed financing on firms (Chapter 2), and the indirect effects of government debt financing policies on the financial markets firms use (Chapter 3).

In Chapter 2, I study the impact of government loans on small and mid-sized firms in South Korea. The newly elected government expanded government loans to these firms for inclusive economic growth. Using financial statement data on Korean firms, I find that firms eligible for government loans experienced reduced borrowing costs relative to ineligible firms, leading to increased investment by eligible firms facing high borrowing costs before this government loan expansion. However, this policy also prolonged the survival of less productive firms, resulting in a negative effect on overall productivity. While government support stimulated investment by constrained firms, positively impacting aggregate productivity with a better capital allocation across firms, it simultaneously dampened productivity by sustaining low-productivity firms. Using a heterogeneous firm dynamics model, I find that an expansion of government loans to firms as large as the one observed in Korea decreases aggregate productivity by 0.3% over 10 years, explained by a 0.1% increase coming from higher investment by formally constrained firms and a 0.4% decrease attributed to the reduced exit rates among low-productivity firms.

In Chapter 3, I explore how emerging governments’ local currency debt financing affects firms’ credit access and shapes the vulnerability of emerging economies to global financial conditions. Borrowing in local currency is expected to provide a shield for emerging economies from global financial market fluctuations because local currency debt is free from the currency mismatch problem. Using data from 11 emerging economies, I find this shield is only partial, dependent on the level of financial market development and government debt. In countries with underdeveloped financial markets and high government debt, local banks disrupt lending to firms when foreign investors withdraw from the local bond market. This leaves the local economy exposed to external shocks as government debt crowds out credit for firms, negatively impacting economic activity. To better understand these patterns, I develop a sovereign default model with local currency bonds that can be held by local banks and a heterogeneous set of foreign investors. The model replicates key patterns observed in the data, related to the relationship between an economy’s capacity to maintain private credit during capital outflows, credit risk, and external vulnerability.

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