Lack of credit choked off long-term investment, enfeebling growth
The financial crisis choked off the investment in research and development (R&D) needed for many firms to prosper long-term, costing the UK 5% in GDP, according to research by Maarten de Ridder, to be presented at the Royal Economic Society''s annual conference at the University of Bristol in April 2017.
His study compares the funding for corporate innovation received by firms that borrowed from banks most exposed to the crisis with those that were less exposed. Firms that relied on loans from the most credit-constrained banks reduced their R&D investments by 32% in 2008 and 2009. The results were dramatic: between 2011 and 2014, sales at the most severely affected firms fell 12% behind firms with the least exposure.
''If investments had been unaffected by the crisis, GDP today would be 5% higher'', the author concludes. ''The public sector should therefore actively facilitate the provision of credit for such investments during a crisis.''
The global financial crisis has led to a decline in corporate innovation. In the wake of Lehman Brothers'' bankruptcy, firms were cut off from the credit they need to cover the upfront costs of long-term investments. This led to a reduction in key innovative investments like research and development.
This study shows that this shortfall in investments helps to explain why income in countries like the UK remains 15% lower than forecast prior to the crisis.
The crisis affected innovation because it reduced the supply of loans to corporations. In the United States, where the crisis started, new loans fell by 79% between 2007 and the end of 2008.
A reliable and stable access to finance is an important ingredient of innovative investments, because firms need to cover substantial costs upfront. A temporary reduction in credit can therefore permanently lower GDP, as innovative investments are a driver of economic growth. New production technologies are needed to create more and better goods with finite resources.
De Ridder shows that the crisis negatively affected innovative investments using a natural experiment. He compares investments across firms whose preferred bank was either heavily or mildly exposed to the financial crisis. Many firms have a preferred bank on which they rely for credit, as it is best informed about the details of the firm and is therefore in the best position to judge its creditworthiness. If the preferred bank is unable to provide new loans because it suffered large losses in, for example, its mortgage portfolio, the firm''s access to credit is blocked.
He finds that firms that relied on loans from the most credit-constrained banks reduced their innovative investments by 32% in 2008 and 2009, compared with firms relying on the least credit-constrained banks. This put a drag on innovation and output in the years that followed.
Between 2011 and 2014, sales at the most severely affected firms fell 12% behind firms with the least exposure. That is roughly three to four years after the start of the crisis, which is in line with how long it takes for innovative investments to become profitable.
For future crises, De Ridder''s results hold an important lesson: the costs to temporary reductions in innovative investments are large. If investments had been unaffected by the crisis, GDP today would likely be 5% higher. The public sector should therefore actively facilitate the provision of credit for such investments during a crisis – for example, through guarantees.
INVESTMENT IN PRODUCTIVITY AND THE LONG-TERM EFFECT OF FINANCIAL CRISES ON OUTPUT – Maarten De Ridder, University of Cambridge