economic sanctions and the political economy of banking crises peace science society meeting 2016...

Economic Sanctions and the Political Economy of Banking Crises

Peace Science Society Meeting2016

Emre Hatipoğlu (Sabancı University)

Dursun Peksen(University of Memphis)

Research Question

Do economic sanctions lead to banking crises in targeted countries?

Conceptual Clarification: Sanctions

Sanctions are intended to induce behavioral change in targeted countries.

These actions refer to the deliberate, government-enforced restrictions of exports, imports, and/or the flow of finance.

Conceptual Clarification: Banking Crisis

• “In a systemic banking crisis, a country's financial and banking industry experiences a significant number of defaults while financial entities face vast problems fulfilling financial contracts on time.” (The FED – 2015)

• Is not a currency crisis.

A Typical Sanction Episode

Do sanctions work?When do sanctions work?

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Hufbauer et al. 1990, 2007; Tsebelis 1990; Morgan & Schwebach 1997; Pape 1997; Hart 2000; Noouriddin 2002; Allen 2005

A Typical Sanction EpisodeWhen are economic sanctions utilized?

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Drury 2001; Cox & Drury 2006; Goenner 2007; Palmer & Morgan 2006; Hafner-Burton & Montgomery 2008

A Typical Sanction Episode

How long do economic sanctions last?

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END

Dorussen & Mo 2001; McGillivray & Stam 2004; Hatipoglu 2014

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UNINTENDED (ADVERSE) CONSEQUENCES OF ECONOMIC SANCTIONS

•Human Consequences• Humanitarian Crises (Weiss et al. 1997)• Health (DaPonte & Garfield 2000)• Deterioration of Women’s Status (Drury & Peksen 2014)

“Results of the 1999 Iraq Child and Maternal Mortality Survey” UNICEF

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UNINTENDED (ADVERSE) CONSEQUENCES OF ECONOMIC SANCTIONS

•Human Consequences• Humanitarian Crises (Weiss et al. 1997)• Health (DaPonte & Garfield 2000)• Deterioration of Women’s Status (Drury & Peksen 2014)

•Political Consequences• Repression (Wood 2008; Grauvogel & von Soest 2014)• Regime Destabilization (Marinov 2005; Escriba-Folch & Wright 2010)

•Economic Consequences• Trade flows (Caruso 2003; Early 2009)• FDI inflows (Lektzian & Biglaiser 2012; Biglaiser & Lektzian 2013)

• Banking Crises

Banking Crises: How do they occur?

“Banks are financial intermediaries whose liabilities are mainly short-term deposits and whose assets are usually short- and long- term loans to businesses and consumers” (Demirguc-Kunt & Detragiache 1998, p. 85)

Banks profit from (and stay solvent due to) the positive rate differential between lending rate and deposit rate.

When economy under distress, depositors run on banks and make banks insolvent…

When a large portion of banks in the banking system become insolvent, a country experiences banking crises.

(Paucity of studies looking at political determinants of banking crises.)

Sanctions and Banking Crises: The Causal Link

Domestic Effect:Rising cost of depositsDrop in value of loans

International Effect:Inability to resort to international capital

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 20030

5

10

15

20

25

30

35

40

45

Lending interest rate; 20.6%(1993)


Deposit interest rate; 14.5%(1993)


Deposit - Lending Rate Differential: Indonesia (1993-2003)

Lending Interest Rate Deposit Interest Rate

Inte

rest

Rat

e (%

)

SANC

TION

S

2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

2

4

6

8

10

12

14

16

18



Lending interest rate;16.7%(2004)


Deposit - Lending Rate Differential: Iran (2004-2013)

Inte

rest

Rat

e (%

)

SAN

CTIO

NS

Data: World Bank

Sanctions and Banking Crises: The Causal Link

Domestic Effect:Rising cost of depositsDrop in value of loans

International Effect:Inability to resort to international capital

• 1968 : Overthrow of President Arias.

• Gov’t expenditures stagnated; Gov’t investment decreased.

• Credit to private sector grew less than the trend.

• Dollarized economy adjusted.• Banks relied heavily on foreign

capital to finance their local operations.

• +7% growth in GDP.

• 1988-9: Reagan/Bush economic sanctions.

• $300mil withdrawn from deposits (11% of all deposits).

• Access to international capital restricted.

• (Domestic Effect): Construction boom cut short - ↓value of outstanding loans.

• Banks closed for two months.• -15.6% contraction in GDP.

International Effect: The case of Panama

Hypothesis: Economic Sanctions increase the probability of a banking crisis onset in the targeted country.

Statistical Analysis Design

• 1971-2005; Unit of Analysis: country-year• 99 banking crises in 78 different emerging

economies (Laeven & Valencia 2008)

• 65 different countries sanctioned (Hufbauer et al. 2008)

Χ2 p-value= 0.003

Sanctioned in Previous Year No Yes TotalNo 2,877 72 2,949Yes 547 27 574

Total 3,424 99 3,523

Banking Crisis in That Year

Χ2 p-value= 0.003

Sanctioned in Previous Year No Yes TotalNo 2,877 72 2,949Yes 547 27 574

Total 3,424 99 3,523

Banking Crisis in That Year

Argentina 1980 Indonesia 1997Armenia 1994 Kenya 1992Azerbaijan 1995 Latvia 1995Cameroon 1995 Lebanon 1990Chile 1976 Nicaragua 1990Chile 1981 Panama 1988China 1998 Romania 1990Colombia 1998 Togo 1993Congo / Kinshasa 1991 Turkey 1982Congo / Kinshasa 1994 Turkey 2000Ecuador 1998 Ukraine 1998Egypt 1980 Uruguay 1981El Salvador 1989 Yemen 1996Haiti 1994

LIST OF 27 BANKING CRISES FOLLOWING SANCTIONS IN OUR SAMPLE

Statistical Analysis Design

• 1971-2005; Unit of Analysis: country-year• 99 banking crises in 78 different emerging

economies (Laeven & Valencia 2008)

• 65 different countries sanctioned (Hufbauer et al. 2008)

• Logistic regression– Time dependence controlled – Huber-White std. errors clustered on target country

• Control variables: World Bank, IMF, Polity Data

LIST OF VARIABLES EMPLOYED

Variable Name Description

Dependent Variable

Banking Crisis Presence of a banking crisis (0-1)

Sanction Related Covariates

Economic Sanctions All economic sanctions (0-1)

Final Sanctions Financial sanctions only (0-1)

Trade Sanctions Trade (import and export) sanctions only (0-1)

High Cost Sanctions Sanction regimes with major economic cost (0-1)

Low Cost Sanctions Sanction regimes with minor economic costs (0-1)

IGO Sender IGO-led sanctions (0-1)

US Sender US-led sanctions (0-1)

Macroeconomy-Related & Other Covariates

M2/Reserves Money and quasi money (M2) to total reserves ratio

Domestic Credit Domestic credit to private sector (% of GDP)

Credit Growth Annual change in net domestic credit (current LCU)

Output Growth GDP growth (annual %)

Inflation Inflation, GDP deflator (annual %)

Currency Stability Official exchange rate (LCU per US$, period average)

GDP per Capita GDP per capita (constant 2005 US$)

Democracy Polity 2 Score of the Polity IV dataset (-10,10)

Foreign Interest Average of annual short-term interest rates for the US, Germany, Japan, France, the UK and Switzerland

Northern Growth Percentage growth rate of real OECD output

Trade Annual change in total exports and imports (% of GDP)

Past Financial Crisis Presence of at least one of the three financial crises (banking/currency/debt crisis) in the past year (0-1)

All Sanctions (1) (2) (3) Economic Sanctions 0.6626*** 0.7022*** 0.6021***

(0.2163) (0.2271) (0.2346)

M2/Reserves

0.0006*** 0.0004*

(0.0001) (0.0002) Domestic Credit

0.0074* 0.0084

(0.0043) (0.0052) Credit Growth

0.0154* 0.0034

(0.0087) (0.0097) Output Growth

-0.0411***

(0.0159) Inflation

0.0001

(0.0001) Currency Stability

-0.00004

(0.00002)

GDP per Capita

-0.0536

(0.0984) Democracy

0.0192

(0.0149) Foreign Interest

0.2209***

(0.0672) Northern Growth

-0.1561

(0.1057) Trade

0.0063

(0.0086) Time Trend 0.0111** 0.0018 0.0404**

(0.0054) (0.0061) (0.0177)

Past Financial Crisis -0.0231 -0.1966 -0.4707

(0.3865) (0.4338) (0.4794)

Constant -25.7544** -7.4042 -85.0519**

(10.7662) (12.0135) (35.9286)

Observations 3,523 3,235 2,978 Notes: Robust standard errors adjusted for clustering over country appear in parentheses. *** Significant at 1%, ** at 5%, * at 10%. All time-variant explanatory variables are lagged at t–1.

All Sanctions (1) (2) (3) Economic Sanctions 0.6626*** 0.7022*** 0.6021***

(0.2163) (0.2271) (0.2346)

M2/Reserves

0.0006*** 0.0004*


0.0074* 0.0084

(0.0043) (0.0052) Credit Growth

0.0154* 0.0034

(0.0087) (0.0097) Output Growth

-0.0411***

(0.0159) Inflation

0.0001


-0.00004

(0.00002)

GDP per Capita

-0.0536

(0.0984) Democracy

0.0192


0.2209***

(0.0672) Northern Growth

-0.1561

(0.1057) Trade

0.0063

(0.0086) Time Trend 0.0111** 0.0018 0.0404**

(0.0054) (0.0061) (0.0177)

Past Financial Crisis -0.0231 -0.1966 -0.4707

(0.3865) (0.4338) (0.4794)

Constant -25.7544** -7.4042 -85.0519**

(10.7662) (12.0135) (35.9286)

Observations 3,523 3,235 2,978

Financial Sanctions Trade Sanctions (4) (5) (6) (7) (8) (9)

0.7030*** 0.7406*** 0.6366*** 0.6303** 0.6367** 0.5530* (0.2281) (0.2333) (0.2376) (0.2603) (0.2820) (0.3012)

0.0005*** 0.0003*

0.0007*** 0.0005***

(0.0001) (0.0002)

(0.0001) (0.0002)

0.0079* 0.0088*

0.0066 0.0076

(0.0041) (0.0050)

(0.0045) (0.0054)

0.0152** 0.0031

0.0156* 0.0025

(0.0087) (0.0096)

(0.0091) (0.0095)

-0.0425***

-0.0416***

(0.0171)

(0.0164)

0.0001

0.0001

(0.0001)

(0.0001)

-0.00003

-0.00001

(0.00002)

(0.00001)

-0.0549

-0.0504

(0.0981)

(0.0985)

0.0215

0.0186

(0.0147)

(0.0149)

0.2217***

0.2214***

(0.0671)

(0.0674)

-0.1519

-0.1621

(0.1061)

(0.1057)

0.0063

0.0062

(0.0087)

(0.0084)

0.0109** 0.0012 0.0389** 0.0120** 0.0027 0.0416** (0.0054) (0.0059) (0.0174) (0.0053) (0.0060) (0.0178) -0.0283 -0.2014 -0.4877 0.0085 -0.1589 -0.4352 (0.3870) (0.4343) (0.4821) (0.3857) (0.4326) (0.4760)

-25.4594** -6.2111 -82.1142** -27.4346*** -9.2464 -87.3767** (10.6491) (11.7787) (35.4565) (10.5988) (11.8673) (36.0633)

3,523 3,235 2,978 3,523 3,235 2,978 Notes: Robust standard errors adjusted for clustering over country appear in parentheses. *** Significant at 1%, ** at 5%, * at 10%. All time-variant explanatory variables are lagged at t–1.

Notes: Robust standard errors adjusted for clustering over country appear in parentheses. *** Significant at 1%, ** at 5%, * at 10%. All time-variant explanatory variables are lagged at t–1.

(10) (11) (12) (13) (14) (15) (16) (17) (18) Economic Sanctions 0.7508*** 0.765*** 0.7043*** 0.9127*** 1.085*** 0.970***

(0.2273) (0.2381) (0.2446) (0.3094) (0.3216) (0.3218) IGO Sender -0.4876 -0.3386 -0.6135

(0.5244) (0.5580) (0.6283) US Sender

-0.3237 -0.4998 -0.4947

(0.3696) (0.3976) (0.4132) High Cost Sanctions

0.9813*** 1.148*** 0.8061**

(0.3425) (0.3567) (0.3670)

Low Cost Sanctions

0.5436** 0.5498** 0.5369**

(0.2559) (0.2653) (0.2781)

M2/Reserves

0.0005*** 0.0003

0.0006*** 0.0004*

0.0006*** 0.0004*

(0.0001) (0.0002)

(0.0001) (0.0002)


0.0074* 0.0085*

0.0079* 0.0091*

0.0084** 0.0086*

(0.0043) (0.0051)

(0.0044) (0.0053)

(0.0042) (0.0052)

Credit Growth

0.0150* 0.0029

0.0161* 0.0040

0.0127 0.0026

(0.0087) (0.0095)

(0.0088) (0.0098)

(0.0089) (0.0091) Output Growth

-0.0419***

-0.0409***

-0.0404**

(0.0162)

(0.0162)

(0.0159)

Inflation

0.0001

0.0001

0.0001

(0.0001)

(0.0001)


-0.00003

-0.00004

-0.00001

(0.00002)

(0.00002)

(0.00003)

GDP per Capita

-0.0568

-0.0607

-0.0488

(0.0984)

(0.0982)

(0.0981) Democracy

0.0197

0.0175

0.0199

(0.0147)

(0.0149)


0.2160***

0.2250***

0.2212***

(0.0674)

(0.0674)

(0.0670)

Northern Growth

-0.1548

-0.1563

-0.1553

(0.1053)

(0.1062)

(0.1057) Trade

0.0059

0.0063

0.0063

(0.0088)

(0.0086)

(0.0086)

Time Trend 0.0116** 0.0020 0.0396** 0.0107** 0.0010 0.0408** 0.0099* -0.0004 0.0392**

(0.0054) (0.0061) (0.0176) (0.0054) (0.0061) (0.0177) (0.0055) (0.0062) (0.0176)

Past Financial Crisis -0.0223 -0.1935 -0.4747 -0.0279 -0.2003 -0.4716 -0.0267 -0.1985 -0.4637

(0.3875) (0.4344) (0.4833) (0.3861) (0.4336) (0.4774) (0.3863) (0.4337) (0.4786)

Constant -26.8136** -7.9409 -83.3907** -24.8933** -5.8347 -85.7924** -23.2991** -3.0836 -82.7038**

(10.7085) (12.0080) (35.7304) (10.7543) (12.0681) (36.0351) (10.9101) (12.3333) (35.8197)

Observations 3,523 3,235 2,978 3,523 3,235 2,978 3,523 3,235 2,978

Simulated Probabilities

Type of SanctionNo

Sanction Sanction ∆All EconomicSanctions 0.022 0.040 82%

Financial EconomicSanctions 0.022 0.042 91%

Trade-related Economic Sanctions 0.022 0.040 81%

High Cost Sanctions 0.022 0.048 118%

Low Cost Sanctions 0.022 0.037 68%

Cells denote simulated probability of a banking crisis onset at a country at a given year when other variables are held at their means or medians. The ∆ column denotes the ratio of probabilities from a case of no sanction to a case of sanction.

To conclude…Sanctions increase the risk of a banking crisis through

1) imposing a shock in the economy2) limiting response to this shock

Scholarly implications: Lingering effects of sanctionsFocus on processes and mechanismsPost-conflict reconstruction of polities

Policy implications: The need for targeted sanctions

Thank you!

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economic sanctions and the political economy of banking crises peace science society meeting 2016...

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