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May 6, 2025

Amplification of Trade Shocks

A reduction in the supply of credit followed China's entry into the World Trade Organization.

Tyler Smith

Source: Sergey Novikov

A large body of economic  has shown that China’s accession to the World Trade Organization (WTO) in 2001 caused competing industries in developed countries to contract more than previously believed. But much of this work overlooks the impact of the financial sector, which spread negative effects of the so-called China shock to the rest of the economy in unanticipated ways. 

In a paper in the 蝌蚪网 Review, authors , , and explore how banks can turn sector-specific trade shocks into economy-wide credit contractions, affecting even the firms expected to benefit from the shock.

The researchers drew their conclusions by merging loan-level information from Italy's credit registry with bank balance sheets, firm financial data, and international trade statistics. This comprehensive dataset allowed them to track the effects of China's WTO entry on Italy's banking system between 1998 and 2007.

Figure 3 from the authors’ paper shows the evolution of bank lending patterns to nonfinancial firms before and after China's entry into the WTO.

from Federico et al. (2025)

Panel A compares lending growth between banks that were highly exposed to sectors competing with Chinese imports (dashed red line) and those with lower exposure (the solid blue line). Though these two groups followed similar lending trajectories before 2001, they diverged afterward. Banks with loan portfolios concentrated in vulnerable sectors significantly reduced their lending growth compared to less exposed institutions.

Panel B provides a more granular view, further subdividing lending by firms' vulnerability to Chinese competition. The panel shows that banks with high exposure to the China shock reduced lending across the board, not just to firms directly competing with Chinese imports. And the most dramatic lending contraction affected firms in the hardest hit sectors, indicated by the dotted yellow line.

In addition, the authors show that when firms in import-competing sectors suffered, many defaulted, creating a surge in nonperforming loans at highly exposed banks. These banks responded by restricting credit throughout the economy—even to sectors not competing with China, which should have benefited from cheaper Chinese inputs or expanded export opportunities. This in turn resulted in lower employment, investment, and output at affected companies.

The findings reveal a potential amplification mechanism through which trade shocks can spread to the wider economy and affect even sectors expected to expand as a result of liberalization.