Firms can react to geopolitical and supply chain shocks by altering their input sourcing and sales destination choices. This column presents new evidence of the effect of war on the trade flows of third countries. The authors show that in response to the excess demand shock caused by sactions on Russia following its invasion of Ukraine in 2022, Indian leather exporters redirected or reshored their sales of leather goods from relatively unimportant export destinations to Russia, while keeping exports to major destinations – primarily Europe and the US – undisturbed.
The full-scale war that Russia declared on Ukraine in February 2022 took the world by surprise. It is the biggest conflict in Europe since WWII, resulting in a significant death toll and a large refugee crisis. Following the declaration of war in February 2022, Russia was politically shunned by the Western world – led by the US and EU – with a barrage of sanctions affecting its trade linkages. Sanctions can cause large losses to the targeted economies, especially in terms of dampening trade relations with the countries imposing the sanctions (Bělín and Hanousek 2019). Figures 1 and 2 show this has been the case for Russia using trade data from WITS-World Bank for the years 2019-2023. Figure 1 plots the share of imports from Russia to total imports by the US (Panel A) and the EU (Panel B), while Figure 2 draws the share of imports by Russia from the US (Panel A) and the EU (Panel B). Both the plots highlight a significant drop in trade from and to these destinations.
Figure 1 Russia’s exports to its major trade partners
Notes: The figure plots the yearly OLS coefficients (and their 95% confidence intervals) which are the differences in the share of imports from Russia by its major trade partners to their total imports. Panel A plots it for the US while Panel B does it for the EU. The vertical dashed line denotes the Russia-Ukraine War of 2022.
There is a recent literature attempting to link the effects of war and/or conflicts with trade, but the scope is still very limited. Ksoll et al. (2023) show that violent conflicts arising from Kenyan elections led to a disruption in supply chains and a fall in exports. Korovkin and Makarin (2023), with respect to the Russia-Ukraine crisis of 2014, show that conflicts can have spillover effects to the neighbouring regions that are not affected by the war. However, these existing studies largely focus on the effects of war and violence on countries that are party to the conflict themselves. There is a major lacuna in the literature which is yet to answer what happens (during a war) to the trading partner countries that are outside the scope of the war.
Figure 2 Russia’s imports from its major trade partners
Notes: The figure plots the yearly OLS coefficients (and their 95% confidence intervals) which are the differences in the share of exports to Russia from its major trade partners to their total exports. Panel A plots it for the US while Panel B does it for the EU. The vertical dashed line denotes the Russia-Ukraine War of 2022.
In a recent paper (Chakrabarti et al. 2024), we try to fill this gap by utilising the Russia-Ukraine war that started in February 2022 as a natural experiment to study the export responses of Indian firms, especially for the exporters of leather goods. Two reasons drive our choice. First, trade and supply chain disruptions often occur due to explicit political sanctions and not economic motives. India is outside the ambit of the ongoing political tensions between Russia and the US and the EU which started with the Crimea War of 2014. When sanctions were imposed against Russia following the start of the war in February 2022, India – a long-term trading partner of the US, the EU (note that these two are India’s largest export destinations), and Russia – took an explicit stance of neutrality. 1 Second, India is the second largest exporter of leather garments, the third largest exporter of saddlery and harnesses, and the fourth largest exporter of leather goods in the world. In addition, leather products, especially jackets and certain types of footwear such as high boots, are needed by the soldiers who are participating in the war, thereby creating extra excess demand due to the severing of trade relations with the EU. This is also motivated by a Guardian article which states, “Russia was a regular market like any other market, like China or Europe, but suddenly after the war there was a boost in demand,” said Tahir Rizwan, the director of Homera Tanning. “I think one of the reasons we had this boom was because the West was no longer supplying to them.”
We employ a differences-in-differences approach and exploit novel firm level monthly shipment data for the universe of leather exporters from January 2021 to October 2023 with detailed information on export value, quantity, product variety (at the HS 6-digit level), and mode of transport of the export shipment across all the destinations that a firm exports to. We use exporters exporting to Russia as the treated and others as the control group. We find that the exports of a leather exporter selling to Russia went up by 180-334% vis-a-vis the rest of the world (RoW), with footwear having the highest increase (450%). In terms of absolute value, an average leather exporter earned $160,000 more by exporting to Russia in comparison to the RoW. This increase in value of exports is driven by both quantity expansion (118–262%) and price rise (100%). We do not find much increase in the number of product varieties that are exported.
Figure 3 India’s leather exports to Russia
Notes: The figure plots the yearly OLS coefficients (and their 95% confidence intervals) which are the differences in the value of exports to Russia from India with respect to (w.r.t) the value of exports to the RoW (Panel A); quantity of exports to Russia w.r.t the quantity of exports to the RoW (Panel B); unit export prices charged on Russian exports w.r.t the unit prices charged to the RoW (Panel C). The vertical dashed line denotes the Russia-Ukraine War of 2022.
Figure 3 presents the event-study plots of the quarterly coefficients for the value of leather exports (Panel A), quantity exported (Panel B), and unit export price (Panel C) for Russia with respect to the RoW. Our event study plots show that while there was no differential effect before the war, the difference between leather products exported to Russia and others started to appear after the war started. All this change happened at the intensive margin and a large proportion of the increase in exports is due to an increase in air rather than maritime shipments, indicating that the excess demand shock was needed to be fulfilled with urgency.
We find that this redirecting or reshoring of sales to Russia is primarily driven by the incumbent exporters. This increase in exports to Russia is directly proportional to the size of the exporter – firms belonging to the top quartile, in terms of size distribution, registering the largest increase.
This brings us to the following question: how did these firms produce the additional leather exports within such a short period of time? Under the capacity constraints assumption, which is a likely scenario for a developing country like India, one way to meet the excess demand in one certain destination would be to pull out of sales to other destinations (in this case, redirecting or reshoring of sales from one or a few destinations to Russia). Our results show that the bulk of this reshoring or redirection of sales happened from South-east Asia, Africa, Caribbean Islands, and Oceania, which are relatively poor and/or unimportant trade partners for India. In contrast there was no change in the export volume with respect to the relatively important trade destinations of India, such as the US and Europe. Our results indicate that this reshoring happened purely due to economic reasons. Indian firms simply saw an exogenous expansion of demand in one particular destination which opened up the possibility of larger economic gains and therefore redirecting their sales to a more profitable destination.
What are the key contributions of our work? The literature recognises that globalisation is a choice, and it can be reversed (Acemoglu and Yared 2010). Therefore, when faced with a shock of such large proportion, countries may reshape their trade patterns. Specifically, firms can change their trading decisions, leading to major changes in the global trade matrix. Martin et al. (2008) present a very important strategic insight for us. They argue that the common wisdom that trade and wars are negatively related is only partially correct. In a bilateral scenario, trade is indeed negatively related to the propensity to engage in war due to high opportunity costs associated with the loss of potential trade arising from war. However, in a multilateral scenario, the opportunity cost lessens as countries would be less dependent on any given trading partner and hence, can engage in war. To the best of our knowledge, our study is among the first to show how firms in a third country reshore their sales, in response to a war, to one of the countries involved in the war. Our results also provide support to the findings of Duong et al. (2024).
Korovkin et al. (2024), using railway-shipment data during the 2014 Russia-Ukraine conflict, show that firms with prior supplier or buyer linkages to the conflict areas substantially decreased their output. Overall, their results underscore the fact that localised conflicts have detrimental, far-reaching economic costs. We extend this strand of the literature and show that not only do spillovers exist, but such spillovers can also be global in nature – leading to supply chain reorganisation across the globe between parties that are not even taking part in the war.
Source : VOXeu
