Macroeconomic Shocks Have a Major Effect on Politics
Do negative economic shocks trigger social unrest? The declining support for mainstream parties and the rise of populist movements across Europe in the aftermath of the Eurozone crisis have brought this question to the fore of debate among academics, policy makers, and the general public.
Despite its relevance, however, we don't yet have a clear answer, and the data are often hard to interpret. The reason is that we often observe social unrest in countries with poor economic performance, but in general we do not know what causes what. Intuitively, poor economic performance may exacerbate social tensions; but social unrest itself can also worsen investment prospects, leading to lower employment and output.
To address this challenge, in a paper with Fabio Braggion of Tilburg University and CentER and Haikun Zhu of Rotterdam Erasmus University ESE, we turn to study a credit shock in 1930s China. That helps us isolate the direction of causality, from economic performance to social unrest, via a natural experiment triggered by the U.S. 1933 Silver Purchase program. Undertaken for purely U.S. domestic reasons, and independent of Chinese economic conditions, the Silver Purchase raised the price of silver worldwide and drained the Chinese silver stock. Because China was on the silver standard, the credit capacity of its banks was tied to their silver holdings. Banks with lower silver holdings were more exposed to the Silver Purchase "shock" and had to cut credit, potentially with a social impact.
Using extensive archival information, we assemble a database on credit, labor relations, and underground Communist activities in 1930s China. Our data reconstruct a Chinese "credit registry" for the period 1931-1935, and document firm-level labor unrest episodes in three major Chinese cities (Nanjing, Shanghai, and Tianjin), as well as Communist Party penetration among workers at Shanghai firms.
We provide two pieces of evidence, linked by the credit shock. First, we show that banks with a larger exposure to the Silver Purchase (lower pre-1933 silver reserves) curb credit after 1933, in comparison to banks that are less exposed. Second, we show that labor unrest episodes and Communist penetration in Chinese firms relate to their banks' exposure to the Silver Purchase. Intuitively, firms borrowing from exposed banks face tighter financial constraints, which limit investment and lead to pay cuts and layoffs, increasing the likelihood of labor unrest and Communist support.
Our main results are immediately visible in the data. Chinese credit sharply contracts over 1933-35: credit-to-GDP drops by about 15%, similar in magnitude to more recent credit crises. We find that this is driven by banks with lower pre-1933 silver reserves. Firms borrowing from those banks, in turn, experience increased labor unrest intensity. Our estimates imply that the most exposed borrowers experience a 30% larger increase in the number of labor unrest episodes, and a 15% longer average episode duration. Using data from the archives of the Shanghai Municipal Police (SMP), which used to infiltrate Communist cells in the 1930s, we also show that they experience increased Communist penetration. Based on our estimates, there is a 3 to 6.5% larger increase in Communist penetration at the exposed firms, relative to firms with access to the largest silver reserves pools.
Taken together, our findings indicate that the social and political consequences of credit and, more generally, economic shocks are material, and suggest that "social" considerations can be relevant for regulators and policy makers.
The paper is available for download on SSRN:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2714815