Trade Credit, Global Value Chains, and the Propagation of Financial Shocks Along International Supply Chains

Abstract

The fragmentation of production across borders has created supply chains in which a single exported good embodies inputs financed and shipped through several countries. Because most business-to-business transactions are settled on deferred payment terms, these chains are also chains of credit: every supplier is a creditor of its customer, and every customer is a debtor of its supplier. This article reviews the theoretical and empirical literature on trade credit and examines its role in the propagation of financial shocks along global value chains. It first surveys the theories of why firms lend to one another, distinguishing financing, monitoring, insurance, and enforcement motives. It then reviews evidence on the redistribution of liquidity through trade credit during financial crises, and on the transmission of firm-level shocks through production networks, drawing on studies of corporate failures, natural disasters, and bank credit contractions. Two stylized illustrations clarify the mechanisms: one showing how a bank credit shock to an exporter propagates upstream with and without a trade-credit buffer, and one showing how input specificity governs the decay of propagation with distance from the shocked firm. The review concludes that trade credit is both a shock absorber, redistributing liquidity from financially strong to financially weak firms, and a shock transmitter, converting one firm's illiquidity into its suppliers' losses, and that which role dominates depends on the financial strength of the chain's anchor firms and the substitutability of its inputs. Implications for supply-chain finance, trade finance policy, and the measurement of value-chain vulnerability are discussed.