Trade sanctions and global value chains: The role of financial development and capital openness in emerging markets

This study assesses the impact of financial development and capital openness on global value chains (GVC) participation in the context of trade sanctions. Specifically, we test three hypotheses: first, whether financial development and capital openness mitigate the impact of trade sanctions on access to foreign intermediate goods (backward linkages); second, whether they alleviate the consequences of trade sanctions that increase the cost of finished products (forward linkages); and finally, whether the moderation effect matters for emerging markets. Using a gravity model with a purpose-built dataset covering GVC participation indices in 66 source and destination countries and 23 sectors from 1995 to 2020, our analysis reveals a negative impact of sanctions on GVC participation, with a notable persistence in interrupting backward participation. Higher levels of financial development and capital openness enhance countries' resilience to sanctions, particularly for backward participation and in countries with limited access to international capital. Focusing on emerging markets, we find evidence of significant interplay between foreign and domestic financial resources, where underdeveloped internal financial conditions are eased by international finance and vice-versa, allowing emerging markets to partially offset the adverse impact of sanctions.