Decoupling: Ties That No Longer Bind
Emerging market economies have protected themselves from global economic downturns.
Everybody knows that the global economy is becoming more tightly integrated — that factors ranging from the collapse of ocean shipping costs, to the rise of multinational manufacturing, to the growth of truly international securities markets, have bound national economies to each other as never before. This, of course, must mean we’re now all in it together. Booms and busts in rich countries will reverberate ever more strongly through developing and emerging market economies. Right?
Sounds reasonable, but that’s not what’s happened. The big emerging market economies (notably, China, India and Brazil) took only modest hits from the housing finance bubble and subsequent recession in the U.S., Japan and Europe, then went back to growth-as-usual.
Hence the paradox: Emerging-market and developing countries have somehow "decoupled" from the Western business cycle in an era of ever-increasing economic integration. But the experts have yet to agree on why. Here are the two contending explanations:
Changing Trade Patterns
Just a few decades ago, most developing countries depended heavily on commodity exports — everything from bananas to copper to soybeans to oil. And trade patterns were pretty straightforward: Rich countries supplied industrial goods in return for those commodities. When Europe, Japan and the U.S. went into recession, their demand for commodities fell, dragging supplying countries down with them. Actually, the impact was even worse than you might expect, since commodity suppliers were hit by the double whammy of falling export volume and falling export prices.
The content of trade shifted in the 1980s and 1990s with the movement of industries that used lots of cheap labor to low-wage economies, mostly in Asia. But most of the demand for the exports of poor and emerging market countries came from the U.S., the E.U., and Japan. So when the U.S. burped, Thailand, Mexico and Chile all got indigestion. (Hey, be thankful I found an alternative to the sneeze/caught cold metaphor.)
Many countries — notably, the oil and mineral producers — remain one-trick ponies, heavily dependent on commodity exports. But as the major emerging-market economies have grown bigger and more sophisticated, they’ve diversified their exports and moved up the food chain with higher-tech products. China, not so long ago the global hub for cheap apparel and shoes, now exports (among so many other things) solar panels and medical equipment. India exports pharmaceuticals and software as well as cotton, sugar and home furnishings. Brazil exports weapons and commercial jets along with coffee, soybeans and oranges.
This has set the stage for a radical shift in who trades what, and with whom. China and India have become voracious importers of commodities from countries that once looked only to the rich industrialized countries for markets. By the same token, emerging market economies are selling a greater proportion of their manufactured exports to other emerging market economies. All told, EME exports to other EMEs has risen from less than 10 percent of their total to close to 40 percent today. As a result of this diversification, both emerging market exporters of manufactures and developing country exporters of commodities have become less sensitive to the ups and downs of rich economies.
The obvious example is the new synergy between China and the major oil exporters. Growing Chinese demand probably prevented a collapse in oil prices during the recession, and is being blamed by the White House for the current spike in fuel prices But the impact of the shift — including the political friction it is creating — can be seen all over the place. India has resisted US-led efforts to embargo trade with Iran because it gets much of its oil from Iran in return for sugar and rice. Mexico and Brazil recently settled a trade dispute in which Brazil sought to keep out Mexican autos that competed with domestic Brazilian production.
Decoupling has been documented more rigorously. A recent statistical study from the Inter-American Development Bank found that the impact of a change in GDP in China on the GDP of Latin America has tripled since the mid-1990s, while the impact of a change in US GDP on Latin America has halved.
Better Policy Making
One reason emerging-market countries managed to skate through the last recession without much damage is that they used fiscal and monetary tools appropriately to offset the impact of falling demand for their exports. Beijing ordered China’s provincial and local governments to spend an extra $580 billion (mostly on infrastructure projects) in response to falling exports to the U.S. and Europe. India’s central bank, for its part, sharply cut the interest rate at which banks could tap government funds and directly injected funds into financial markets through other means. Brazil’s left-center government used a combination of fiscal and monetary stimulus to end its own economic downturn after just two quarters, and managed a stunning 7 percent growth rate in 2010.
So, isn’t that what any sensible government would do? Britain and, arguably, the eurozone, have not behaved sensibly, leaving them vulnerable to a "double-dip" recession. The more important point here, though, is that China, India and Brazil were able to act decisively to decouple from the rich countries’ recession because they had built credible records in managing budget deficits and containing inflation.
Equally important — and more surprising — developing countries that were heavily dependent on commodity exports also managed to buffer the impact of the downturn. Traditionally, these countries have been unable to resist government spending binges in boom times and have lacked the capacity to borrow in lean times to offset the fall in export revenues. Their fiscal policies were thus "pro-cyclical" in the sense that they exacerbated swings in total demand.
But as Jeffrey Frankel of Harvard has shown, most commodity-dependent exporters have managed to get their fiscal acts together, and were thus able to expand demand with "counter-cyclical" stimulus policies during the last recession. Chile has led the way with a remarkably sophisticated law that largely forces the government to build fiscal reserves when the price of Chile’s premier export — copper — is high, and allows it to spend down the fund when copper declines. More generally, Frankel argues, developing countries are getting better at buffering export price fluctuations because they are building credible government institutions for managing their economies.
There is no real need to choose between these explanations. By virtue of their size and diversification, emerging market economies have now more influence on the economic fortunes of other emerging-market and developing economies. And by virtue of their improving track records as credible inflation-fighters, they have more capacity to use fiscal and monetary stimulus to stay ahead of global recessions.
This is surely good news. But it does leave a big unanswered question. The big emerging market countries are acquiring the will and the way to protect their own interests during global economic crises. We don’t know, though, whether they will have sufficiently broad perspective to step up to leadership roles in managing global crises as their economic power converges with that of the rich industrial countries.