Over the last year, as the US economy has slipped toward (and likely into)
recession, there has been much talk of decoupling. According to this idea, the
global economy has decoupled from the US economy and can continue growing even
if the US goes into recession.
That idea is now proving fragile. Instead of decoupling, the global economy is
showing signs of a concertina effect. Thus, as the US economy grinds to a halt,
much of the rest of the world seems to be also slowing and bumping in behind.
Ever since the East Asian financial crisis of 1997, the US has served as the
locomotive of the global economy. This locomotive role has had US consumers
engage in a 10-year consumption
binge financed by debt and rising house prices. That binge pushed the household
saving rate to record lows, and it also resulted in record US trade deficits.
Trade data show the US has run large trade deficits with every major industrial
region of the global economy - Europe, Japan, China, East Asia, Canada and
Mexico. That pumped spending into these regions, fueling their growth.
This economic arrangement has created a dependence on the US market, and that
dependence has been further deepened by policies of export-led growth. Unable
or unwilling to grow their own domestic markets, countries have relied on
policies that explicitly promote exports.
In many developing countries these policies have had the added benefit of
attracting foreign direct investment (FDI). Thus, exports have kept factories
busy, while the prospect of future exports has tempted companies to relocate
production facilities to developing economies.
In effect, developing countries have gotten a "twofer" - export-led growth plus
FDI. Meanwhile, the US economy has benefited from cheap imports, while its
manufacturing sector has been eroded and consumers have loaded up on debt in an
unsustainable fashion.
The bursting of the US house price bubble has shifted this process into
reverse, slowing US import growth and replacing financial exuberance with
financial fear, and rather than global decoupling, there are signs of a shared
global slowdown.
The North American Free Trade Agreement economies of Canada and Mexico are
clearly vulnerable because of their large trade dependence on the the other
member of the pact, the US, and their tight integration into the US supply
chain. In Europe, Ireland, Spain and Italy are either in recession or on the
cusp of recession. Growth has also slowed sharply in the UK and France, and
Japan has also lowered its growth outlook.
Germany, which is Europe's largest economy, was supposed to replace the US
locomotive. However, it is one of the world's most export-dependent economies.
German growth has kept going longer than other European economies because of
low consumer debt and export growth to OPEC economies, but Germany is now also
slowing. Moreover, its policies of wage restraint and hyper-export
competitiveness pose a menace rather than a help to the overall European
economy.
The hope that China could pull East Asia through a US slowdown was always a
fiction. A quick inspection of China’s trade shows that its trade deficits with
other East Asian economies are derived from its trade surpluses with the US.
China assembles imported parts from the rest of East Asia and sells the
assembled product in US markets. That means when the US slows, the slowdown
ripples back via China into the broader East Asian economy.
The commodity-exporting economies of Australia, Latin America, and Africa have
all done well from the commodity price boom. However, if the industrial
economies of North America, Europe and East Asia slow, that can be expected to
negatively impact commodity prices and exports.
Closer co-movements of national economies are a logical consequence of
corporate and financial globalization since it makes economies more
inter-dependent. Those co-movements can become a concertina when they are
driven by a common factor such as export-led growth that relies on
debt-financed US consumers serving as buyer of last resort.
The key to avoiding a concerted global downturn is for developed economies to
sustain confidence in financial markets, resist misdiagnosed calls for a war on
inflation, and initiate policies that strengthen demand. Meanwhile, developing
countries must continue spending even as their exports to the US slow. These
countries now have the foreign exchange reserves to ride out a weakened trade
outlook. The open question is whether they have the sources of internal demand.
Developing that internal demand is a core problem. However, it remains off the
development policy agenda because the current paradigm is obsessed with the
supply-side and neglects development of the demand-side. As long as that is so,
the global economy will remain beset by an unstable and inadequate
configuration of demand.
Thomas I Palley is the founder of the Economics for Democratic and Open
Societies Project.
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