Even while the US was struggling with several quarters of economic slowdown, the emerging economies continue to grow at a clip, thereby giving rise to the notion that the economic decoupling has finally arrived.
The decoupling theory holds that European and Asian economies, especially emerging ones, have broadened and deepened to the point that they no longer depend on the US for growth, leaving them insulated from a severe slowdown and a full-fledged recession.
Faith in the concept has generated strong performance for stocks outside the US—until now. Decoupling was a rage early last year when international financial markets ignored the increasing turmoil in the US economy and stock market. However, investment advisers point out that the segments of the US economy that were showing wear and tear then were those to which the rest of the world would never be heavily exposed. This is no longer true, they say, and markets are responding accordingly.
In 2008, when the US slowdown was driven almost entirely by housing, it made sense that the rest of the world kept going. However, the scenario has changed significantly now. The nature of the slowdown has changed in two key aspects. The credit crunch that began in mid-summer is not just a US phenomenon; the rise in risk aversion is global and will have an impact on credit terms and availability everywhere. We are finally seeing evidence that the US job market is losing steam and consumer spending is slowing.
Critics of decoupling theory say that the notion that the US can go into recession with no negative knock-on effect on the rest of the world doesn’t hold. Several studies indicate that there are still a variety of important trade, financial, currency and commodity links between the OECD economies and a large number of emerging economies. These links indicate that a change in OECD growth rates would have a material impact. Is then decoupling theory more of a myth than reality?
Against this background, proponents of decoupling explain that the emerging markets’ economic growth is moving northwards in spite of the ongoing economic slowdown in the US. Even in case of financial markets, while the developed markets have been shaken by the US Subprime crisis, financial markets in emerging economies, especially China and India, have proved surprisingly resilient. This clearly illustrates: what the global economy is presently experiencing are divergences in economic and financial performance; or in other words, “economic decoupling.” For instance, Indian companies are growing its share in Europe and Middle East to de-risk their business model away from the US.
The debate about decoupling has always centered on the remarkable rise of the BRIC (Brazil, Russia, India, and China) economies, without having any negative impact from the US slowdown. These economies would remain on a steady upward course without pause. According to Goldman Sachs, 30 percent of global domestic demand has originated from BRIC (Brazil, Russia, India, and China) economy. Though this demand is not much compared to that of US, it is nonetheless not far behind and these economies are gearing up to cross the US demand. At present, the US comprises about 26 percent of the world economy whereas BRIC is about 10-11 percent. If these four economies witness a demand growth of more than 6 percent, they will have stronger demand impetus for the world than from the US economy.
Going ahead, by 2030, several reports indicate that America will be able to contribute around 20 percent of world GDP, whereas China’s contribution will increase from the current 5 percent to 10 percent. These trends indicate the fact that the world economy will continue to witness re-orientation in its economic order.
When the US economy sneezes…
Critics of economic decoupling opine that it would be a mistake to single out trade flows as the channel for spreading any US slump worldwide. According to them, financial markets are the main route and Uncle Sam shares account for 52 percent of global equities, and dollar-denominated bonds (wherever issued) account for 37 percent of global bonds.4 In today’s globalized world, financial markets are closely synchronized than trade flows. It’s like – when Wall Street catches cold, other markets sneeze.
Today, the global worry is not slower US GDP growth, but concerns about ballooning US government debt. Further, there are signs of overheating in the BRIC regions, which amplify concerns that rates are heading upwards elsewhere. Against this backdrop, both China and India have tightened their monetary policy in the recent past. These economies are facing record inflation, which implies that the growth for these countries in recent years is not sustainable. Most emerging and developing countries’ stock markets are in doldrums and investors are nervous, and this indicates that demand from the region cannot be relied upon. Therefore, it is hard to draw conclusions about economic decoupling.
To conclude, global economies are indeed witnessing divergence in their economic performance. But it holds true only when we consider the recent quarters of economic growth. During this period, the US economy slowed to a greater extent than other developed nations. At the same time, economic activity in these economies has stalled more than the emerging market economies. During the economic downturn of 2001, the global economy witnessed uniform economic slowdown. However, today, financial conditions in most emerging market economies have remained fairly steady than in industrial economies.
Jany, Lead Economist
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