M. Ayhan Kose
There has been an extensive debate about whether business cycles in emerging economies have been decoupling from fluctuations in industrial countries. In light of the results of some recent studies, this article provides brief answers to seven commonly asked questions surrounding this debate.
Question 1: Why has there been an intensive debate about decoupling in recent years?
Answer: The debate stems from some profound changes the global economy has witnessed over the past two decades. First, international trade and financial linkages have become much stronger. Second, emerging market economies have differentiated themselves from other developing countries by growing at an extraordinary pace while rapidly integrating into the global economy (Claessens and Kose, 2008; IMF, 2008a). With increasing economic clout and faster growth than in the major industrial economies, the emerging markets have become major contributors to world growth. These changes have prompted questions about the relevance of the conventional wisdom that when the U.S. economy sneezes, the rest of the world catches a cold. That wisdom is coming into question especially because emerging market growth has continued to be strong in recent years despite relatively tepid growth in the United States and some other major industrial countries. These developments have led to a fierce discussion about whether emerging markets have been “decoupling” from industrial economies, in the sense that their business cycle dynamics are no longer tightly linked to industrial country business cycles.
Question 2: What does economic theory suggest about this debate?
Answer: The decoupling debate centers around the impact of globalization on the synchronization of business cycles. However, economic theory provides ambiguous predictions on how globalization affects the strength of cyclical linkages across nations. On the one hand, the closer economic linkages among the emerging markets and industrial countries have the potential to tie their business cycles more closely together (Kose, Otrok, and Whiteman, 2008). If this is the case, the forces of globalization in recent decades would be expected to lead to a convergence of business-cycle fluctuations. On the other hand, the fact that emerging markets have themselves become engines of global growth suggests that developments in the United States and other industrial countries can now have smaller spillover effects on the growth dynamics of emerging markets. This implies that business cycles in emerging markets can diverge (or decouple) from macroeconomic fluctuations in the United States and other industrial countries. These are both plausible theoretical arguments suggesting that this debate can only be settled by empirical studies.
Question 3: Is it possible to observe both convergence and decoupling in a highly integrated world economy?
Answer: To answer this question, recent empirical research utilizes the data of a large number of countries over a fairly long time period. For example, Kose, Otrok, and Prasad (2008) study the evolution of the degree of global cyclical interdependence over 1960–2005. They categorize the 106 countries in their sample into three groups—industrial countries, emerging markets, and other developing economies. Using a dynamic factor model, they then decompose macroeconomic fluctuations in key macroeconomic aggregates—output, consumption, and investment—into global, group-specific, and country-specific factors. The global factor represents fluctuations that are common to all countries and all three variables in each country. The group-specific factor captures fluctuations that are common to a particular group of countries. The country-specific factor accounts for the fluctuations that are common across all three variables in a given country but that are specific to that country.
They report that, during the period of globalization (1985–2005), there was some convergence of business-cycle fluctuations among the group of industrial economies and among the group of emerging market economies. Surprisingly, there has been a concomitant decline in the relative importance of the global factor. In other words, there is evidence of business cycle convergence within each of these two groups of countries but divergence (or decoupling) between them.
Question 4: How can these findings be explained?
Answer: These results are driven by the changing nature of shocks and international linkages over the past two decades. There were a number of large global shocks from 1960–84, including the two oil shocks and the synchronized disinflationary episode of the early 1980s. But from the mid-1980s onward (globalization period), there have been fewer large common shocks, and their role in explaining international business-cycle fluctuations has declined. These developments have led to a decline in the importance of the global factor in accounting for business cycles.
At the same time, intra-group trade and financial linkages among industrial countries and emerging markets have risen rapidly, especially after the mid-1980s (Akin and Kose, 2008). Moreover, during the period of globalization, the countries in these two groups have increased the pace of diversification of their industrial (and trade) bases. This has been accompanied by a greater degree of sectoral similarity across countries within each group. With these changes, intra-group spillovers have begun to contribute more to concurrent cyclical fluctuations than common disturbances. These changes have been associated with a notable increase in the roles played by group-specific factors for the groups of industrial and emerging market economies. Using a panel regression model, Akin and Kose (2008) also find that the impact of economic developments in industrial countries on the growth dynamics of emerging markets has declined during the globalization period.
Question 5: What are the implications of these findings for the decoupling debate?
Answer: These findings suggest the need for a nuanced approach to this debate. Contrary to the convergence hypothesis, rising trade and financial integration are not necessarily associated with a global convergence of business cycles, as evidenced by the decline in the importance of the global factor. But there is indeed some evidence of convergence at a different level. Greater economic integration among industrial countries and among emerging market economies has been associated with the emergence of group-specific cycles.
However, these results do not imply a blanket endorsement of the decoupling view. In particular, the secular changes documented above apply to a large set of industrial countries, not just the United States. Moreover, adverse developments in the U.S. economy can have a significant impact on emerging markets in the presence of certain nonlinearities involving the amplitude of business cycles. For example, IMF (2007) documents that a deep and protracted U.S. recession can have much larger spillovers than a mild and short one.
In addition, these results address the potency of linkages through real macroeconomic aggregates, but do not account for financial ones. In other words, these findings do not speak to the possibility of financial decoupling (or lack thereof). The turmoil in global financial markets in the past year has clearly shown that, in an age of closely linked financial markets, a prolonged period of financial decoupling is highly unlikely.
Question 6: What do we know about the decoupling potential of different regions?
Answer: The studies summarized above primarily focus on the interactions between emerging markets and industrial countries. Recent research has also examined whether certain regions are better positioned to decouple from a recession in the United States. The potential of Asia, in particular, has been studied in detail mainly because of the strong growth performance of some of the Asian emerging market economies in recent years (ADB, 2007; He, Cheung and Chang, 2007; IMF 2008b). Some studies emphasize the rapid expansion of trade and financial linkages between the United States and the Asian emerging markets and, using a variety of methodologies, conclude that the U.S. slowdown could have a substantial impact on these economies (IMF, 2008b). However, others argue that while the impact of a slowdown in the U.S. economy would be relatively small on the growth dynamics in the Asian emerging markets, it could have a much larger impact if the slowdown translates into a recession and leads to severe dislocations in global financial markets (Park, 2007).
Another line of study has focused on the transmission of spillovers from the United States to its partners in the North American Free Trade Agreement (Canada and Mexico) and to Latin American countries (Roache, 2008). Swiston and Bayoumi (2008) report that business cycle fluctuations in Canada and Mexico have over time become more sensitive to developments in the United States, implying that it is hard to make a strong case for these economies to decouple from a potential recession in their large neighbor.
Ilahi and Shendy (2008) study the intra-regional growth linkages among the major oil exporters of the Gulf Cooperation Council (GCC) and eight countries in the Middle East. They document that growth in the Middle East has been associated with remittance outflows from and the accumulation of financial surpluses in the GCC. These findings suggest that the growth impact of industrial countries is relatively smaller for the developing countries of this region. One interpretation of these results is that the Middle Eastern countries in their sample appear to be better positioned to decouple from business cycles in the United States.
Question 7: Is it correct to claim that the decoupling debate is a new one for the new century?
Answer: Not necessarily. This can be seen as an extension of an old debate about the dependency of developing countries on developed economies, a topic which has been extensively studied by development economists over the years (Akin and Kose, 2008). For example, in his 1979 Nobel Prize lecture, Sir Arthur Lewis stated: “For the past hundred years the rate of growth of output in the developing world has depended on the rate of growth of output in the developed world. When the developed world grow fast the developing world grow fast, when the developed slow down, the developing slow down. Is this linkage inevitable?”(Lewis, 1992)
In a sense, the decoupling debate is about the same question Lewis asked almost 30 years ago. Although the debate appears to be an old one, the topic itself promises to be fertile ground for research because of the dramatic changes in the global economy during the past two decades. As a result of these changes, the nature of economic interactions between industrial economies and emerging markets has evolved from one of dependence to multidimensional interdependence. Understanding the implications of these changes is important for the design of macroeconomic policies and theoretical models.
Akin, Cigdemand M. AyhanKose, 2008, “Changing Nature of North-South Linkages: Stylized Facts and Explanations,”Journal of Asian Economics, Vol. 19, No. 1, pp. 1–28.
Asian Development Bank (ADB),2007, “Uncoupling Asia: Myth and Reality.” In Asian Development Outlook (Hong Kong: Oxford University Press).
ClaessensStijn, and M. AyhanKose,2008, “Emerging Markets: On the Verge of a New Era?” In Euromoney Emerging Markets Handbook, 2008/9 (Bedfordshire, UK: Euromoney Institutional Investor PLC).
He, Dong, LillianCheung, and JianChang, 2007, “Sense and Nonsense on Asia’s Export Dependency and the Decoupling Thesis,” Hong Kong Monetary Authority Research Memorandum 06/2007.
Ilahi, Nadeem, and RihamShendy, 2008, “Do the Gulf Oil-Producing Countries Influence Regional Growth? The Impact of Financial and Remittance Flows,”IMF Working Paper 08/167.
International Monetary Fund (IMF), 2007, “Decoupling the Train? Spillovers and Cycles in the Global Economy.” In World Economic Outlook, April 2007 (Washington: International Monetary Fund).
International Monetary Fund (IMF), 2008a, “Global Prospects and Policies.” In World Economic Outlook, October2008 (Washington: International Monetary Fund).
International Monetary Fund (IMF), 2008b, “Can Asia Decouple? Investigating Spillovers from the United States on Asia?” In Regional Economic Outlook: Asia and Pacific, April2008 (Washington: International Monetary Fund).
Kose, M. Ayhan, ChristopherOtrok, and EswarPrasad, 2008, “Global Business Cycles: Convergence or Decoupling?”Iza Discussion Papers 3442, Institute for the Study of Labor (IZA).
Kose, M. Ayhan, ChristopherOtrok, and CharlesWhiteman, 2008, “Understanding the Evolution of World Business Cycles,”Journal of International EconomicsVol. 75, No. 1, pp. 110–30.
Lewis, Arthur, 1992, “The Slowing Down of the Engine of Growth,” 1979 Nobel Prize Lecture. In Nobel Lectures-Economics 1969–1980,ed. by AssarLindbeck (Singapore: World Scientific Publishing).
Park, Cyn-Young, 2007, “Can East Asia Weather a U.S. Slowdown?’Asian Development Bank Economics and Research Department ERD Working Paper No. 95.
Roache, Shaun, 2008, “Central America’s Regional Trends and U.S. Cycles,”IMF Working Paper 08/50.