Chapter 11. A Complex Affair: Global and National Cycles
- Ayhan Kose, and Marco Terrones
- Published Date:
- December 2015
The 2009 global recession forced a reconsideration of the linkages between the global business cycle and national cycles. Some countries were able to weather the global storm rather effectively, but others went through severe recessions. How does global growth affect national growth? Does the impact of global growth on national growth vary during global recessions and expansions? Do country-specific features affect the sensitivity of national cycles to the global cycle?
Reconsidering the Linkages
The 2007–09 financial crisis sparked intensive discussions about our understanding of the linkages between the global and national business cycles. This was a natural outcome of the significant variation in growth between different groups of countries during the global recession and the ensuing recovery.1 Emerging market economies were surprisingly resilient during the worst of the financial crisis and rapidly returned to growth. In contrast, advanced economies experienced deep contractions and a disappointingly slow recovery.
The 2009 global recession shifted the focus from the dependence of emerging market and developing economies on advanced economies to the relationship between the global business cycle and national business cycles.
These discussions have taken place against the backdrop of a rich research program on various aspects of global and national business cycles. Most of the studies on this topic have focused on the dependency of the emerging market and developing economies on the advanced economies.2 We briefly summarize different channels through which developments in advanced economies affect activity in emerging market and developing economies in a Focus box at the end of this chapter. These studies confirm that the cyclical fortunes of emerging market and developing economies are tightly linked to developments in advanced economies.3
This chapter shifts attention to the linkages between the global business cycle and national business cycles. First, we briefly review our main observations about the linkages between global and national cycles in light of lessons from the analysis in the previous chapters.
From Global to National Growth
Our analysis of global recessions and recoveries so far points to three broad observations about the linkages between the global cycle and national business cycles.
- The global cycle behaves significantly differently during recessions and recoveries: average growth in world output per capita is about −0.7 percent during global recessions, but 2.3 percent during global recoveries (Figure 11.1).
- The growth performance of different country groups varies considerably over the global cycle. This implies that the sensitivity of national cycles to the global cycle depends on the phase of the global cycle. Advanced economies tend to perform worse than other country groups during global recessions and often experience weaker recoveries. Differential growth outcomes across country groups are also evident in the time series of growth in GDP per capita.
- The fraction of countries in recession increases significantly during a global recession. Specifically, 60 percent of countries, on average, experienced recessions during the four global recessions whereas only about 25 percent did during the full sample period (1960–2012).
Figure 11.1Growth and Synchronization: The Big Picture
Note: Each bar in panel A corresponds to purchasing-power-parity-weighted average growth rate of GDP per capita of all countries during the indicated periods. Each bar in panel B corresponds to purchasing-power-parity-weighted average growth rate of GDP per capita of respective country groups during the indicated periods. Each line in panel C shows the purchasing-power-parity-weighted GDP per capita growth rate for the respective country group. Each bar in panel D shows the proportion of countries in recession during respective global recessions. The bar “Average (1960–2012)” shows the average proportion of countries in recession during 1960–2012.
Need a new Model
In light of these three broad observations, we examine the sensitivity of national cycles to the global cycle over the two different phases of the global cycle. Specifically, we consider the impact of global growth on national growth during global recessions and expansions and study how this impact varies depending on different country characteristics using an econometric assessment of the interactions between the global cycle and national business cycles. Our econometric model explicitly accounts for the linkages between global growth, national growth, and global financial conditions. It also accommodates national and global real factors (often captured by domestic and worldwide productivity shocks) and global financial conditions (often captured by world interest rate shocks) to assess how these affect cyclical growth outcomes.We focus on the impact of two major global variables on national growth outcomes: rest of the world growth per capita and the world real interest rate. The first variable is similar to the global business cycle measure employed in previous chapters. For each country, it is the purchasing-power-parity-weighted output growth of the remaining countries in the sample minus their population growth. The second variable is based on a widely used measure of the world real interest rate and corresponds to the difference between the three-month U.S. dollar London interbank offered rate (LIBOR) and U.S. inflation. It helps capture the influence of global credit and monetary conditions on national cycles.4
In addition, we use standard de facto measures of trade and financial integration in our model: the ratio of the sum of imports and exports to GDP and the ratio of the sum of total assets and liabilities to GDP. We also account for country-specific features (fixed effects) by capturing differences in institutions, structural factors, and initial conditions.
To structure our analysis of the linkages between the national cycles and the global cycle, we ask three basic questions. How does global growth impact national growth? How does its impact vary across country groups? Are country-specific features important? We present a preliminary analysis of these issues. There are obviously many extensions to consider and we provide a discussion of some of these in the last chapter.
How Does Global Growth Impact National Growth?
There is a positive and statistically significant association between national output growth and rest of the world growth, which implies that national cycles tend to move in tandem with the global cycle (Figure 11.2).5 However, the strength of this relationship varies over the two phases of the global cycle. In particular, national cycles tend to be much more sensitive to the global cycle during recessions than during expansions.
Figure 11.2Linkages between National and Global Cycles
Note: The bars show the impact of a 1 percentage point increase in the rest of the world per capita output growth on the national output growth rate per capita. See table 1 in Appendix J for detailed results.
A 1 percentage point increase in global growth is associated with a 0.7 percentage point pickup in national growth rate during global expansions, but it is associated with a 1.4 percentage point rise during global recessions. These findings imply that the impact of the global cycle on national cycles is much more pronounced during global recessions than during expansions.
There appears to be a negative association between national cycles and the world real interest rate, but this relationship differs across the two phases of the global cycle.6 During global expansions, it is negative and statistically significant, whereas during global recessions it is slightly positive but insignificant (Figure 11.3). A 1 percentage point increase in the world real interest rate during a global expansion is associated with a 0.12 percentage point decrease in the growth rate of these countries. These links, however, weaken substantially during global recessions as lenders retrench their activities, including for international trade.7
Figure 11.3National Cycles and the World Interest Rate
Note: The bars show the impact of a 1 percentage point increase in the world real interest rate on the national output growth rate per capita. See table 1 in Appendix J for detailed results.
Why is national growth more sensitive to global growth during global recessions? First, as documented earlier, global recessions often coincide with large shocks that adversely affect many countries. This reduces external demand and leads to a significant decline in international trade flows. This in turn hurts national growth, especially in countries that rely heavily on exports. Second, global recessions are often periods of financial turmoil that coincide with contracting credit and declining asset prices. In a highly integrated world economy, disruptions in global financial markets often translate into slower national growth as international capital flows quickly dry up. Disruptions in global financial markets also affect the financing of exports and imports, aggravating the growth effects of declining international trade flows.
How Do linkages Vary Across Country Groups?
The nature of linkages between the national and global cycles appears to vary across different country groups (Figure 11.4). In particular, both advanced and emerging market economies are more sensitive to the global business cycle during global recessions than are other developing economies. During global recessions, a 1 percentage point increase in global growth is associated with a 1.5 to 2 percentage point rise in the national growth rate in the emerging market and advanced economies, compared with only a 1 percentage point pickup in other developing economies. These results are consistent with those from other studies analyzing the importance of global and national factors in explaining business cycles in different country groups.8
Figure 11.4Linkages between National and Global Cycles: Country Groups
Notes: The bars show the impact of a 1 percentage point increase in the rest of the world per capita output growth on the national per capita output growth rate during recessions and expansions. See Appendix J (J.2) for detailed results.
The sensitivity of national cycles to world interest rates also differs across country groups (Figure 11.5). For advanced economies, national cycles tend to move with the global interest rate cycle given the statistically significant positive association between domestic growth and the world real interest rate. However, for emerging market and other developing economies, national cycles tend to move in the opposite direction of the world interest rate cycle during global expansions. For example, a 1 percentage point increase in the world real interest rate during a global expansion is associated with a roughly 0.2 percentage point decrease in the national growth rate of the emerging market economies. In contrast, an increase in the world real interest rate during global recessions has a negative, but statistically insignificant, effect on the growth of these countries.
The impact of global growth on national growth is more pronounced during global recessions.
Figure 11.5National Cycles and the World Interest Rate: Country Groups
Note: The bars show the impact of a 1 percentage point increase in the world real interest rate on the national output growth rate per capita. See table 2 in Appendix J for detailed results.
These results likely reflect that movements in interest rates have differential effects on the business cycles of debtor and creditor countries. While there has been a role reversal in recent years, advanced economies were historically creditors and emerging market and other developing economies debtors during most of the period under study. Creditors tend to benefit from increases in interest rates, whereas debtor countries face larger debt-service costs.
Are Country-Specific Features Important?
Both trade and financial integration appear to influence the sensitivity of national cycles to the global cycle and to the world interest rate. For instance, national cycles are more sensitive to the global business cycle in countries that are more open to trade flows. The intensity of this empirical relationship, however, varies between the two phases of the global cycle. A 1 percentage point increase in global growth is on average associated with a roughly 0.7 percentage point increase in the national growth rate during a global expansion for a country if its degree of trade openness is equal to the average of countries in our sample (about 70 percent). Likewise, a 1 percentage point reduction in global growth is associated with about a 1.6 percentage point decrease in the national growth rate during a global recession for a country if its degree of trade openness is equal to the average of countries in our data sample.
There is a statistically significant negative association between the national cycle and the global interest rate cycle during global expansions, but this association becomes weaker in countries with stronger international financial linkages. This result probably stems from the fact that countries with stronger financial linkages are able to attract a diverse variety of capital flows, including foreign direct investment and portfolio investment, whereas those with weaker links with the rest of the world often rely on debt flows that are sensitive to movements in world interest rates.
Movements in global interest rates have differential effects on creditor and debtor countries.
The inclusion of variables measuring a country’s integration with the global economy to our baseline econometric model does not change the positive association between the global and national cycles. Increased trade integration tends to accentuate the sensitivity of national cycles to the global cycle, whereas increased financial integration helps shield national growth from fluctuations in world interest rates during global expansions.
What Does It All Mean?
Our findings collectively portray an intricate relationship between the global business cycle and national cycles. National business cycles are tightly linked to the global cycle, but the sensitivity of national cycles to the global cycle is much higher during global recessions than during expansions. There are significant differences in how countries respond to the global cycle, with advanced economies seemingly more sensitive than developing economies. Moreover, countries tend to be more sensitive to the global cycle the more integrated they are with the global economy.
Transmission of Cycles across Borders
As emerging market and developing economies establish stronger linkages with the world economy, macroeconomic fluctuations in these countries become more sensitive to external developments. Indeed, the 2007–09 financial crisis originated in a small set of advanced economies, but it rapidly spread to a large number of emerging market and developing economies. The cycles in advanced economies can be transmitted to emerging market and developing economies through three channels: trade, finance, and direct sectoral linkages.
During the 2009 global recession, the financial channel played an important role in transmitting the initial shock from advanced to emerging market and developing economies. In addition, the other channels associated with trade and sectoral interdependence significantly affected macroeconomic fluctuations in the latter group.9
The Trade Channel
- Foreign demand shocks. Business cycles in advanced economies have a significant effect on demand for commodities, intermediate goods, and finished goods produced by emerging market and developing economies. As their trade relationship with the advanced economies has rapidly expanded in recent decades, emerging market and developing economies have become increasingly more affected by aggregate demand conditions in the advanced economies. This is especially true for the many Asian and Latin American countries that have strong trade linkages with advanced economies (Kim 2001; Canova 2005; Akin and Kose 2008; Fidrmuc and Korhonen 2010).10
- Aggregate productivity shocks. For many emerging market and developing economies, technology transfers occur mainly through imports from advanced economies. Technological spillovers and their effects on macroeconomic fluctuations therefore tend to be larger for countries that have strong trade relations with advanced economies, although this also depends on the nature of products traded (Kose, Prasad, and Terrones 2003a, 2009; Jansen and Stokman 2004).
- Terms-of-trade fluctuations. Research indicates that terms-of-trade shocks could account for a substantial fraction of output fluctuations in developing economies. These shocks include variations in commodity prices that are often influenced by cyclical conditions in advanced economies. The volatility of commodity prices tends to have large spillover effects within developing economies that rely on exports of commodities and other primary products for much of their export earnings (and, in some cases, for a significant fraction of their national incomes). In this vein, commodity price shocks have been shown to be important determinants of investment and output fluctuations among commodity-exporting countries (Kose and Riezman 2001; Eicher, Schubert, and Turnovsky 2008; Broda and Tille 2003).11
The Financial Channel
- Private capital flows. Foreign direct investment and other forms of capital flows from advanced to emerging market and developing economies have expanded considerably in recent decades. The magnitude and volatility of capital flows from advanced economies can significantly influence investment and output in developing economies (Kose, Prasad, and Terrones 2003b, 2006). The effects of capital inflows and their reversal on domestic activity in emerging market and developing economies are well documented (Mendoza 2001; Cardarelli, Elekdag, and Kose 2010). The phenomenon of financial contagion also implies that macroeconomic disturbances in one or a few emerging market and developing economies could be transmitted rapidly to other countries via the financial channel. The rising correlation of stock market fluctuations is another aspect of this phenomenon. As emerging market and developing economies strengthen their linkages to international financial markets, the financial channel is likely to become increasingly important in transmitting fluctuations to these countries.
- Aid and remittance flows. The volatility of aid and remittance flows can also affect macroeconomic fluctuations in some emerging market and developing economies. Research finds that while these flows are volatile, they appear to help smooth the home country business cycles (Ratha 2005; Acosta, Lartey, and Mandelman 2009; Durdu and Sayan 2010; Frankel 2011; Mandelman and Zlate 2012).
- Global financial market conditions. Changes in world interest rates and investors’ appetite for risk, along with perceptions of the riskiness of investments in emerging market and developing economies, are likely to influence the quantity of capital inflows to these economies. The ability of these countries to conduct countercyclical macroeconomic policies could also be constrained by externally generated changes in interest rates and spreads. Evidence suggests that the effects of world real interest rate shocks on output volatility tend to be significant for countries with high external indebtedness (Kose 2002; Neumeyer and Perri 2005).
- Similarities in economic structure. These similarities imply that sector-specific shocks—including productivity shocks and shocks to the composition of import demand from advanced economies—tend to have similar effects on aggregate fluctuations across national borders. Some studies find that the high degree of business cycle synchronization across the major East Asian economies compared with those in Latin America may be largely attributable to similarities in the sectoral composition of output in these countries (Imbs 2004; Dées and Zorell 2012).