“The past is a foreign country: they do things differently there.”
— L.P. Hartley, English novelist
Economically speaking the world is at a level no one ever could have imagined. If an economist predicted thirty years ago that Europe and the United States would be the centers of an economic crunch, people would have though he is bonkers. Fred Bergsten said; “The unforeseen is now routine”
Due to globalization induced diversification in the sources of economic growth or structural changes and policy improvements emerging economies have become more resilient to global shocks (Economist, 2009).
However, the popular decoupling argument is both less straightforward and more controversial than what its narrative suggests. The decoupling argument has two different interpretations: business cycle synchronicity, relating to global recessions and synchronized expansions and on the other hand we have the argument of sensitivity between markets and economies, especially between the G7.
The correlation of business cycles is the measure of decoupling and it has become standard in the economic literature. This mixes the amplitude and sensitivity as the correlation between the world and emerging markets (say, G7) – can increase with EM sensitivity to global growth as well as the ratio of output volatilities. The correlation could be increased despite to the extent that volatility is reduced in the G7 to the ultimate that it raises characteristic volatility. This could increase the correlation despite of the element that the link between the two countries remains unbroken. On the other hand, pure synchronicity measures, while closer to the canonical definition of decoupling, are silent about the economic relevance of the connection.
The evidence of decoupling is seldom found. If anything, the 2000s seem to have witnessed an increase in the correlations of EM and G7 cycles (Figure 1).2 By contrast, with a few exceptions, emerging markets have been exhibiting growth outperformance that, according to most analysts’ forecasts, will continue (and possibly deepen) in the next few years (Figure 2)
Daniel Gros arguments to the extraordinarily point that it is obvious that the the kind of fiscal adjustment currently being proposed for some of the peripheral countries is going to have one immediate consequence which is that these countries are going to be sent off to outer darkness of sharp GDP contractions. These contractions run the risk of triggering pre- Argentina 200 type situations. Debt to GDP ratios will increase and the return would be deeper short-term fiscal cuts and even stronger contractions.
Let’s move on from the issue of whether or not convergence is a realistic objective for Europe’s economies given the large demographic miss-matches between countries. The European countries have an situation where they have the best of all possible worlds in the one hand but on the other hand they have a group of drawbacks and forgers.
There are various reasons why the European decoupling group is in trouble. The main reason may be the fact that if the group of forgers and drawbacks wanders off to deep into the darkness the European banking systems would experience some difficulties. German banks may have little exposure to Greek debt, but their exposure to Spain and Ireland is enormous
Gideon Rachman admitted that this one felt like a significant moment to him. We have two proposals on the table, and neither of them will work. In the first place simply treating the problem on Europe’s periphery as an essentially fiscal one will not return these countries to competitiveness, and will simply precipitate GDP contractions, and deflationary spirals, that will lead inexorably towards failure, default, and possibly exit from the Eurozone which, in fact, seems would be an acceptable outcome to all this.
By Johan Steenkamp
Rose, A. (2009), “Debunking ’decoupling’,” VoxEU.org, 1 August
Economist (2009), Decoupling 2.0, 21 May