US growth and the decoupling thesis

Conquering The Coming Collapse

Conquering The Coming Collapse

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Since the outbreak of the sub-prime crisis, US economic activity has slowed steadily. The annualised quarter-on-quarter real GDP growth rate fell from close to 5 per cent during the third quarter of 2007 to below 1 per cent in the next two quarters. Economists are still divided about whether the US economy will fall into deep recession, but most agree that US economic growth is likely to stay well below the trend level for at least several quarters. This should have important implications for the outlook for the Chinese economy in the coming year.

To some economists, slowing growth in the United States but steady expansion of the Chinese economy in 2007 provided convincing evidence of the decoupling thesis. The decoupling proposition suggests that as Asian economies grow and economic interactions between them deepen, the relative importance of the US economy for Asia will decline.

The decoupling thesis is an exaggeration of real economic relations, to say the least. If anything, Asia and China's economic linkages with the United States strengthened, rather than weakened, during the past 10 years. China, in particular, became a much more open economy. The export share of GDP rose from 18.6 per cent in 1997 to 36.1 per cent in 2007, while the share of United States-bound GDP increased from 3.3 per cent to 6.9 per cent in the same period (Figure 2.3).

The fact that Chinese growth did not soften alongside slowing US growth in 2007 was probably more of a special situation than a general rule. First, the slow-down in the United States in 2007 was concentrated in the housing sector; non-housing activities continued to grow at 2.5 per cent. The situation has now changed and the growth slow-down in the United States in 2008 is occurring mainly in the non-housing sector, especially in consumer spending and business investment. Second, softening of United States-bound exports was offset by European Union-bound exports, when the euro strengthened significantly. This will, however, be difficult to repeat; the European economy already shows increasing weakness and the euro is under pressure to weaken, at least in the coming quarters.

It is probably also premature to count on growing intra-regional trade to support Asian economic growth. Although intra-regional trade grew exponentially after China joined the World Trade Organization (WTO) in 2001, the majority of this—at least 70 per cent—was trade in intermediate goods. The key destinations for Asia's finished-goods exports are the G3 economies (the United States, the European Union and Japan, 61 per cent), Asia (21 per cent) and the rest of the world (18 per cent). This implies that Asian domestic

Figure 2.3 Shares of total exports and United States-bound exports in China's GDP, 1993-2007 (per cent)

Figure 2.3 Shares of total exports and United States-bound exports in China's GDP, 1993-2007 (per cent)

Sources: CEIC Data Company and Citi.

demand is still not significant enough to support regional economic growth, should the US economy slow sharply. Asia and China could become decoupled from the United States and other industrial economies when regional domestic demand is large enough, but that is at least 10 years away.

I examine the likely impacts of a US slow-down on Asian economies through model simulations applying the Oxford Economic Forecasting (OEF) model. The results suggest that a 1 percentage-point slow-down in the US economy could lower Asian economic growth on average by 1.1 percentage points and reduce Chinese growth by 1.3 percentage points (Figure 2.4). The real changes are likely to be smaller as the model cannot endogenously generate a policy response to support growth. In China, for instance, the government will most likely employ fiscal stimuli if external demand weakens significantly.

Another mechanism that could offset growth moderation in China is the likely change in capital flows. In a world faced with slowing US growth and rising US financial risk, capital inflows to China could accelerate, as evidenced by changes during the first two quarters of 2008. Unfortunately, however, China's economic constraint is not a lack of capital; rather, too much capital inflow could further increase domestic liquidity and therefore add further pressure to domestic inflation.

Figure 2.4 Model simulation: impacts of a 1 per cent slow-down of the US economy (per cent)

Figure 2.4 Model simulation: impacts of a 1 per cent slow-down of the US economy (per cent)

Source: Simulation results applying the Oxford Economic Forecasting model.

Figure 2.5 Nominal and real oil prices, January 1959 - June 2008

NominalWTI RealWTI

Figure 2.5 Nominal and real oil prices, January 1959 - June 2008

NominalWTI RealWTI

Jan-59 Jan-65 Jan-71 Jan-77 Jan-83 Jan-89 Jan-95 Jan-01 Jan-07

Source: Citi.

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