Emerging economies increasingly decoupled from the US?

I have been thinking about the RBS's interest rate policies and their drive to deflate inflationary expectations in Australia when all the evidence suggests that the US economy is probably already experiencing recession as well as emerging inflation.

The catch is that the interest rate hikes that have occurred in Australia over the past few years impact on aggregate demand with a long lag - perhaps 12 to 18 months. By the time they impact Australia may be experiencing the direct effects of a US slowdown and the indirect effects of such a slowdown on the Chinese economy which directs 21% of its exports to the US. A decline in US import demands would trigger a decline in demand for our raw material exports to China.

The double wammy of a policy-induced local interest rate hike coupled with a global slowdown might well drive the Australian economy into a policy-induced recession. It is a fear that needs to be balanced against the urgent need to retqain RBA credibility at controlling the commodity cost driven inflation that Australia is now experiencing as well as the biggest investment boom Australia has experienced in 20 years.

The empirical question here vis the extent to which events in the US will drive events in Australia or, to put it another way, the extent to which the Australian economy is coupled with or decoupled from the US economy.

This article in The Economist studies the decoupling debate. One approach to the decoupling issue is to say that with increasing economic integration and interdependence decoupling is less likely. Empirical evidence from developing countries however suggests they are more decoupled than in the past. While the US economy has been stumbling countries such as China have reduced their exports to the US but substantially increased their exports to other emerging countries - half of China's exports now go to emerging economies.

Moreover in the face of a US decline consumption and investment spending in many emerging economies has continued to grow strongly. In China this is so because less than 15% of total investment is linked to exports - over half is in infrastructure and property.

A recent IMF study by Cigdem Akin and Ayhan Rose finds that decoupling can proceed alongside globalisation. Growth seems to have become more synchronised among developing countriesw and among developede countries but developed countries as a group have decoupled (increasingly diverged) from developing countries as a group. Again the reason seems to be that emerging countries are increasingly trading among themselves.

The Economist concludes:

A severe recession in America could still have a nasty impact on the developing world if commodity prices collapsed and if it caused stockmarkets to fall more steeply, depressing global consumer and business confidence. A sharper fall in the dollar could also further squeeze emerging economies’ exports.

But for perhaps the first time ever, developing countries would be able to make full use of monetary and fiscal policy to cushion their economies. In the past, when they were net foreign borrowers, capital inflows tended to dry up during global downturns as foreign investors shunned risky assets. This forced governments to raise interest rates and tighten fiscal policy.

Economies with large external deficits are still vulnerable, but most emerging economies now have a current-account surplus and large foreign reserves; many have a budget surplus or are close to balance, leaving ample room for a fiscal stimulus if necessary.

Perhaps the best support for decoupling comes from America itself. Fourth-quarter profits of big companies, such as Coca-Cola, IBM and DuPont, were better than expected as strong sales growth in emerging markets offset a sharp slowdown at home. Bits of American business are rising above their own economy. With luck, the world economy can rise above America’s.

This is perhaps good news in terms of the indirect effects of a US recession on Chinese demands for Australian exports. We will still cop the coupled direct effects but the indirect effects will be muted because much Chinese demand for our raw materials is not export related and, in any event, China is increasingly diversifying its exports away from dependence on the US.