The decoupling debate has never been so vigorous. On one hand, the ongoing recession has been unnervingly synchronised across real and financial markets in all major economies. On the other, Asian economies registered the global crisis much later than the US or EU, remaining relatively insulated in the period between 2006 and the first half of 2008. Similarly, they have rebounded sharper than developed economies, with several Asian countries showing signs of recovery, even posting double-digit growth rates in the second quarter of 2009. Proponents of decoupling argue that the Asian recovery heralds a new era of Asia-led growth, whereas ?coupling? theorists argue that the synchronicity of the global downturn is telling, and that the Asian recovery is not sustainable given Asia?s high export exposure to the developed world. This leads to the question of whether academic evidence has examined this issue and if theoretical and empirical evidence supports or opposes the decoupling hypothesis.
Theoretically, there are several channels through which increased trade and financial openness induce business cycle co-movements. The first is intuitive?higher trade linkages imply higher reliance on external demand. Similarly, as financial integration increases, capital flows in different countries are synchronised through various channels of financial contagion. More nuanced channels include commodity price linkages?demand from larger economies such as the United States or China drive oil prices, which then affect cyclical fluctuations of smaller oil-importing countries. Similarly, cyclical fluctuations in advanced economies affect private remittances to developing countries. Despite these theoretical channels for coupling, there is no clear empirical consensus that greater openness increases business cycle co-movement. A recent paper by Julian Giovanni and Andrei Levchenko of the IMF extends this analysis, accounting for vertical linkages in production as well as differing levels of synchronisation across sectors. They find that increased trade linkages do strengthen sectoral co-movements, especially in sectors that are tightly vertically linked. They estimate that these linkages explain up to one-third of the overall impact of bilateral trade on aggregate co-movement. However, their sample does not cover the 2006-2008 period, where much of the decoupling story is sourced.
Similar to the debate on trade is that on finance. Given floating exchange rates and high levels of capital account openness in many Asian economies, it is difficult to prevent equity and foreign exchange market synchronisation, which have significant impacts on household and firm net worth. Michael Hutchinson of the University of California investigates linkages in capital markets between emerging and developed countries in the current crisis, and finds that financial and real news of US economic events transmitted strongly to Asian equity markets in the second half of 2008, although Asia remained relatively insulated until summer 2008. However, financial linkages are often more deep-rooted than equity price or foreign exchange synchronisation, as foreign investment also takes the less cyclically-sensitive form of direct investment. Empirical evidence on the growth effects of this form of financial integration has not focused on the decoupling hypothesis.
One possible resolution for the mixed empirics is the definition of co-movement. Sebastian Walti of the Swiss National Bank argues that the issue of trend decoupling must be separated from that of cyclical decoupling. While globalisation has resulted in a greater convergence in cyclical fluctuations, the divergence in trend fluctuations masks this in the data. This is especially seen in developing Asia, where countries like China and India have seen a significant acceleration in trend GDP due to structural domestic economic reform that unleashed growth potential. Using a conventional decomposition of growth into trend and cycle, he maps out an index of decoupling between a given set of emerging and developed economies, and studies the trend of this index over time. He finds little evidence to support the decoupling hypothesis, as the index of decoupling does not decline with time for any set of emerging markets.
This method, however, does not take into account trend-cycle interaction effects. In several emerging economies, especially export-led East and South East Asia, positive or negative shocks to cyclical fluctuations has been documented to affect trend growth. Similarly, ongoing cyclical fluctuations in the US and the EU are touted to permanently lower long-term trend growth. Separating trend and cycle effects may actually remove the important transmission channel from short-term fluctuations to longer-term growth.
Overall, there is no clear empirical consensus on decoupling, although theoretical channels support the hypothesis that increased globalisation and trade would result in increased business cycle co-movements.
?The author lives and works in Singapore