What Is This 'Decoupling' of Which You Speak?

Dani Rodrik notices that businessmen in emerging economies are relatively nonplussed about the possibility of a U.S. recession:

But if you talk to businessmen (alas they were all men) from India, Russia, China, Turkey or the Gulf States, you would hardly know that we have just experienced a credit market freeze-out in the West. They are all ho-hum about it. Yeah, we could shave a point or two off our growth estimates, they say, if the U.S. goes into a deep recession, but it's no big deal--and can you pass the wine please. Indians are saying we don't rely that much on exports anyhow; the Chinese are relying on their growing middle class; and others have their own stories.

Is this the famous "decoupling" at work? Will this be the beginning of a new era of the world economy, with several key developing countries, the BRICs and the N-11 (using the faddish terms that attach to them), gaining real ascendancy over their Western counterparts?

Probably not. But something interesting is going on.

Meanwhile, the world's financial markets -- from the relatively deep and rich (EuroZone) to the relatively shallow and unsure (Asia) -- have not reacted very well to trouble in the U.S. markets and the possibility of recession:

Decoupling holds that European and Asian economies, especially emerging ones, have broadened and deepened to the point that they no longer depend on the United States for growth, leaving them insulated from a severe slowdown there, even a fully fledged recession. Faith in the concept has generated strong outperformance for stocks outside the United States - until now.

As opinion began to solidify after the start of the year that a recession, or something close to it, was likely in the United States, stock prices accelerated their declines, with the selling intensifying early last week. Contrary to what the decouplers would have expected, the losses were greater outside the United States, with the worst experienced in emerging markets and developed economies like Germany and Japan. ...

Decoupling was all the rage early last year when international financial markets all but ignored the increasing turmoil in the U.S. economy and stock market. Investment advisers point out, however, that the segments of the U.S. economy that were showing wear and tear then were those to which the rest of the world would never be heavily exposed. That is no longer true, they say, and markets are responding accordingly.

"Decoupling is yesterday's story," Stuart Schweitzer, a global strategist at JP Morgan Private Bank, said. "Last year, when the U.S. slowdown was driven almost entirely by housing, it made sense that the rest of the world kept right on going. Housing is a domestic story, plain and simple.

"The nature of the slowdown has changed in two key respects. The credit crunch that began in midsummer is not just a U.S. phenomenon; the rise in risk aversion is global and will have an impact on credit terms and availability everywhere. And we're finally seeing evidence that the U.S. job market is losing steam and consumer spending is slowing."

The fact of the matter is that many markets, particularly financial markets, are most integrated than they have ever been. This is good for spreading risk around, and it helps produce more efficient investment outcomes. And, if some developing country gets into trouble, it is both easier for them to get back on their feet and for investors in that country to not go bankrupt in the fall-out.

But this whole system still revolves around the U.S. It may be true that the world somewhat less dependent on the U.S. than they were in the 1990s (although this is arguable), but it is not true that the world isn't still dependent on the U.S. At this point, "decoupling" is something of a myth. In the future, it will probably become reality, but not in the sense that most people mean it. It won't mean that individual economies will be less susceptible to major movements in major companies; rather, it will likely that the relative importance of the U.S. over all others declines somewhat. The absolute importance of the U.S. will remain for a long, long time.