The level of economic activity in individual economies is never constant (i.e. never in a state of equilibrium). Economic growth usually moves in cycles – in other words, instead of sustaining a steady rate of growth from year to year, most economies go through periods of above average growth that then lead into a period of below average growth. These ups and downs of the business cycle. Just as individual economies experience stronger and weaker periods of economic growth, so too does the global economy. This ebb and flow of world economic growth is known as the international business cycle, which refers to the changes in the level of economic activity in the global economy over time. Although the levels of economic growth each year often differ greatly between countries, for most countries, economic growth is stronger when the rest of the world is growing strongly and weaker when other countries are experiencing a downturn.
The transmission of economic conditions from one country to another is made more immediate by the increased integration of economies during the globalisation era:
• Trade flows: If there is a boom or recession in one country, this will affect its demand for goods and services from other nations. The level of growth in an economy will have flow on effects on the economic activity of its trading partners.
• Investment flows: Stronger economic conditions in one country will make it more likely that businesses in that country will invest in new operations in other nations, which will then add to their economic growth. In the late 2000s, for example, one of the causes of slowing foreign direct investment (FDI) inflows to developing countries was the weaker economic growth performance in the United States.
• Transnational corporations: Transnational corporations (TNCs) are an increasingly important means by which global upturns and downturns are spread throughout the global economy. In 2011 for example, Toyota temporarily reduced its manufacturing operations in Australia because of the impacts of the earthquake and tsunami in Japan on the company.
• Financial flows: Short term financial flows also play an important role in transmitting the international business cycle. A 2009 IMF paper, “How Linkages Fuel the Fire”, concluded that 70 per cent of financial market volatility in advanced economies is transmitted to emerging economies and that it only takes one to two months to reach emerging economies. This was the main reason the downturn of the late 2000s was so quickly spread from the United States to other economies.
• Financial market and confidence: Consumer confidence and the ‘animal spirits’ of investors are constantly influenced by conditions in other countries. This is highlighted by the strong correlation between movements in share prices of the world’s major stock exchanges – i.e. they tend to go up and down at the same time.
• Global interest rate levels: Monetary policy conditions in individual economies are increasingly influenced by interest rate changes in other countries. If weak economic growth makes it necessary for the central bank to lower interest rates in the United States, this places pressure on central banks in other economies to follow suit.
• International organisations: International forums such as the Group of Twenty (G20) or Group of Eight (G8) can play an important role in influencing global economic activity. Discussions of global economic conditions at summit meetings mean that the G20 or G8 can act as the unofficial forum coordinating global macroeconomic policy especially during periods of economic uncertainty.
KEY terms
International division of labour is how the tasks in the production process are allocated to different people in different countries around the world.
International business cycle refers to fluctuations in the level of economic activity in the global economy over time.