Stephen King: Globalisation puts Fed's actions at centre stage

The US downturn is a global problem ... it has immediate ramifications in a wide range of countries
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The Independent Online

So who's to blame for the global slowdown? Japan's been weak for ages. Germany's now flat on its back but had already been down on its knees. The UK continues to outperform. All eyes, then, on the US. An economy that was growing at an annualised rate of more than 8 per cent in the final quarter of 1999 is now shrinking. Admittedly, the decline in the third quarter – on the basis of very provisional estimates – was a minuscule 0.4 per cent (at an annualised rate). Nevertheless, the extent of the slowdown is dramatic – it's a pattern that's only really been seen with the onset of recession.

Last week, the bad news proliferated. The purchasing managers' survey, which supposedly tracks the path for the US manufacturing economy, collapsed. The Conference Board's index of consumer confidence showed further signs of implosion. And employment fell by more than 400,000 in October, the biggest single monthly fall since the 1980 recession. Put another way, the decline in October was bigger than any of the monthly falls seen during either the 1982 or 1990/91 recessions.

Some of the latest weakness doubtless reflects the horrors of 11 September and the subsequent anthrax attacks. How much, though, remains a mystery. Following the release of the October employment report, the US Labor Department said that it was unable to isolate the impact of the 11 September attacks from other factors influencing the US labour market. In my view, a lot of October's job losses were on the cards before 11 September.

Are America's difficulties all home grown? From a US perspective, there are good reasons to think that at least some of the blame must lie with others. After all, one of the main factors behind the slowdown so far has been a collapse in export growth. Adjusting for inflation, US exports were up more than 10 per cent year-on-year at the beginning of 2000. They're now falling almost 10 per cent year-on-year. This is a very different picture from America's last recession in the early 1990s. Back then, export growth was a ray of light, remaining positive throughout a period of domestic economic weakness.

Part of the difference reflects the unusual features of the world economy in the early 1990s. Although the US went into recession early on, the other major countries did not. Japan was still enjoying its bubble and Germany was in the middle of its reunification boom. This time, there have been no obvious special factors supporting growth elsewhere. Nevertheless, the US may feel that it can legitimately blame others for not loosening policy enough: after all, if exports have been dragging down US growth, then the Fed's own actions can't really help very much.

All this sounds fairly sensible. But is it the right interpretation? I somehow doubt it. The first chart shows the growth of US exports of goods and services, adjusted for inflation, over the last 30 years, together with the growth of US imports of goods and services. The interesting feature of America's recent experience has not so much been the collapse in exports on its own but the simultaneous collapse of both exports and imports. What does this mean? The easy explanation is that both the US and the rest of the world have weakened at the same time. But that doesn't quite ring true. Growth in the US has fallen back much more quickly than elsewhere, suggesting that, if anything, imports should be falling a lot more than exports. That's clearly not happening.

In fact, a key reason behind the fall in US exports is the fall in US domestic demand. Now, I know this sounds a bit implausible. But there's a good reason for thinking that this might be a more realistic explanation. US companies have globalised their production over the past decade on an extraordinary scale. The thirst for shareholder value, the creation of NAFTA, the removal of capital controls and a whole host of other factors have ensured that US companies are even less linked to a domestic production platform than was the case 10 or 20 years ago.

One result of this process is that increasing proportions of exports from the US and imports into the US are simply the result of goods being transferred from one plant to another as they evolve from a pile of raw materials into a computer or some other technology gadget. It just so happens that not all the plants, not all the production facilities, are based in the US. For example, a lot of US companies may have production facilities based in Mexico. They're not there to take advantage of booming Mexican demand, they are taking advantage of relatively low labour costs to improve profitability.

Some useful numbers on the scale of this globalised production come from my second chart. The easy way to explain this chart is through an example. Take Mexico. The chart basically says that, of total US exports to Mexico, roughly 45 per cent are intra-company trade flows. Either they're exports from US parent companies to their Mexican subsidiaries, or they're exports from Mexican subsidiaries based in the US through to their parent companies south of the border. The same theme works in reverse. Of total US imports from Mexico, approaching 70 per cent are intra-company trade flows.

Oddly, the numbers for Asia are a lot lower, suggesting that there is no close relationship between the US and, say, Korea or Taiwan. That, however, is probably the wrong conclusion. The low Asian numbers reflect differences of ownership. US companies own lots of production facilities in Mexico but they tend only to trade with Asian companies. The same argument, however, still applies. US companies export, say, chips to Taiwan where they're assembled into a computer and shipped back to the US. Thus a fall in US exports to Taiwan may ultimately reflect falling US demand, not falling Taiwanese demand.

So, when US exports start to collapse, it may be more a sign of domestic trouble than of foreign angst. Falling exports may be signalling a completely different set of problems from those that have cropped up in the past. The globalisation of production facilities is in many ways a good thing: it ensures a more efficient allocation of resources, it spreads capital around and it creates far-flung employment opportunities. However, it also means that countries elsewhere in the world are much more dependent on the ebb and flow of the US economy. The latest US downturn is a big global problem for the simple reason that it has immediate ramifications for production and employment in a wide range of dependent countries. Asia's terrible economic experience this year has a lot to do with its dependence on technology production that ultimately is supported by US domestic demand.

In other words, US policy makers have to work doubly hard. The US downswing is a downswing which is not confined to the US. Mexican policy makers can't do much about Mexican production. Korean policy makers may be limited in what they can do to support Korean production. All these countries are now much more dependent on what the Federal Reserve and the US administration decide to do on monetary and fiscal policy. Hopefully, they won't have to wait too long: Alan Greenspan and his friends at the Fed will doubtless be delivering another interest rate cut this week, aimed at saving not just the US economy but the world at large.

Stephen King is managing director of economics at HSBC.