Globalization Fueled Downturn; Will It Aid Recovery?

One of the unique aspects of the economic crisis is how quickly it became a global problem. Several countries experienced bubbles almost simultaneously, and economic slowdowns are occurring worldwide. The question now is: Will globalization also mean the world economy will recover more quickly than it would have in less interconnected times?

The Commerce Department next week will release its first estimate of the U.S. economy's performance in the third quarter. White House Press Secretary Dana Perino said Thursday that the Bush administration fears the number will "not be a good one."

Economists predict a downturn, and they say it will be felt around the world — in part, because of globalization. The world economy is now so interconnected that countries go through recessions together.

Six months ago, it appeared that the subprime mortgage crisis meant the United States was in for a period of economic distress. But at least one economist — Nouriel Roubini — was already on the record predicting that the crisis would be international. His article "The Coming Financial Pandemic" was on the cover of the March issue of Foreign Policy magazine.

Speaking at Columbia University this week, Roubini said the economic data eventually showed he was right. "The numbers from the second quarter of this year," he said, "suggested that not only the U.S. was entering a recession but also the U.K. was entering a recession, the rest of Europe was entering a recession, Japan was beginning to have an economic contraction, Canada was starting to have a recession."

Since then, it has only gotten worse, said Roubini, chairman of RGE Monitor, a strategic analysis firm.

"People usually say, when the U.S. sneezes, the rest of the world catches the cold," he noted. "This time around, the U.S. is not just going to sneeze; it's going to have a severe case of pneumonia, or something more severe than that, and therefore the transmission to other countries is going to be also very, very severe."

Indeed, it's the rate at which this economic crisis has been transmitted from the United States to the rest of the world that has most caught the attention of international economists.

"The speed is phenomenal — and frightening," said Jeffrey Sachs, director of the Earth Institute at Columbia University in New York. Sachs pointed to one event in particular: the collapse of the Lehman Brothers investment bank on the weekend of Sept. 14.

"It was really the shock of the financial panic in the week of Sept. 15 that ricocheted around the world nearly instantaneously that has made the worldwide contagion effect utterly dramatic," Sachs says.

Contagious diseases spread when people come into contact with each other; the financial crisis now sweeping the world could not have spread so quickly were it not for the many ways the economies of the world are now so interconnected — much more so than at the time of the last major global recession 30 years ago.

"The amount of trade as a share of national income, the financial flows as a share of just about anything, are much larger now than they were back in the 1970s," says Sachs, who is also an economic adviser to U.N. Secretary-General Ban Ki-moon. "This means that the piping of the international system connects the world's economies in more varied ways and certainly in more intense transmission linkages than would have been true 30 years ago."

U.S. banks got in trouble because they were holding mortgage securities that were worth a lot less than the banks initially thought they were. It turns out that many European banks had invested in those same mortgage securities.

The boundaries between national economies are disappearing. This can be helpful: U.S. consumer spending boosts the companies in China that make the goods that U.S. consumers buy. China in turn has more money to invest — in the United States. This "coupling" can mean the effects of a downturn in any one country can be softened.

"When underlying forces are going in different directions, with the U.S. economy tending to slow and the rest of the world still pretty strong, it helps push us up at the same time it's slowing them down a little bit," says Michael Mussa, a former chief economist at the International Monetary Fund. "When we're all slowing down together, though, then it's self-magnifying."

The effect is self-magnifying, Mussa says, because economic interconnectedness means a global downturn will happen more quickly, spread more widely and go deeper than it otherwise would.

That is what is happening right now — because of globalization. But there is a silver lining, says Mussa, now a senior fellow at the Peterson Institute for International Economics in Washington, D.C.

"For the same reason that going down together tends to magnify on the downside," Mussa says, "coming up together tends to magnify on the upside."

Globalization on one hand means recessions can be felt instantly around the world. But it should also mean that when a few key economies make a turning point toward recovery, those countries will quickly lift the rest of the world with them. Mussa thinks that "global uptrend" should happen sometime next year.

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