Economic ties between countries

Different economies are connected by trade and investment. It is through these two channels that recessions and expansions spread internationally. Consider an example with the U.S. and Mexico.

When the U.S. economy goes into a recession, U.S. consumers buy less of everything, including products from Mexico. They go less frequently on holidays to Mexico. This lowers the production of Mexican companies as they struggle to sell their output. In addition, U.S. companies have less cash to invest and are more risk averse because of the recession. They reduce their investments in the U.S. and internationally, including in Mexico. The flow of investment funds to Mexico declines.

These two factors: lower exports and investments, are a drag on the Mexican economy. The same situation in reverse: the U.S. economy is growing rapidly; U.S. consumers buy more products from Mexico; and U.S. companies invest more in Mexico. The Mexican economy picks up.

Notice on the graph that the Mexican economy grows when the U.S. economy grows. If the U.S. economy slows down, so does the Mexican economy.

The direction of that effect is from the big economy to the smaller economy. If Mexico goes into a recession, that would not impact the U.S. as much. For one, the U.S. is less dependent on exports as U.S. companies sell only about 13 percent of their products internationally. In contrast, Mexican companies sell more than one third of their production internationally and much of it goes to the U.S.

There has been a lot of discussion lately about the “decoupling” of the global economy and, specifically the emerging markets, from the U.S. economy. It used to be that “when the U.S. sneezes the world economy catches a cold.” Lately, that seems to be less so as emerging markets rely more on the regional and domestic markets. Still, it will be some time before the global economy can grow rapidly without support from the economies of the U.S. and the European Union.

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