International Spread of Business Fluctuations

This example gives us an idea why business fluctuations spread from country to country. If one country is very prosperous, its citizens increase their buying of all sorts of goods, including imports from other countries. One country's imports are, of course, some other country's exports. In the countries that produce the exports, there is an increase in net exports, which in turn will increase equilibrium income by a multiple. Thus a boom can spread from country to country as if by contagion.

This analysis applies equally to a decrease in net exports, of course -- as we observed, a decrease in net exports will reduce equilibrium income by the same multiplier. So, just as a boom can spread from country to country, so a recession can spread from country to country via the multiplier effect. When one country falls into recession, its imports decrease. Those imports are the exports of other countries, and the other countries thus experience reductions in net exports and multiple declines in equilibrium income as well (ceteris paribus).

This is an especially important source of business fluctuations for smaller countries that are more dependent on trade, especially with larger neighbors, like Canada and the Netherlands. In Canada, the saying is that when the United States sneezes, Canada catches a cold. That is, a modest decline in U. S. income and imports can translate into a large decline in Canadian net exports and a large impact on the Canadian economy.

Nevertheless, larger countries can be affected, too. During 1997, some of the countries of eastern and south-eastern Asia ran into unexpected economic difficulties. Countries like Thailand, Malaysia, Indonesia, Singapore, and South Korea faced drops in the international value of their currencies connected with banking failures and difficulties of many large corporations. Japan, which had been in a period of economic stagnation in the mid-1990's, was set back in its recovery because of its close relations with those countries. In all of these countries, consumption, investment and imports were dropping at the end of 1997. Many economists and other people expect that U. S. economic growth will be slowed because of the decrease in exports to those countries, and increased competition from them. There is some (very tentative) evidence that this slowing may have begun as I write -- Dec. 27, 1997. Stay tuned!

Chapter Summary