Slow Foreign Growth: Should America Worry?

Executive Summary

The economic expansion that has been underway in the United States over the past five years is increasingly becoming self-sustaining. However, some major foreign economies are not faring as well at present. The Eurozone economy has essentially stalled, and the rate of economic growth in China continues to slow. Could a slowdown in the rest of the world have significant knock-on effects on the U.S. economy? 

Although there is a high degree of correlation between growth in global industrial production (IP) and growth in U.S. IP, services, which largely are produced and consumed domestically, account for the vast majority of value added in the American economy. Thus, it likely would require a very pronounced decline in foreign economic activity to produce a mild recession in the United States. In other words, the economic expansion that has been underway in the United States likely will not be tripped up by foreign economic growth in the foreseeable future.

Strong Linkages in Industrial Production Across Countries

There have been numerous indications lately of slow economic growth in some foreign economies. For example, the Eurozone economy stalled in the second quarter and monthly data indicate that momentum remained weak in the third quarter. In China, growth in IP slumped to only 6.9 percent in August, the slowest year-over-year rate of IP growth in China since the depths of the global financial crisis. Although real GDP in the United States shot up 4.6 percent in Q2-2014, which was the strongest annualized rate of growth in nearly three years, can the U.S. economy continue to enjoy robust growth if the rest of the world is struggling? Due to the high correlation between growth in global IP and growth in U.S. IP (Figure 1), is it time to start fretting about the U.S. economic outlook?

Exports are the channel through which the high correlation between global IP growth and U.S. IP growth that is evident in Figure 1 arises. Exports of goods are equivalent to about 27 percent of the value of manufacturing shipments at present, so fluctuations in foreign economic growth are quickly transmitted to export growth and ultimately to growth in U.S. IP.

However, the manufacturing sector is a relatively small part of the U.S. economy, accounting for only 12 percent of value added. Services are the overwhelming largest sector in the American economy, accounting for two-thirds of all the value added created in the economy, and only a small proportion of services are exported.3 Perhaps the high correlation between global IP growth and U.S. IP growth that is shown in Figure 1 overstates the overall sensitivity of the U.S. economy to growth in the rest of the world. Indeed, Figure 2 shows that U.S. real GDP growth and global IP  growth do have some degree of co-movement, but that the former is not as volatile as the latter.