Could Developing Countries Take Down Developed Economies?

Executive Summary

The economic heft of developing economies has increased over the past two decades, and advanced economies have more economic exposure to the developing world than they did 20 years ago. Final spending in developing countries currently accounts for about 6 percent of value added in advanced economies, nearly double the ratio in 1995. Six percent may not seem like a large number, but most advanced economies are growing at a slower pace today than they were when the last wave of economic and financial crises swept through the developing world in the late 1990s.

The Eurozone and Japan have the most to lose from a slowdown in the developing world. Both economies are more economically exposed to developing economies than the United States and both are already growing at a sluggish pace. Although the slowdown in the developing world that is in train today may not be large enough to bring advanced economies to their collective knees, many of those economies can ill afford much of a negative shock from slower growth in final spending in the developing world.

Global Economic Heft of Developing Economies Has Increased

Developing countries have been front and center lately with many emerging market currencies falling sharply versus the U.S. dollar and stock markets in those countries encountering strong selling pressure. Some of this turmoil in emerging markets reflects prospects for slower growth in many developing economies. Currency depreciation could put upward pressure on CPI inflation rates in the developing world. If central banks in developing economies hike interest rates in a bid to stabilize inflation expectations, economic growth in the developing world could slow even further.1

Does slower growth in many developing countries threaten the economic outlook for advanced economies? A quick glance at some data raises some cause for concern. Due to strong economic growth over the past two decades, the economic heft of the developing world has increased. As shown in Figure 1, developing economies accounted for about 20 percent of global GDP at the turn of the century. That ratio has nearly doubled over the past 15 years. In addition, developing countries today take in about 25 percent of advanced economies’ exports, up from 17 percent in 2000 (Figure 2).

Aswe have pointed out in previous reports, however, simple export-to-GDP ratios are not the best way to measure the economic effect that one country has on another economy. 2 For example, Germany may export intermediate inputs to Hungary where they are assembled into finished goods and subsequently re-exported to France, where they are consumed. In this example, German exports to Hungary would overstate the effect that the Hungarian economy has on the German economy. Similarly, published data on exports would understate the effect that the French economy has on Germany. What we really want to know is how much effect final spending in a given country has on value added in another country.