National economies are increasingly moving in sync and responding to the same booms and busts as a result of near-instantaneous communications and interdependent global supply chains. This is a sharp change from much of the 21st century, when economies were primarily affected by economic shocks in neighboring countries.
That’s what we found in a paper published in the journal Economic Letters, in which we calculated measures of economic correlation using data on gross domestic product for 70 countries over the past 60 years. Along with fellow economic scholars Yoonseon Han and David Lindequist, we found that physical distance was indeed less important than it used to be, particularly with regard to how interconnected countries are to one another.
Specifically, we measured the extent to which countries have found their business cycles — the traditional boom-bust intervals of economic performance — in sync. For example, when there is a positive shock to production in Germany, to what extent does this affect incomes in the United States?
We were interested in whether the relationship between distance and economic correlation has changed over time.
What we found was that from 1960-1999, business cycles were strongly localized. That is, a country’s economy was much more likely to be impacted by shocks to nearby countries than by shocks in faraway countries. For example, the U.S. was more affected by economic conditions in Canada or Mexico than it was to economic conditions in the United Kingdom or South Korea.
This finding is not surprising and fits well with a long economic literature showing that countries are more likely to trade with nearby countries and that the volume of trade between two countries is a significant predictor of how synchronized their business cycles are.
However, we went on to find that this relationship between physical distance and economic correlation started to break down after 2000. Specifically, for the past 20 years, there has been no statistically significant relationship between the geographic distance between two countries and the extent to which incomes in the two countries move together — what economists refer to as their economic covariance.
Why it matters
In the late 1990s and early 2000s, a number of economists, including Frances Cairncross and Thomas Friedman, popularized the idea that new technologies like the internet and containerization had led to the death of distance, in which our new lives would be increasingly globalized. They imagined a future in which these new technologies not only impacted how goods were produced — like global supply chains — but also how we work and live.
Such theories were met with some skepticism by trade researchers at the time, and not all of the predictions have come true. For example, the link between distance and trade flows has proved stubbornly persistent. Even today, the top-two trading partners of the U.S. remain Canada and Mexico. And one only has to look at housing prices in major urban centers in the U.S. to see that physical location remains highly valued to most people.
However, our research suggests that at least some of the popular predictions about the globalized economy might be coming true. For instance, the world economy appears to have made countries increasingly susceptible to global, as opposed to localized, shocks.
This was made devastatingly clear to millions of people during the pandemic, when supply chain bottlenecks reverberated across the globe, subsequently generating a worldwide rise in prices. As a result, U.S. economic and trade policy discussions have been increasingly focused on potential vulnerabilities to foreign shocks. Indeed, a new buzzword during the Biden administration was “supply chain resiliance.”
What still isn’t known
Our work provides evidence that business cycles and economic shocks have become more globalized over the past couple of decades. Many of the main economic events from 1960-2000 – like the 1980s savings and loan crisis or the 1997 Asian currency crisis – had primarily localized effects. But more recently, the principal economic events of the past two decades — like the 2008 financial crisis — have had far more global implications.
What we don’t know is whether this pattern will continue, resulting in a new era in which most of the world’s economies move in tandem. Or will a new turn toward economic nationalism lead to a reversal in which economies – and economic shocks – become more localized once again?
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