The rebounding world economy is still fragile, and a strong commitment by all nations to collaboration and responsible growth is essential. But one country’s false step could have repercussions across the globe.
The so-called “butterfly effect,” which figuratively posits that the fluttering of a butterfly’s wings can impact a tornado several weeks later, has been recognized since at least the early 19th century. But while its real-world applications in weather, chaos theory, and quantum mechanics are hotly debated, the metaphor holds true for global economics. Countless research studies have shown that the (often internal) actions of one nation can have a significant effect on other nations. In other words, countries’ economies are not independent of one another.
When one state’s economic decision or undertaking influences the economic well-being of another state, this is known as an economic spillover. These spillovers, which most often occur through channels such as trade, financial linkage, policy coordination, or policy shocks, can have positive or negative effects.
As a hypothetical example, imagine that Brazil chooses to drastically reduce tariffs on all imports from South American countries. This would help increase the exports of neighboring nations, meaning that both Colombia and Peru would be able to ship much-desired oil and petroleum products to Brazil at lower costs. Conversely, this same initiative would likely decrease exports from Mexico, whose oil would suddenly become more expensive for companies in Brazil (its fifth-largest trading partner). Brazil’s tariff reduction could even have both positive and negative effects on a country like the United States, where oil exports to Brazil would become costlier, but other U.S. goods might be more in demand if the overall economy in South America were to expand as a result of the tariff cut.
European nations have passed laws requiring banks to boost domestic investment. As a result of this policy, emerging markets may miss out on $1 trillion in investments over the next two decades.
Obviously, the best outcome for world economies as a whole is to maximize the positive spillover effects while minimizing the negative ones. To that end, the International Monetary Fund (IMF) and World Bank have been focusing on this goal in their recent biannual meetings. Speaking before the April 2017 meeting, IMF Managing Director Christine Lagarde noted increases in expectations for global economic growth, but cautioned, “We need to make sure that this momentum is sustained and that we continue to up that growth and more.”
Lagarde outlined what she called a three-pronged approach that nations should take in order to maintain and bolster the positive economic momentum: using their fiscal, monetary, and structural economic policies. Lagarde cited such goals as reinvigorating productivity through innovation and trade, continuing to focus on fiscal and structural reforms, and sculpting economic growth so that it is stronger, more inclusive, and more cooperative.