When the US sneezes, will the rest of the world catches a cold and how can your start-up react?

U.S. Economy

The U.S. remains the world’s leading economy in terms of GDP and GDP per capita (amongst the large economies). It also is the world’s largest trading partner and the leading financial centre (in terms of stock market’s capitalization).

State of U.S. Economy

At the current time, the U.S. economy is facing a slowdown in growth from an estimated 2.1% in 2007 to expected 1.5% in 2008. At the same time, inflation and core inflation (excluding food and energy) has grown, with a risk that inflation could further increase. As such, it puts a pressure on the monetary policy to balance economic growth and inflationary patterns.

State of Rest of the World

However, major emerging markets, like China and India, continue to grow rapidly and other major countries, like Japan and EU members, continue to grow at a normalized pace.

How can the U.S. slowdown impact rest of the world?

The U.S. impact on the world has two potential linkages: financial linkage and trade linkage. Financially, the global markets are increasingly linked (i.e. globalized) with the U.S.. In addition to being the leading stock market of the world, the globalized nature of the financial markets has resulted in the impact of the credit crisis in the U.S. being felt across the world.

The U.S. is also the world’s largest trade partner. As such, a weak domestic demand in the U.S. creates a slowdown in its imports and has a linkage to its importing partners.

Since, supply and demand are interconnected, business cycles are driven by both prices and expectations of the future.

Aggregate demand, the expenditure on goods and services produced in an economy, consists of the following:

Y = C + I + G + X – M (consumer spending, investment (business, government and housing), exports less imports)

Based on a short run supply and demand curve model, if the U.S. demand slows, it leads to lower prices and reduced output, i.e. (recession). Given that the U.S. is the world’s leading economy and trade partner, the above theory implies that world GDP growth should be impacted by the current slowdown in the U.S.

Limitation of the impact of the U.S. slowdown

Countries & Industries differ in exposure to business cycle

Increasingly, major emerging markets, like the BRIC and Mexico, are becoming the motor of the global economic growth. Since their economies vary from the U.S. economy (in terms of the dissimilarity in sectors, etc.), their business cycles are relatively different.

The Great Moderation: services are more stable in business cycles

U.S. is increasingly a service-based economy. Since services are more stable vis-à-vis manufacturing and construction with smoother consumption and limited exposure to the investment cycle, current slowdown in the U.S. is expected to be milder.

The Great Moderation: moderate globalization

As a whole, the world is more globalized as a result of trade, investment and capital markets, etc. While it is apparent that the financial markets are highly globalized and thus, a credit crisis in the U.S. has a swift and global impact; in terms of trade, the world is less globalized. As such, a degree of moderate globalization helps avoid more volatile business cycles.

The Great Moderation: Information-based economies

Business cycles have moderated as a result of Just-In-time (J.I.T.) and other Information-Based decision making practices, which assist companies make superior decisions and control their outputs; whereby, helping downturns be milder.

The Great Moderation: monetary policies being run by economists, not politicians

Most major economies have been able to make better use of monetary policy to control fluctuations in business cycles. A separation of political influences from the central banks has greatly assisted economists make better monetary decisions, with limited need to appease the politicians.

Beneficial Effects of Business Cycles

To a great degree, business cycles, including the current downturn in the U.S. can have positive effects on its own economy and the world-at-large. Some of the reasons are: competitive pressures during a downturn can help both American and international companies to innovate, restructure and reorganize and the job movements during cycles lead to a better match of skills (“creative destruction”)

Overall Impact

Business cycles are essential medium-term fluctuations between expansions and recessions that have a fall-out across sectors and countries. As such, the U.S. slowdown should have an impact across other countries. However, as a result of moderate globalization, the net impact resulting from the U.S. slowdown and the emerging market growth, should cushion the overall global GDP growth. Further, better usage of monetary policy in the slower-growing major economies, like the EU and the U.S. should further moderate and shorten the negative impacts of the U.S. slowdown.

So How Should Your Start-Up React?

Diversification

A diversified customer base is always helpful. Ideally, your customers should not only be geographically diversified but also sectorally. If you are in the B2C sectors, is your product base wide enough, to attract a diverse base of clients?

Lean and Mean

If you gained a lot of fat during the comfy years, now is the time to lose some of it. Fire. Streamline. Focus on the bottom line. This actually is one of the benefits of the business cycles – they help us reflect on what is essential and what is not.

Survival of the Fittest

If you cannot survive a modest downturn, truthfully, maybe it makes sense for you to look for something else.

Next Time Around

The dotcom crash taught us a lot. It taught us that good times do not last forever. If you did not learn it last time, this is your chance.