Eurozone impact on world economy

This is my latest Perspective column for Fund Strategy.

What is the impact of the eurozone crisis likely to be on the rest of the world? Much commentary in recent months has focused on the 17 countries that use the euro but relatively little has discussed the broader effect of the region’s woes.

There are many uncertainties involved in answering the question. It is not even clear what the outcome will be within the eurozone, although it is unlikely to be pretty. Every day the news seems to get worse. Nor is it immediately apparent how resilient the rest of the global economy is likely to prove.

It is always easier to examine the past than predict the future. Figures from the International Monetary Fund (IMF) database help put the eurozone crisis into context. From the outset it should be clear that the big gulf in relation to growth is between the advanced economies and the developing world. The growth rates for America, Britain and the eurozone are broadly similar while the emerging world has proved far more dynamic.

Indeed, the growth record exposes the absurdity of the claim made by many politicians that Britain shares a weak performance record with the rest of the world. Although the eurozone and America have performed poorly the emerging economies, despite a dip in 2009, have powered ahead. In each of the past six years even the eurozone economy has, albeit slightly, outperformed Britain. The graph also suggests that a degree of “decoupling” has occurred between the developing world and the advanced economies.

Despite the dip in 2009 the developing economies have performed well. They are not likely to be immune to a big shock in the western economies but they are more autonomous than in the past.

Another useful set of figures is the weight of different countries and regions in the world economy. These also help put the eurozone crisis into some context.

According to the IMF the eurozone accounts for about 14.5% of world economic output in 2010, the last year for which final figures are available, when measured at purchasing power parity (adjusting for price levels in different countries). The advanced economies as a whole accounted for 52%, while the emerging and developed economies were at 48%.

However, purchasing power parity figures are better for comparing living standards than measuring the relative importance of different economies. At market exchange rates the eurozone accounts for about 19% of the global economy with the emerging and developing economies accounting for about 34%. In other words at market exchange rates the advanced economies still account for almost two-thirds of global output

The eurozone’s share of world trade is even greater than its share of output. It accounts for over a quarter of both world exports and imports in goods and services. From these figures alone it should be clear that a substantial downturn in the eurozone would have a significant effect on the global economy. With the eurozone accounting for almost a fifth of global output and over a quarter of world trade the knock-on effects are likely to be high. Eurozone imports could well fall sharply while many financial institutions would face difficulties.

However, it is wrong to examine the eurozone question through the concept of “contagion”. If the rest of the world economy were healthy then it would be fairly resilient to a euro shock. The impact would be at least partly compensated for by activity elsewhere.

Unfortunately, the weaknesses of the advanced economies stretch beyond the eurozone. America, Britain and Japan all have trouble generating durable growth and all three have built up high debt levels as a result.

America is the most important single economy because of its size. Its yawning current account deficit is merely the most visible expression of how its competitiveness is falling relative to the rest of the world. The eurozone crisis has distracted attention from America’s domestic weaknesses.

China is the biggest question mark in relation to the durability of the world economy. However, without its rapid growth the global economy would already be in more serious trouble. Even in 2009, a terrible year for the global economy, China managed to expand by 9.2%.

The multi-billion dollar question is whether China can maintain a rapid growth rate or whether it is likely to slow. China faces several potential problems, including the emergence of a financial bubble and weaker export markets. Finding a definitive question to how well it is coping is an urgent task in assessing the health of the global economy.

Even if the rest of the world economy were healthy the eurozone crisis could have a significant effect. Unfortunately it comes against a backdrop of weakness across the developed world as well as question marks over China.

The three most important areas to monitor in the coming period, in ascending order of importance, are likely to be China, America and the eurozone. It looks a safe bet that the road ahead has only just started to get bumpy.