Economic Spillovers

• Author: Vivek Arora and Athanasios Vamvakidis
• Position: IMF's Senior Resident Representative for Lesotho and South Africa, based in Pretoria/Resident Representative for the IMF in Zagreb, Croatia

Exploring the impact trading partners have on each other's growth

Economic integration among countries has increased significantly in recent decades, with the share of world trade in GDP rising from an average of 26 percent in the 1960s to 42 percent in the 1990s. Common wisdom holds that as countries become more integrated, they are increasingly influenced by each other's economic development. Some economies are even considered to be engines of global or regional growth. Countries that trade a lot also tend to grow faster-a link that has been extensively documented.

But just how large is the impact of external economic conditions on a country's growth? And as the world economy becomes more integrated, has the importance of growth spillovers increased? We undertook three studies to try to answer these questions. One study analyzed trade-related growth spillover in over 100 industrial and developing countries. The other two studies sought to assess the impact of the United States and South Africa on the growth of other countries.

Our results show that economic conditions in trading partners do in fact matter significantly for growth. After controlling for other growth determinants, we found that a country's economic growth is positively influenced by both the growth rate and relative income level of its trading partners. Our findings also suggest that countries benefit relatively more if their trading partners grow faster than they themselves do and are richer. And we found evidence that some countries are indeed engines of global or regional growth: the impact of the United States is significant in many countries around the world, and South Africa matters for economic growth in the rest of Africa. In all three cases, we found the estimated impact of growth spillovers to be relatively large. It has been larger in recent decades and for open economies, implying that international spillover effects may increase in importance as globalization continues.

What theory tells us

Economic conditions abroad-including growth rates and income levels-are thought to influence a country's growth through several channels.

· The most obvious channel is trade linkages: a rise in trading partners' growth leads to an increase in their demand for imports, which then contributes directly to an increase in the net exports of the home country. And the positive implications of trade for economic growth are not limited to countries that run surpluses, since countries can benefit from technology transfers and other efficiency gains associated with international trade (Coe and Helpman, 1995).

· With growing foreign direct and portfolio investment, the spillover effects of trading partners may also be transmitted through financial linkages.

· Finally, there may be indirect effects, with business and consumer confidence in major...