Globalization of Gross Domestic Product and Business Cycle - Literature review Example

Globalization of GDP and business cycle Name Subject & Code: Instructor Date Table of Contents Table of Contents 2 Introduction 3 The concept of business cycle 4 The concept of Gross domestic product (GDP) 5 Link between business cycle and GDP 6 Conclusion 12 References 12 Globalization of GDP and business cycle Introduction Different scholars have conceptualized the phenomenon of globalization. According to Sulaiman and Aluko (2), globalization refers to an increase in the number of economies that are open to international trade, foreign direct investment, and financial flow. The accelerating rate of international trade has augmented the global output since the 1960s. It has also propelled the snowballing volume of international trade by nearly three-fold compared to the global output over time (Alimi and Akinwande 344-48). An increasingly impressive element in the globalization process is the rise in capital flows across borders during the last two decades. Indeed, as Artis and Okubo (2) argues, the gross capital flows has catapulted from nearly 5 percent of the GDP from the 1980s to nearly 20 percent. Regarding the developing nations, the gross capital flows continue to increase by nearly fourfold during the same period and currently accounts for roughly 5 percent of GDP in these economies. This paper explores the globalization of GDP and business cycle. It first examines the concept of business cycle, the concept of globalisation, the link between business cycle and GDP, and the effects of business cycle on GDP. The concept of business cycle According to Aruoba et al (16), business cycle refers to the regular periods of positive and negative or rise and fall in economic outputs. Benson et al. (1-3) also described business cycle as the flow in a sequence of fluctuations in economic activities as demonstrated by the rise and fall of the real outputs as well as the general macroeconomic performance. While the business fluctuation events may be demonstrated by a succession of the rise and fall in economic outputs. The economic growth theories, such as the endogenous and neoclassical growth models, both agree that business cycle influences economic growth. Benson et al. (1-3) describe the business cycle as consisting of pattern of contraction and expansion that aggregate economic activities measured through the real GDP (See Figure 1). Figure 1: Illustration of a typical business cycle model According to Aruoba et al (16), one complete business cycle is made up of four elements: a peak and a contraction, and a trough, an expansion. The trough sets off the business cycle, and means that whenever an economy arrives at the lowest GDP level it sets off an expansion, it triggers a new business cycle. The second phase is the expansion phase, and is generally sustained to promote real economic growth. Once the expansion is at the highest level of GDP, it reaches the peak, which is also the third phase of business cycle. Subsequent to the peak is the falling GDP level, which is referred as a contraction phase. The contraction persists until ultimately, a new low point is attained. This marks the start of a new trough, hence the beginning of a new business cycle (See Table 1). Table 1: Events associated with each business cycle phase From a review of business cycle, it is clear that two types of cycles exist. The first cycle include the classical cycle is identifiable from the idea that it consists of an absolute fall or reduction in economic events, from the high and absolute rise in economic events to trough. These cycles are non-existent in the growing economic and have tended to be comparatively RARE fir global economies during the recent decades. The second identifiable types of business cycle is the growth or deviation cycle, which promotes the idea that business cycle, which is identifiable as a cycle comparable to the trend (Kose et al. 57-62). The concept of Gross domestic product (GDP) The Gross domestic product (GDP) refers to the market value of the recordable final goods and services that a country generates within a specific time period (Aruoba et al 16). Globalisation has fundamental effects on the GDP. In general, globalisation marks the increase in trade activities, elimination of trade barriers, economic integration, greater technological flow, capital flow, and labour flow. As these factors are associated with growth of economies, it therefore implies that GDP growth can be achieved through globalisation. Link between business cycle and GDP Business cycles are components of national and global economies and characterise the rise and fall that happens around the aggregate economic events globally. As Aruoba et al (16) posits, they are triggered by negative positive as well as unexpected events that happen to an economy, which may lead to the growth or decline of unemployment rates because of intensified or limited economic activity. During the recent decades, the global business cycle has experienced significant recession, specifically as witnessed during the 2008-2009 Financial Crisis. Such a recession has led to the global financial crisis that happened in 2008, as a result heralding the Euro-debt crises. Business cycle affects all economies, and GDP is used as a business cycle indicator as the cycle is associated with aggregate economic activities. Indeed, Carty (1) has examined the link between business cycle and GDP in respect to globalised, in her review of the relationship between business cycle and GDP. His underlying assumption was that while as economy undergoes the business cycle phases, it may negatively or positively affect GDP. During the contraction phase globally, the economic output of different economies becomes slower, often because of a decrease in the demand for commodities, or a rise in the cost of raw materials (Carty 1). What this implied is that companies may collectively fail to make as many products as services. Because of these, the companies would start laying off workers leading to an increase in the unemployment rate (Kose et al. 2-5). As GDP is used in measuring the value of economic output, then it simply means that as the contraction phase comes about, a country’s GDP is likely to decrease. While the GDP reduced in the event of a contraction, it still remains positive (Benson et al 3-5). On the other hand, during the phase of an economic trough globally, a phenomenally high rate of national unemployment occurs in different economies, accompanied by low output levels (Carty 1). This may show that the economy is headed towards recession. Different from the contraction phase, where GDP tends to reduce yet still remains positive, in the trough phase, the GDP becomes negative, which implies that economic output stops growing absolutely (Kose et al. 2-5). Subsequent to the economic trough phase, economies begin experiencing recovery. When different economies grow for two or more successive financial quarters, it becomes an indicator that it has started experiencing recovery (Carty 1). At the same time, GDP starts increasing. However, the phase may not be considered to be in recovery or expansionary phase merely after a single quarter of growth as some economic growth trends may only be transitory. The phase of economic peak refers to the uppermost point of economic growth and output, which lead to an increased GDP across economies. Despite this, economic peaks may lead to an upward inflationary pressure or even possible currency devaluation (Carty 1). Due to these factors, the peak phase may be considered a negative economic event as well as an indicator that an economy is headed toward a new contraction phase, despite the rise in GDP (Kose et al. 57-62). A case scenario of South Africa The economic events in South Africa between 2006 and 2012 show globalisation of GDP is affected by business cycle. Figure 2: South Africa’s composite leading indicators and coincident indicators (Source: Gauteng Province Treasury 2012) The Figure 2 above shows South Africa’s monthly composite leading indicators and coincident indicators between 2006 and 2012. According to Benson et al (3-5), composite indicator refers to an index made by drawing on the weighted averages of many individual indicators. As indicated in the above graph, coincident and leading composite indicators increased in from January 2006. Prices also rose, before the leading indicator was consistently. The coincident indicator, on the other hand, persistently rose. As the coincident indicator shifted nearly during the same period as the GDP, it shows that economic growth remained positive during the period time, although it started slackening (Benson et al 3-5). However, in March 2008 during the global financial recession, the leading indicator started showing downswing. During this time in South Africa, constant electricity interruptions in the country led to reduced national output growth just before the global recession that reduced the demand for the country’s exports leading to recession in the country. As a consequence, recovery in China and India reenergised the demand for South African mining products and manufacturing exports leading to increase n real wages because of the ease in monetary policy (Alimi and Akinwande 344-48). Figure 3: South Africa’s GDP Growth (Source: Gauteng Province Treasury 2012) Figure 3 above indicates the GDP growth rate for South Africa between 2007 and 2010. Effects of business cycle on GDP Because of the effects of business cycle on GDP, substantial economic shocks in one country affect the businesses cycle shocks in other countries. Several studies have attempted to explore the international interactions among different business cycles of varied countries. Scheide (99-102) examined the correlation between Japan, Germany, and United States and established contemporaneous relationships that tended to be unstable. He further analyzed the link between Germany, United States, and European Union's output gaps through the use of a vector autoregressive (VAR) model that used transitory interest rates. The results indicated a substantial reaction of Germany and Europe's businesses cycle shocks in the U.S., which tended to remain stable. Slow growth of GDP of major industrialised nations affect international business cycle transmissions. The sluggish growth in GDP across many industrialized nations, particularly the OECD countries, and the corresponding recession in the global stock markets also show how stock markets can accelerate the rate of international business cycle transmissions (Scheide 99). Of special concern is the observed co-movement of the European stock market and the United States stock market as well as the business cycle shocks from Europe and the U.S. Schroder (Scheide 99-102) attempted to quantify the link between German GDP and the United States GDP and the German and United stock market. The study attempted to differentiate pure expectation of the influences of the stock market from their effect on GDP. In a study by Aruoba et al (2011), the researchers presented their estimation of globalization of GDP and business cycle with regards the country factors and discussed the manner in which they can be associated with the fundamental activity variables. The researchers captured the main macroeconomic developments during the a 40-year period in order to indicate periods of expansions and recessions, which tended to correspond to the business cycle narrative of the United States, Germany and Japan. As regards the country factors, Aruoba et al (2011) estimated the country factors through the use of transition equations and measurement equations. A significant point at this level is how successful the country factors can be used to capture the episodes of business cycles, for instance since the 1970s. In answering such a question, Kose et al. (2-5) examined the effects of country factors on the macroeconomic developments in G-7 countries. They established that country factors tend to demonstrate recession and expansion periods, which are quite consistent with the business cycles of the countries they studied. They went ahead to capture the recessionary episodes like the downturns that characterised the mid-1970s,1980s,1990s, as well as 2000s, as well financial recession of the 2008-2009 are clearly captured by the country factors (See table 1). Table 2: Country factors and indicators When the Aruoba et al (2011) extracted country factors, they found that the co-movement between country factors and indicators of economic events are different in the countries they studied. As showed, the co-movement between GDP and country factors is showed to be higher, varying from as low as 0.61 for a country like Germany to as high as 0.89 for France. On the other hand, the co-movement between the country factors and certain other indicators like income and retail sales appears to be relatively low. On the other hand, the United Kingdom, United States, and Canada have comparatively correlated country factors (Kose et al. 2-5). Surprisingly, they also established that the United States country factor show greater co-movement with the two activity variables compared to GDP. Indeed, among the six economic activity indicators in the table, GDP tend to feature the greatest correlation with the country factor in all the countries save for the United States. Overall, the results showed that a tight link between the country factors and GDP. Therefore, GDP seems to be the most significant variable that drives country factors in all areas save for the United States, U.S. where industrial production appears to be the most influential (Kose et al. 2-5). Conclusion Business cycle affects all economies, and GDP is used as a business cycle indicator as the cycle is associated with aggregate economic activities. Because of the effects of business cycle on GDP, substantial economic shocks in one country affect the businesses cycle shocks in other countries. Additionally, slow growth of GDP of major industrialised nations affect international business cycle transmissions. References Alimi Olorunfemi and Akinwande Atanda. "Globalization, Business Cycle and Economic Growth in Nigeria."African Journal of Scientific Research, 7.1 (2011): 344-356 Aruoba, Boragan, Francis X. Diebold, M. Ayhan Kose, and Marco E. Terrones. "Globalization, the Business Cycle, and Macroeconomic Monitoring." IMF Working Paper, 2011. Benson, Nichole, Miranda Campbell-Magana, Charlie Gipson and Murtaza Sharifi. "In what ways the globalization affects the domestic economic recovery?" 2013. 2 May 2016, Carty, Sue-Lynn."What Is the Relationship Between Gross Domestic Product and the Business Cycle?" Houston Chronicle, 2015 Gauteng Province Treasury. "Business Cycles and Their Impact on the South African Economy," Quarterly Bulletin, 2012. 2 May 2016, Kose, Ayhan, Eswar Prasad and Marco Terrones. How Doews Globalisaion Affect teh Synchronisation of Business Cycles," IMF Working Paper WP/03/27, 2003 Kose, Ayhan, Eswar S. Prasad, And Marco E. Terrones. "How Does Globalization Affect the Synchronization of Business Cycles?" AEA Papers And Proceedings, (2003): 57-62 Michael Artis and Toshihiro Okubo. "Globalisation and Business Cycle Transmission," 2008. 2 May 2016, Scheide, Joachim, Thomas Straubhaar, Rainer Winkelmann. "Globalisation." Duncker & Humblot: New York, 2015, 99-103 Sulaiman L and Aluko O. "Globalisation And Economic Performance In Developing Nations: The Nigerian Experience." International Journal of Economics, Commerce and Management, 2.10 (2014): 1-9 Read More