An ocean apart? The effects of US business cycles on Chinese business cycles

Abstract

This study investigates the economic interdependence between China and the United States. In view of the growing trade and investment between China and the United States, and the reaction of the Chinese economy to the US subprime mortgage crisis, one might reasonably ask, what effect do US business cycles have upon the Chinese economy? We approach this problem by examining various channels of economic interaction, including international trade and foreign direct investment between the two countries. We use regressions, the Markov switching vector autoregressive model, and recursive correlations in an attempt to measure business cycle transmission from the United States to China using annual, quarterly, and monthly data.With both annual and quarterly GDP growth data between 1951 and 2001, business cycles in China and the US are not correlated. Starting in 1978, China undertook significant economic reforms and opened up to the rest of the world. After 1992, trade between the US and China increased, and US firms began to engage in FDI in China. After China's accession to the WTO in 2001, trade accelerated, and the correlation between the GDP growth rates of the US and China increased dramatically. There is evidence that the US has some marginally significant but increasing business cycle transmission effects upon China. Recursive correlations reveal that the synchronization between the two countries is strongest during economic downturns, suggesting that economic downturns and crises are responsible for most of the business cycle synchronization.