Re-Coupling/De-Linking: To Be or Not To Be?

 |  Includes: DIA, EEM, EFA, IEV, QQQ, SPY
by: Max Fraad Wolff

One of today’s great debates involves the presence or absence of coming trauma to developing countries/emerging markets from US and EU economic pain. I do not share the prevailing wisdom that de-coupling/de-linking will smoothly occur. US and Euro Zone slowing will be global in impact. As has always been true, different states will grow- or shrink- at very different rates.

What interests me, and I humbly submit should interest you, involves the speed and size of de-linking between the American Macro-Economy and our leading multinational enterprises [MNE]. The mirror image of this is the growing link between our MNE and other economies. I believe this has quietly been driving much offshore growth and onshore underperformance. US, Japanese Euro Zone MNE investment, sourcing, growth and operational decision looks to be at the center of a form of de-linking. It is also the core of another form of linkage or coupling.

America’s corporate engine is increasingly linked to offshore growth. Our firms are dragging more of “their” macro wagon and proportionally less of our macro wagon. De-linking has been occurring for years and is the norm, not the exception. We may be looking at the wrong metrics and engaging questionable areas of analysis when we debate de-linking. Re-linking, de-linking and new global patterns are the defining element of the global economic order. De-coupling, as commonly assumed, is highly questionable. De-linkages and re-linkages are reshaping the world rapidly. The pace will grow more rapid, violent and potent in the present rebalancing.

To be

A look at the growth in off-shore operations of US MNE and their affiliates reveals de-linking of macro commitment. Even during the boom years for domestic profit growth, 2003-2007, US MNE increasingly looked off-shore for expansion. Reduced proportional activity in the US has correlated to enhanced activity outside of the US and developed markets. Our firms are a rising share of their economies. This suggests one interesting de-linkage. It also speaks to greater our firms to their national economies linkage. Simultaneously, globalization questions the prevailing wisdom on near term international economic performance. Our weakness can be, initially, their strength as production shifts. We live in the same global economy and compete for jobs, sales, profits and technology through the same firms. Us and them, is increasingly a game of where the same firms grow operations and report income. The newest data from the BEA suggests this trend has been running since 2002 and has intensified recently.

Worldwide employment by U.S. multinational companies (MNCs) increased 3.3 percent in 2006, to 31.3 million workers, following a 1.4-percent increase in 2005. Employment in the United States by U.S. parent companies increased 2.7 percent, to 21.9 million workers, following a 0.8-percent increase. The employment by U.S. parents accounted for almost one-fifth of total U.S. employment in private industries. Employment abroad by the majority-owned foreign affiliates of U.S. MNCs increased 4.7 percent, to 9.4 million workers, following a 3.0-percent increase.

Source: BEA News Release 17 April 2008, Summary Estimates for Multinational Companies

The most recent BEA release on multinationals, indicates the size of employment by multinationals in the US, 20% of private sector employment, and a more rapid rate of foreign growth. There is every indication that this trend accelerated since the end of the reported data. The US Dollar has fallen and foreign economic growth has outpaced. Our firms and consumption are woven deep into the fabric of global economic growth. The newest patterns led a series of new linkages. Their integration with our firms has been growing rapidly. Deregulation, new technology and openness have created a single global economy defined by vastly divergent national performance and position. The various and evolving firms, states and trends in the global economy de-link, re-link and shift constantly. Success and failure are visited on firms, regions and industries rapidly. We can argue over where or what will rise and fall. Arguing against interconnectedness is absurd.

The below offered data is designed to demonstrate the case for re-linking made above. The profound trend has been one of re-linking OECD MNE growth to developing economies and reduction in older linkage patterns. However, profits and safety of return come from developed markets with their traditionally less volatile business cycle and relatively wealthy consumers.

Foreign profits rose by over 7.5% across 2007 and now account for more than 1 in 3 profit dollars by S&P500 firms. Another way to see that involves thinking about the other $2 of $3 that our leading forms make in their developed home field. OECD, World Bank, IMF and bank consensus forecasts suggests that foreign GDP and profit growth will be significantly above US for the next few years. Thus, a future of dramatic shifts in linkage is nearly assured. If our firms ever more intimately shape their reality, the health of our firms in the present downdraft is hardly irrelevant to decoupling and developing country growth.

U.S. Direct Investment Abroad, Majority-Owned Foreign Affiliates, Net Income Aggregate Totals for (1997-2005).

Figure 1

Figure 2 below (Chart 1 in the BEA Summary Estimates for Multinational Companies) reveals the trend in US employment to be the mirror image of growth off-shore.

Figure 2

The trends in growth onshore and offshore are hard to avoid seeing. There has been a rapid rise in the non-US share of leading firm growth and earnings. The more rapid growth in offshore activity seems correlated to declining hiring in the US. A sharp decline in US consumption is universally predicted. This should further reduce American focus by leading firms.

The rapid increase in foreign investment, especially in India and China, is likely to rise in proportional terms. Most metrics suggest that there are very direct and potent links between US firms and foreign growth. In other words, partial de-linking of US MNE and the American economy will continue as it has for some time. Global de-linking is a fading fantasy from a bygone era. Re-linking will become a more dramatic driver of national macro-economic divergence as all experience retrenchment in a global slowdown. Our firms, our economy and their economies are all in this together, ever more together.

U.S. Direct Investment Abroad, Capital Outflows Without Current-Cost Adjustment By Country (Major Countries) for (1998-2006)

Figure 3

Figure 4

U.S. Direct Investment Abroad, All Foreign Affiliates, Net Income
Aggregate Totals for (2000-2005)

Not to be

The linkages between US MNE and foreign economies have grown more potent, not less. MNE related growth outside the world has been booming. MNE remain largely based in The US, EU and Japan.

These firms face three sets of growing problems. First, there are growing protectionist sentiments around the world. Home markets are full of essential consumers who are angry and blame MNE for weak employment and earnings growth. Export host nations are filled with growing nationalism artfully exploited by local politicians and domestic competitors. Second, profit conditions are under pressure around the world. Resource shortages, basic material price spikes and nationalism are placing great pressure on all net input importers. Export restrictions and protectionist opposition to imports are mounting simultaneously. All of this is to say, the world is becoming more protectionist just as MNE become more dependent on long and vulnerable supply and demand chains. This suggests the MNE driven developing nation growth is imperiled by US and EU weakness and the likely reactions to it.

Second, rising prices of food and basic materials mean rising wage pressures and capital costs. Rapid currency shifts and input cost increases disrupt and alter price structures and profit expectations. Long deferred wage demands grow as food costs rise, energy costs soar and inflation rises. Low cost labor, cheap materials, free trade and easy credit made for a great MNE growth and profit period. All these pillars are being rattled.

Third, the end of the long credit glut is creating harder to come by and more expensive credit. The next few years will see more cautious financing extended at greater cost. Developed world consumers will be pinched by rising food, energy and currency adjusted costs. Developing world consumers are being pressured by food and energy costs. All are vulnerable to the health of MNE balance sheets. The rosy de-linking story widely ascribed to on Wall Street is just that, a story. I may be sustained through dreams and past momentum for a precious few months. It is not a viable macro-structural possibility over long term frames.


There will continue to be very differential growth rates around the world. The developing world will continue to be a more volatile place to be business, to the upside and to the down. Global integration will continue to inch forward. It will face setbacks and reverses as political opposition, resource prices and resource shortages motivate nationalist responses. Arising inflation pressures and currency swings will couple with resource costs oscillations to create a tougher profit environment. Wealthy consumers will retrench as US and EU weakness reduces cash and debt flow to the world’s affluent anchor consumers. We will not get a rosy scenario de-linking. Profit and earnings fortunes are linked as are economic fates by the very integration that produced the present conjuncture in the world economy.

Note: All the data and graphs above are based on or taken from BEA data.