What is the Spillover Effect

Spillover effect refers to the impact that seemingly unrelated events in one nation can have on the economies of other nations. Although there are positive spillover effects, the term is most commonly applied to the negative impact a domestic event has on other parts of the world. For example, if consumer spending in the United States declines, it has spillover effects on the economies that depend on the U.S. as their largest export market. The larger an economy is, the more spillover effects it is likely to produce across the global economy.

BREAKING DOWN Spillover Effect

Spillover effects are a type of network effect that has become more common as globalization deepens the financial connections between economies. The Canada-U.S. trade relationship provides an example of spillover effects. This is because the U.S. is Canada’s main market by a wide margin across nearly every export oriented sector. The effects of a minor U.S. slowdown are amplified by the Canadian reliance on the U.S. market for its own growth.

Since 2009, China has also emerged as a major source of spillover effects. This is because Chinese manufacturers have driven much of the global commodity demand growth since 2000. With China becoming the number two economy in the world after the U.S., the number of countries that experience spillover effects from a Chinese slowdown is significant. China slowing down has a palpable impact on worldwide trade in metals, energy, grains, and many more commodities. This leads to economic pain through much of the world, although it is most acute in Eastern Europe, the Middle East and Africa, as these areas count on China for a larger percentage of their revenue.

Spillover Effects on Unconnected and Safe Haven Economies

There are some countries that experience very little as far as spillover effects from the global market. These closed off economies are getting rarer as even North Korea – an economy nearly sealed off from the world trade – feels spillover effects from the Chinese slowdown. A few developed economies are sway to economic phenomenon that can overwhelm spillover effects. Japan, the U.S. and the eurozone, for example, experience spillover effects from China, but this impact is partially counteracted by the flight to safety by investors when global markets get shaky. Similarly, if one of the economies in this safe haven group is struggling, investment will usually go to one of the remaining safe havens. This effect was seen with the U.S. investment inflows during the EU’s struggles with the Greek debt crisis. When dollars flow into U.S. Treasuries, the yield goes down along with the borrowing cost for American home buyers, borrowers and businesses. This is an example of a positive spillover effect from the perspective of a U.S. consumer.