Spillover Effect:

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 such as an earthquake, stock market crisis, or another macro event.

How the Spillover Effect Works

Spillover effects are a type of network effect that increased since globalization in trade and stock markets deepened 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.

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. Since the U.S. is a leader in the global economy, nations and markets can be easily swayed by domestic turmoil.

Most of the world experiences significant spillover effects when there is a downturn or macro effect in the world's two largest economies: the United States and China.

Since 2009, China has emerged as a major source of spillover effects as well. 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.

When China's economy experiences a downturn, it has a palpable impact on the 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 rely on China for a larger percentage of their revenue.

Special Considerations

Unconnected 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 world trade in 2019 — has begun to feel the⁠ spillover effects from intermittent Chinese slowdowns.

Safe-Haven Economies

A few developed economies are vulnerable to certain economic phenomena that can overwhelm spillover effects, no matter how strong. Japan, the U.S., and the Eurozone, for example, all experience spillover effects from China, but this impact is partially counteracted by the flight to safety by investors into their respective markets when global markets get shaky.

Similarly, if one of the economies in this safe haven group is struggling, investments 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 in 2015. When dollars flow into U.S. Treasuries, the yield goes down along with the borrowing cost for American homebuyers, borrowers, and businesses. This is an example of a positive spillover effect from the perspective of a U.S. consumer.