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Spillover Effect: Definition – Overview – Types – Example

What Is the Spillover Effect?

Spillover EffectThe spillover effect in economics refers to the effect on a country’s economy from unrelated events happening in another country.

The effect refers to the impact that seemingly unrelated events in one nation can have on the economies of other nations. There are positive spillover effects.  However, the term is most commonly applied to the negative impact a domestic event has on other parts of the world.  These events include such events as an earthquake, stock market crisis, or another macroeconomic event.  Most of the world experiences significant spillover effects when there is a downturn in either of the world’s two largest economies.  Namely, the United States and China.

A spillover effect can have economic, social, or political consequences.  The impact can be felt in one region or across the world.  It is due to an independent event occurring from a seemingly unrelated event. More often, the event occurs in a specific country that leads to an impact spreading to the rest of the world. In return, it creates a social crisis or a shock in the economy like a boom or financial crash.

A spillover effect is a type of large-scale ripple effect.  The impact increases as globalization in trade and stock markets deepen.  This results in greater financial connections between economies. The Canada-U.S. trade relationship is a good example.  The U.S. is Canada’s main trading partner by a wide margin across nearly every export-oriented sector. The effects of a minor U.S. slowdown have an immediate impact.  This is due to Canadian reliance on the U.S. market for sustenance and growth.

Globally, if consumer spending in the United States declines, the spillover effect is even more widespread.  It is felt by all the economies that depend on the U.S. as their major trading partner. The larger an economy is, the greater the spillover effect it is likely to produce across the global economy. The U.S. is the world’s largest economy.  Nations and markets that trade with the USA are strongly affected by upturns as well as downturns in the U.S. economy.

In the past two decades, China has emerged as the world’s second-largest economy.   As a result, Chinese manufacturers are driving much of the global commodity demand growth. With China becoming a dominant economic power, the number of countries that experience spillover effects from a Chinese slowdown is growing. When China’s economy experiences a downturn, it has an immediate impact on worldwide trade.  It affects finished goods as well as metals, energy, grains, and many more commodities. Much of the world is impacted by trade with China.  However, Eastern Europe, the Middle East, and Africa are deeply impacted.  This is because these particular areas rely on China for a larger percentage of their revenue.

Spillover Effect – Positive and Negative 

In most cases, the spillover effect causes more negative effects than positives. Here is how they compare:

Positive Spillover Effect

Positive spillover effects occur when an action leads to a positive increase or a better overall social, political, or economic environment. The positive results should outweigh any negative effects. For example, consider free public education offered by the government. The students benefit from the program directly by gaining knowledge and skills.  General society profits from a better educated, moral, and developed population. The economy benefits from a higher educated workforce and greater productivity. The economic benefits result in a greater tax base and increased tax revenue to fund additional social programs.  The workforce can also travel overseas to further extend the spillover effect to other countries.

Negative Spillover Effect

A negative spillover effect is the opposite of a positive spillover. When it occurs, it increases unwanted social, political, and economic behaviors. For example, consider an industrial plant releasing smoke, carbon dioxide gas (CO2), oil, wastewater, and other harmful waste materials into the environment. The accumulation of CO2 with other air polluting gases contributes to global warming.  Melting ice in polar regions raises sea levels destroying valuable coastlines and coastal population centers.  Accumulation of chemical pollutants in seas and oceans leads to acidic water endangering aquatic food sources. The negative impact of a polluted environment negatively impacts everyone whether they are actively polluting or not.

Spillover Effect Examples

  • Great Depression – The spillover effect typically emanates from a single source.  However, its impact leads to other non-participants experiencing negative or positive social, political, or economic interference. For example, the Great Depression beginning in 1929 demonstrate the effect.  What began as a financial panic in the U.S. on Wall Street quickly became a severe economic downturn that spread to the rest of the world. The depression led to reduced global output, widespread unemployment, and severe deflation in financial markets around the world.
  • Covid 19 Pandemic – A more recent spillover effect event is the COVID-19 pandemic. An event that appears to trace to a food market area in Wuhan, China, spread to the whole world.  It quickly became a global disaster. During lockdown periods, trans-border trades are limited, stock prices are volatile, and cross-country borders are shut down. A similar disaster occurred in the 1918 Spanish Flu pandemic. However, the COVID-19 pandemic provided some positive spillover effects as well. China and much of the world enforced strict lockdown measures.  As a result, pollution fell significantly due to the dramatic reduction of human activities. China reported that the sun could be seen over the skyline. In India, New Delhi’s India Gate could be seen without the typical smog blocking the views.

Effect of Globalization

In today’s global economy, financial markets are interconnected like never before in history.  As a result, the spillover effect can lead to a global crash in financial markets.  Even a minor downturn can quickly erode investor confidence and slow business activity.  However, some economies are somewhat insulated from a spillover effect.  For example:

  • Unconnected Economies – Some countries experience very little as far as spillover effects from the western financial markets. These closed-off economies are getting rarer, but they do exist.  However, even North Korea⁠ now feels the⁠ spillover effects from intermittent Chinese slowdowns.  Even though as an economy, North Korea is nearly sealed off from world trade at large.
  • Safe-Haven Economies – Virtually all developed economies are vulnerable to certain economic events that carry overwhelming influence.  Japan, the U.S., and the Eurozone, for example, all experience spillover effects from China.  However, this impact is partially mitigated by the flight to safety when global markets get shaky. Investors can always retreat into the safety of their respective home markets in times of economic instability elsewhere.  Similarly, if one of the economies in this collective group struggles, investors can further retreat to one of the remaining safe havens in the group.

The safe-haven 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.

Final Words

The spillover effect is amplified by the effects of globalization, international trade, and interconnected financial markets between different economies of the world. An example of the spillover effect is the US-China trade war. China had been the second-largest trade partner of the US, after Canada. The interdependency of the US-China trade increased over the past decade.  However, the US Trump administration has imposed heavy tariffs on Chinese goods since early 2018. China retaliated by imposing tariffs on US-made products.  The result is a trade war between the two largest economies of the world.

The US-China trade war has had spillover effects that are both negative and positive.  Various economies of the world feel the effects, particularly many Asian economies.  Japan’s economy has significantly gained in terms of better trade relations with China.  However, global industrial demand has been low, especially for commodities, metals, and shipping.

Up Next: What are Littoral Rights?

Littoral RightsLittoral rights refer to the legal use and enjoyment of the shoreline for land that borders a pooled body of water like a pond, lake, or sea.

Littoral land refers to land that borders a pooled body of water, such as a lake, ocean, or sea.  This differs from riparian land that borders a flowing water source like a river or stream. Littoral rights are generally concerned with the legal use and enjoyment of the shoreline. Littoral proprietors are occupants of land that border these bodies of water.  However, individuals do not have title to or ownership of the water.

Nevertheless, property owners whose land adjoins bodies of water have a reasonable right to water use, but the water is not theirs. Therefore, there are limitations to what a property owner can do with that water.

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