Chinas influence on the World Economy 1Chinas influence on the World Economy (Analysis of Business Cycles)Amir Alibasic, 1A TuzlaMicroeconomicsProfessor Dr. Carmen M. Castro, DBAAmerican University in Bosnia and Herzegovina Chinas influence on the World Economy 2Abstract:In the bellow text we will be researching business cycles in China and in selected OECD countries. We show that, unfortunately negative correlation dominates for nearly all countries; we can also see large differences for various frequencies of cyclical developments. Countries facing a comparably longer history of intensive trading links tend to show also slightly higher correlations of business cycles with China. Chinas influence on the World Economy 3Introduction: The emergence of China in the world economy has been one of the major events in the world economy in the last two decades. While China was a predominantly agrarian economy before 1980, it is now to a large extent a modern industrial economy with booming urban regions. High trade growth was supported by large foreign direct investment (FDI) flows (see Eichengreen and Tong, 2005). Not surprisingly, growth in China has changed the distribution of economic activities across the world. Between 1980 and 2006, the share of Chinese GDP in the world economy increased from 1.7% to 5.5% (valued at market exchange rates, the share would be higher if purchasing power adjusted prices were used). Now, China is one of the most important exporting and importing nations worldwide. The new weights of the world economy have also important implications on business cycles around the world. The increasing weights of the emerging countries, and China especially, have lead to higher global growth. Moreover, global economic prospects are less influenced by few large economies(especially the US and Germany) than before. This may make the countries less vulnerable to the demand shocks in a particular region. In turn, business cycles have become also more globalized recently. The literature on business cycle synchronization stresses the importance of foreign trade and capital flows. Thus, the emergence of China as a large trading nation and target for international investment is likely to have a significant impact on the business cycles of its partner countries. Foreign trade and foreign direct investment (FDI) are generally seen as important factors of business cycles. Moreover, FDI can be either a substitute or a complement to exports between a pair of Chinas influence on the World Economy 4countries. In the next couple of paragraphs we will learn about determinants of international business cycle, introduction to the concept of dynamic correlation and pattern of dynamic correlation of business cycles in China and in developed countries.Determinants of Business Cycle: Economic development is determined both by domestic (for example aggregate demand shocks and budgetary policy) and international factors (external demand and international prices for traded goods). Originally, Frankel and Rose (1998) showed that trade, and more generally economic integration among the countries, can result in increased synchronization of individual business cycles since trade links serve as a channel for the transmission of shocks across countries. In turn, Kose and Yi (2006) analyze this issue in an international real business cycle model and conclude that, although the model suggests a positive relation between trade and output co-movement, quantitatively only small effects are obtained. However, it is not trade relations per se which may induce business cycle synchronization. Basically, the idea is that specialization increases the exposure to sector specific shocks and these shocks are transmitted via intra-industry trade. Trade relations are not the only source of synchronization of business cycles (see Artis et al., 2007). Financial integration between countries may play also an important role. Correlation and Dynamic Correlation Analysis:The correlation analysis is the most basic approach which has been applied inliterature to study the degrees of synchronization between economic variables.The most common measure of co-movement between time series is the Chinas influence on the World Economy 5classical correlation, which is also commonly used in literature on businesscycle correlation. Unfortunately the classical correlation is associated withtwo main drawbacks: First, it does not allow for a separation of idiosyncraticcomponents and common co-movements. Second, it is basically astatic analysis that fails to capture any dynamics in the co-movement. Analternative measure of synchronization