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Decoupling

The act of creating gaps

What is Decoupling?

Decoupling represents the creation of gaps. In finance, decoupling happens when different asset classes or markets that typically demonstrate positive correlations start to move in opposite directions.

 

Decoupling

 

In organizational studies, decoupling takes place when there are gaps between formal policies and actual practices in an organization. Eco-economic decoupling considers the environmental impacts of economic growth. It refers to economic growth without leading to greater environmental pressure.

 

Summary

  • Decoupling happens when markets with high positive correlations start to move in opposite directions.
  • Decoupling also refers to the gaps between formal policies and actual practices in organizations. It may result from a conflict of interest.
  • Eco-economic decoupling happens when an economy can grow without causing more environmental pressure or damages.

 

Decoupling in Finance

In financial markets, many different asset classes are positively correlated. The values of the asset classes usually move in the same direction, though at different rates. The higher the correlation, the closer the asset values move together.

When the correlation between the two assets equals 1, the values of the two assets always move together. For example, oil prices and natural gas prices are highly correlated. When oil price increases (decreases), the natural gas price increases (decreases) correspondingly. When the prices of two positively correlated assets start to move in opposite directions, decoupling takes place.

The concept of decoupling not only applies to asset classes but can also apply to different markets. As the economies of developing countries grow, emerging markets become less dependent on the U.S. market. Thus, emerging markets are said to be decoupling from the U.S. market.

A country’s investment market shows a high correlation with its economic environment. Decoupling also refers to the investment market performance detaching from the economic state.

During the COVID-19 shutdown, the U.S. economy experienced a sharp slowdown. The country’s GDP fell as the unemployment rate spiked. After an initial jump, the U.S. stock performance recovered much sooner than the economy. The equity market decoupled from the economy.

 

Decoupling in Organizational Studies

Decoupling happens when gaps between formal policies and actual practices appear in organizations. It is a concept in neo-institutionalism, which studies institutions through the enabling and constraining effects of rules. Such a type of decoupling can take place in a variety of organizations. Government agencies, social organizations, schools, and corporations are some examples.

Organizational decoupling is criticized for serving the interests of organizational leaders. The top executives may avoid practicing the policies that do not align with their benefits. However, decoupling also allows internal flexibility regarding practical considerations while keeping legitimate with the external parts. It is beneficial to an organization itself.

 

Eco-Economic Decoupling

In economics and environmentalism, decoupling happens when an economy is able to grow without causing more environmental pressure or damage. Such a type of decoupling is known as eco-economic decoupling. Most of the time, increasing economic activities requires a greater consumption of resources, especially fossil fuels. It also causes more emissions and pollutants, which will lead to greater environmental pressure.

With eco-economic decoupling, countries should be able to sustain economic growth with reduced resource consumption and pollutant emissions. Resource decoupling measures the reduced rate of using resources for every unit of economic growth. Impact decoupling measures the reduced economic impact for every unit of economic growth.

Impact decoupling consists of two parts. One is the decoupling between economic growth and resource consumption. It can be created by improving the efficiency of energy and resource consumption. The other part is the decoupling between resource consumption and the corresponding environmental impact. It can be reached by switching to clean energies and reducing the waste and pollutant emission per unit of resource consumption.

 

Eco-Economic Decoupling - Graphical Representation

 

Decoupling and Recoupling

In the areas of finance and organizational studies, decoupling is not permanent. When the gaps shrink and the two parts start to converge, recoupling takes place. Before the 2008 Global Financial Crisis, developing countries in Asia and Latin America experienced rapid growth in their economies. They were decoupling from the U.S. economy. During the financial crisis, emerging markets and the U.S. market recoupled and dropped together dramatically. The correlation between them rose.

The demand for capital and resources declines in certain countries during their recession periods. The remaining markets can maintain their economic health due to lower interest rates and commodity prices.

In such a case, decoupling happens among global markets. When global lenders significantly suffer from a crisis, capital supply drops. It will hurt the rest of the markets. Consequently, emerging markets and developed markets recouple.

 

More Resources

CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

  • Emerging Markets
  • Gross Domestic Product (GDP)
  • Environmental, Social, and Governance (ESG)
  • Unemployment

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