Since my last post on the impact of sterling depreciation on
different industry sectors, there have been a number of other interesting
comments on what it means for UK exports.
Some of this is informed, but sometimes the issue of why exports matter
is a little confusing.
In my opinion, trade performance is one of the most
important issues for the UK and has been for a long time. Securing long term growth in living standards
in the UK depends on building and maintaining its ability to export (and in
some areas, resist import penetration).
However, it is often pointed out that, in real terms,
exports are a cost to the nation. They
represent goods produced with domestic labour but enjoyed by persons
overseas. So is more exports a good
thing or a bad thing?
The answer is that what we care about is not so much the
level of exports, but the demand for exports.
Think in terms of a demand curve for exports showing quantity against
price. What we want is to shift this
curve to the right, increasing demand at any given price, rather than
simply to move along that demand curve.
The reason we care about this is not because we care about
the level of exports, but because we care about the terms of trade. Having better terms of trade means that we
have to give up less (exports) in order to pay for the things we want
(imports). The greater the demand for
our exports, the lower the actual volume of exports we need in order to pay for
the same level of imports.
In simple terms this suggests that a boost to exports from a
depreciation of the exchange rate is no cause for celebration. We may export more, but only because our
terms of trade have suffered, which was the main thing we were concerned about
in the first place.
However, this does mean that it is always better to have a
strong exchange rate. Although it still comes
down to the terms of trade, it's not just what those terms are today that
matters. We need to consider what the
terms of trade may be in the future. And
having an exchange rate that is too strong today may mean a weaker exchange
rate tomorrow.
One obvious area of concern here is the long run impact on
exporting industries of overvalued exchange rates. Facing a strong exchange rate can damage
exporters' profitability, which may discourage investment and growth in those
industries restriction future capacity.
If this means weaker export capability in the future, then this may
easily wipe out any benefits gained from the current favourable terms of trade.
"The reason we care about this is not because we care about the level of exports, but because we care about the terms of trade"
ReplyDeleteI think level of exports itself matters, because as Kaldor has argued, from the viewpoint of a single nation, in the long term exports is the only exogenous source of effective demand, the rest are endogenous.
Also, "exports are a cost" is very much a resource endowment theory. It's true exports are not enjoyed by the one who produce them but since faster rise in exports allow a nation to grow faster, the enjoyment is indirect.
Yes, the role of exports in demand is an interesting point. I did think about it when writing the post, but decided not to mention it as I think it complicates the point rather.
DeleteI would still say that what matters for long term demand, certainly in the context of floating exchange rates, is shifting the demand curve to the right rather than moving along it. In other words, the long-term constraint is driven by where the demand curve is, not where you are on it at this current time.
In principle, almost any level of export volume can be achieved at the right price. Even if trade is relatively inelastic at the margin, if it's made dirt cheap, someone will take it off your hands. So the question really becomes what level of export volumes we can achieve at terms of trade that are acceptable and it is this that drives long term demand growth.
So, I think the demand point is actually quite hard to separate from what I'm saying in the post.
I would also note that looking at GDP growth can be quite misleading when we have the potential for significant variations in the terms of trade, if what we are concerned with is living standards. As a simple illustration, it's no benefit to you if your GDP has increased by 5%, if you have had to export the extra produce to pay for the same level of imports. This is tied in to the issue I discussed a few months back on the role of manufacturing in productivity growth and trade. There are some highly counter-intuitive results here, and I was thinking of doing a further post to illustrate it more clearly.
Another way of putting it -
DeleteA country can improve its terms of trade by pursuing contractionary policies to depress domestic demand and hence imports. What I'm asking is what terms of trade can be achieved without resorting to excessively low demand. Or you could ask what level of demand can be achieved, consistent with acceptable terms of trade. The answers to these questions really point to the same state.
Hi Nick,
Delete"is shifting the demand curve to the right rather than moving along it."
What do you mean by that?
"In principle, almost any level of export volume can be achieved at the right price."
I am not sure that's the case. For example, a firm in India manufactures cars at $1,500-2,000 but BMW will still beat them. Even Indian buyers prefer other cars.
So while price does affect, non-price competitiveness is quite important. Also while the Sterling has fallen a lot, it's not always the case that the currency adjusts to the level economic units want.
By "shifting the demand curve to the right", I mean doing something to increase the demand for exports for any given (foreign currency) price, and by "moving along it", I mean changing the demand by changing the price.
DeleteI would certainly agree with you that export demand is relatively price insensitive and that non-price factors are important. I'd say it is difficult to increase export revenue by reducing price, but on the whole I'd say that you do get some small increase in volumes for a drop in price. There may be exceptions.
However, it is also worth pointing out that if, in fact, a price reduction does not increase trade volumes at all, then an exchange rate depreciation is definitely a bad thing, because you're getting no benefit whatsoever, but still having the additional cost.
Nick,
ReplyDeleteI can easily see how increased exports will move the demand curve to the right. I think the economic effect can be easily seen if we think that the workers and resource providers have become part of the economy we are successfully exporting into.
Said in another way, the workers and resource providers, to the extent they are engaged in exports, have become part of the economy they are exporting into.
This distinction brings to light the fact that imports are purchased in the local currency. Exporters cannot produce in that local currency, so there must be a currency exchange mechanism that enables any year-after-year continuing one-way transfer of product. The only alternative is for the exporting nation to build a monetary asset base in the importing country, which in itself requires the building of an asset ownership structure that can have control of both internal and foreign financial assets. (Someone must own profits generated year-after-year from exports.)
There would be nothing bad about this. This is merely a pattern of economic activity that can be repeated year-after-year.
I don't think you'd say that increased exports moved the demand curve to the right, but moving the curve to the right does increase exports.
DeleteI think you are right that we might look at it by considering exporters to be part of the economy they are exporting into. It is an interesting question as to where we draw the line around an economy, when we want to consider different issues. Clearly a currency zone represents one possible boundary, but it is important to remember that it is not an absolute thing.