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.