Transcript Chapter 11

Chapter 11
Basic Determinants of Exports
and Imports
The Importance of Foreign Trade
• The fundamental identity C + I + F + G = GDP
has been used as a foundation for explaining
GDP. Implicit in this equation is the statement
that a rise in F translates into an equal increase
in GDP, so if exports rise, the economy expands,
and if imports rise, the economy contracts.
• That simply is not true – especially for the U.S.,
because the world is on a de facto dollar
standard. Even for other countries, a rise in
exports, or a drop in imports, may not boost real
GDP.
The Importance of Foreign Trade,
Slide 2
• In the long run, the impact of changes in foreign
trade on aggregate demand are minimal.
Instead, the major relationship occurs on the
supply side: increasing foreign trade boosts
total GDP and productivity.
• There are three main reasons for this. First,
comparative advantage means each country
produces goods in which they are relatively
efficient. Second, foreign trade helps to keep
inflation low and stable. Third, when imports
rise in countries with major currencies, inflows of
foreign saving increase, boosting investment.
Current and Capital Account
• In every country, the current account
balance – which is essentially net exports
in goods and services – is the same as the
capital account – which is essentially the
net flow of capital – with the opposite sign.
• For example, if U.S. imports rise, the extra
dollars received abroad eventually make
their way back to the U.S., where it is
reinvested.
Current and Capital Accounts, Slide
2
• Of course, there are some caveats. If too few
investors want to hold dollars, the value of the
currency sinks below equilibrium and the
advantages of foreign trade are partially undone.
• For small countries with rudimentary central
banks, few investors want to hold their currency,
so it must be converted into dollars or other
strong currencies – which may not be available.
• Thus most countries cannot have their imports
exceed their exports for very long. However,
since the world is on a de facto dollar standard,
that does not apply to the U.S.
Balance of Payments Mechanisms
• In the “old days”, countries could demand settlement of
their international balances in gold. However, since the
U.S. went off the International Gold Standard in August
1971, that is no longer an option.
• Accounts are settled through foreign exchange markets.
As long as foreign investors are willing to hold more
dollars (or sterling, euros, or yen) without depressing the
value of the currency, a trade deficit does not have a
negative impact on the economy.
• If investors not wish to hold as many dollars et al, the
value of the currency sinks in forex markets until a new
equilibrium level is reached.
Equilibrium Value of Currency
• There is no longer any set value for any
currency. In economic terms, however, a
currency is near its equilibrium value when the
cost of producing a trade-weighted average of
the market basket of traded goods is the same
for all countries.
• In somewhat simpler terms, equilibrium means
firms are facing a “level playing field” with
foreign competitors. This does not mean that all
firms and industries can compete equally, but
that on average they are able to compete fairly.
Effect of Foreign Trade on GDP
• An individual firm or industry will benefit
when its exports increase, and suffer when
competitive imports increase.
• Yet for the U.S. economy as a whole, the
growth rate is higher during times when
the trade balance is negative or the trade
deficit is rising, and lower when the trade
balance is positive or the deficit is
shrinking.
Effect of Foreign Trade on GDP,
Slide 2
• To a certain extent, a change in net exports is
just a wash. For example, if imports rise, the
increase in foreign capital inflows often means
that capital spending rises more rapidly because
of increased foreign investment?
• However, foreign trade is a wash only on the
demand side. On the supply side, increased
capital spending boosts productivity and
expands total capacity, and increased foreign
trade also boosts quality and productivity.
Effect of Foreign Trade on GDP,
Slide 3
• Remember, this only works if the dollar and
other currencies remain near purchasing power
parity.
• If the dollar is overvalued relative to foreign
currencies, the deficit can then become large
enough that U.S. real growth would be reduced.
But if that happened, the value of the dollar
would eventually decline, because foreign
investors would no longer be as interested in
investing in U.S. assets, and it would return to
equilibrium.
Effect of Foreign Trade on GDP,
Slide 4
• But what about “good jobs at good wages?”
• If high-wage manufacturing jobs disappear
overseas and are replaced by low-wage service
jobs, how does that benefit the U.S. economy?
• For one thing, goods are cheaper. There are
fewer low-tech jobs, but more high-tech jobs, in
the U.S. Most of the losses in manufacturing
employment in recent years have occurred in
low-paid mfg jobs, such as textiles and apparel.
Differences in Trade Patterns
• Since the end of the international gold
standard in 1971, the U.S. has always had
a surplus in capital goods and a deficit in
consumer goods.
• The deficit in consumer goods increased
sharply after the start of NAFTA in 1995.
• The biggest deficits are in motor vehicles,
textiles and apparel, and energy.
Determinants of Imports
• The change in imports is closely related to the
growth rate in the U.S. economy. The elasticity
is greater than unity, so a boom results in a more
than proportionate increase in imports.
• To a certain extent, imports are negatively
related to the value of the dollar. However, the
elasticity is fairly small because most foreign
producers adjust their prices to domestic levels.
Thus, for example, when the dollar
strengthened, foreign car producers do not
boost their prices proportionately.
Determinants of Exports
• To a certain extent, the change on exports depends on
the growth rate in the rest of the world. However, that
growth rate is not independent of what happens in the
U.S. In particular, a boom this year is likely to be
followed by faster growth abroad next year, while a
recession this year is likely to be followed by a slowdown
abroad next year.
• As a result, exports are correlated with the change in
domestic economic activity lagged one year. This is
known as the repercussion effect.
• Also, exports are negatively correlated with the value of
the dollar; the price elasticity is somewhat greater than
for imports.
How Serious is the Trade Deficit?
• Unlike the Federal budget deficit, which
depends on the phase of the business
cycle and can be cured with rapid growth,
the trade deficit appears to be permanent.
Furthermore, the faster the U.S. economy
grows, the larger the trade deficit, cet. par.
• What are the plusses and minuses of an
ever-increasing trade deficit?
Benefits of a Bigger Trade Deficit
• Consumers get a larger variety, better quality,
and lower prices for traded goods. The same
general comments also apply to capital goods.
• Vigorous foreign competition boosts productivity
and reduces inflation, which also keeps interest
rates low
• Increase in foreign saving helps to fund capital
spending and boosts financial market prices
Disadvantages of a Bigger Trade
Deficit
• Loss of manufacturing jobs
• Some industries may be completely shut down,
leaving the U.S. to depend entirely on foreign
sources. However, these may still be owned by
U.S. investors.
• Most serious, if the trade deficit becomes so
large that the value of the dollar falls below
equilibrium, then the advantages of vigorous
productivity growth and low inflation start to
disappear.
What About Increased Foreign
Ownership of U.S. Assets
• It is sometimes claimed that increased foreign ownership
of U.S. assets will cause the returns from capital to flow
to other countries, saddling the U.S. with an everincreasing foreign debt.
• However, the argument here is basically the same as for
the trade deficit. As long as the funds are reinvested in
the U.S., foreign ownership doesn’t matter.
• Only if the dollar falls below equilibrium do the
disadvantages of foreign ownership become serious.
That can be avoided by implementing pro-growth fiscal
and monetary policies that will continue to attract more
foreign investment.