How Importing and Exporting Impacts the Economy
Fact checked by Pete Rathburn
Overseas products or imports provide more choices to consumers. They help them manage their strained household budgets because they’re usually manufactured more cheaply than any domestically produced equivalent so they cost less. It can distort a nation’s balance of trade and devalue its currency, however, when there are too many imports coming into a country in relation to its exports.
The devaluation of a country’s currency can have a huge impact on the everyday life of a country’s citizens. The value of a currency is one of the biggest determinants of a nation’s economic performance and its gross domestic product (GDP). Maintaining the appropriate balance of imports and exports is crucial for a country. Its importing and exporting activity can influence the country’s GDP, its exchange rate, and its level of inflation and interest rates.
Price changes in imports and exports are tracked by the Import/Export Index (MXP) released by the Bureau of Labor Statistics (BLS).
Key Takeaways
- A country’s importing and exporting activity can influence its GDP, its exchange rate, and its level of inflation and interest rates.
- A rising level of imports and a growing trade deficit can have a negative effect on a country’s exchange rate.
- A weaker domestic currency stimulates exports and makes imports more expensive.
- A strong domestic currency hampers exports and makes imports cheaper.
- Higher inflation can also impact exports by having a direct impact on input costs such as materials and labor.
Effect on Gross Domestic Product
Gross domestic product (GDP) is a broad measurement of a nation’s overall economic activity. Imports and exports are important components of the expenditure method of calculating GDP. The formula for GDP is:
GDP=C+I+G+(X−M)where:C=Consumer spending on goods and servicesI=Investment spending on business capital goodsG=Government spending on public goods and servicesX=ExportsM=Imports
Exports minus imports (X – M) equals net exports in this equation. The net exports figure is positive when exports exceed imports. This indicates that a country has a trade surplus. The net exports figure is negative when exports are less than imports. This indicates that the nation has a trade deficit.
A trade surplus contributes to economic growth in a country. It means that there’s a high level of output from a country’s factories and industrial facilities as well as a greater number of people that are being employed to keep these factories in operation when there are more exports. It also equates to a flow of funds into the country which stimulates consumer spending and contributes to economic growth when a company is exporting a high level of goods.
It represents an outflow of funds from that country when a country is importing goods. Local companies are the importers and they make payments to overseas entities, the exporters. A high level of imports indicates robust domestic demand and a growing economy. It’s even more favorable for a country if these imports are mainly productive assets such as machinery and equipment because productive assets will improve the economy’s productivity over the long run.
Important
A healthy economy is one where both exports and imports are experiencing growth. This typically indicates economic strength and a sustainable trade surplus or deficit. It may indicate that foreign economies are in better shape than the domestic economy if exports are growing but imports have declined significantly. It may indicate that the domestic economy is faring better than overseas markets if exports fall sharply but imports surge.
The U.S. trade deficit tends to worsen when the economy is growing strongly. This is the level at which U.S. imports exceed U.S. exports. The U.S.’s chronic trade deficit hasn’t impeded it from continuing to have one of the most productive economies in the world, however.
A rising level of imports and a growing trade deficit can hurt one key economic variable, however: a country’s exchange rate, the level at which their domestic currency is valued versus foreign currencies.
Impact on Exchange Rates
There’s a constant feedback loop between international trade and the way a country’s currency is valued. The exchange rate affects the trade surplus or deficit which in turn affects the exchange rate. A weaker domestic currency generally stimulates exports and makes imports more expensive, however. A strong domestic currency hampers exports and makes imports cheaper.
Exchange Rate Examples
Consider an electronic component priced at $10 in the U.S. that will be exported to India. Assume the exchange rate is 50 rupees to the U.S. dollar. The $10 electronic component would cost the Indian importer 500 rupees without factoring shipping and other transaction costs such as importing duties into the equation.
Its price would increase to 550 rupees ($10 x 55) for the Indian importer if the dollar were to strengthen against the Indian rupee to a level of 55 rupees to one U.S. dollar and assuming that the U.S. exporter doesn’t increase the price of the component. This may force the Indian importer to look for cheaper components from other locations. The 10% appreciation in the dollar versus the rupee has therefore diminished the U.S. exporter’s competitiveness in the Indian market.
Now consider a garment exporter in India whose primary market is in the U.S. again assuming an exchange rate of 50 rupees to one U.S. dollar. A shirt the exporter sells for $10 in the U.S. market would result in them receiving 500 rupees when the export proceeds are received, again neglecting shipping and other costs.
The exporter can now sell the shirt for $9.09 to receive the same amount of rupees (500) if the rupee weakens to 55 rupees to one U.S. dollar. The 10% depreciation in the rupee versus the dollar has improved the Indian exporter’s competitiveness in the U.S. market.
The result of the 10% appreciation of the dollar versus the rupee has rendered U.S. exports of electronic components uncompetitive but it’s made imported Indian shirts cheaper for U.S. consumers. The flip side is that a 10% depreciation of the rupee has improved the competitiveness of Indian garment exports but it’s made imports of electronic components more expensive for Indian buyers.
Note
Currency moves can have a drastic impact on a country’s imports and exports when this scenario is multiplied by millions of transactions.
Impact on Inflation and Interest Rates
Inflation and interest rates affect imports and exports primarily through their influence on the exchange rate. Higher inflation typically leads to higher interest rates. It’s not clear whether this results in a stronger currency or a weaker currency.
Traditional currency theory holds that a currency with a higher inflation rate and consequently a higher interest rate will depreciate against a currency with lower inflation and a lower interest rate. According to the theory of uncovered interest rate parity, the difference in interest rates between two countries equals the expected change in their exchange rate.
The currency of the higher-interest-rate nation would be expected to depreciate 2% against the currency of the lower-interest-rate nation if the interest rate differential between two different countries is 2%. The low-interest-rate environment that’s been the norm around most of the world since the 2008-09 global credit crisis has resulted in investors and speculators chasing the better yields offered by currencies with higher interest rates, however.
This has had the effect of strengthening currencies that offer higher interest rates. This strategy is generally restricted to the stable currencies of nations with strong economic fundamentals, however, because these investors have to be confident that currency depreciation won’t offset higher yields,
A stronger domestic currency can hurt exports and the trade balance. Higher inflation can also impact exports by having a direct impact on input costs such as materials and labor. These higher costs can have a substantial impact on the competitiveness of exports in the international trade environment.
Economic Reports
A nation’s merchandise trade balance report is the best source of information to track its imports and exports. This report is released monthly by most major nations. The U.S. and Canada trade balance reports are generally released by the U.S. Census Bureau and Statistics Canada within the first 10 days of the month with a one-month lag.
These reports contain a wealth of information including details on the biggest trading partners, the largest product categories for imports and exports, and trends over time.
Is Importing or Exporting Better for an Economy?
Both imports and exports are experiencing growth in a healthy economy. A balance between the two is key.
It can impact the economy in negative ways if one is growing at a greater rate than the other. Strong imports mixed with weak exports likely mean that U.S. consumers are spending their money on foreign-made products more than foreign consumers are spending their money on U.S.-made products.
What Are the Benefits of Exporting?
When exports outpace imports, this is a trade surplus and it’s often a sign that U.S. manufacturers are doing good business. This should lead to strong employment.
What Are the Potential Problems of Importing?
Imports that significantly outpace exports can affect the dollar’s exchange rate in complex ways. A strong import market usually correlates with the dollar being strong. This can limit exports because U.S. goods are then more expensive for foreign markets.
The Bottom Line
Inflation, interest rates, the value of the dollar, and our nation’s GDP all are impacted by imports and exports. Both imports and exports should ideally be experiencing growth in a healthy economy. Exports outpacing imports in terms of growth could be a sign that foreign economies are stronger than the domestic economy because of the market for buying U.S. goods. The opposite might be true if the growth of imports outpaces the growth of exports.