How Importing and Exporting Impacts the Economy

When there are too many imports coming into a country in relation to its exports—which are products shipped from that country to a foreign destination—it can distort a nation’s balance of trade and devalue its currency. The devaluation of a country's currency can have a huge impact on the everyday life of a country's citizens because 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. The importing and exporting activity of a country can influence a country's GDP, its exchange rate, and its level of inflation and interest rates.

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 expenditures method of calculating GDP. The formula for GDP is as follows:

GDP=C+I+G+(X?M)

where:

C=Consumer spending on goods and services

I=Investment spending on business capital goods

G=Government spending on public goods and services

X=Exports

M=Imports

In this equation, exports minus imports (X – M) equals net exports. When exports exceed imports, the net exports figure is positive. This indicates that a country has a trade surplus. When exports are less than imports, the net exports figure is negative. This indicates that the nation has a trade deficit.

A trade surplus contributes to economic growth in a country. When there are more exports, it means that there is 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 in order to keep these factories in operation. When a company is exporting a high level of goods, this also equates to a flow of funds into the country, which stimulates consumer spending and contributes to economic growth.

How Imports And Exports Affect You

When a country is importing goods, this represents an outflow of funds from that country. Local companies are the importers and they make payments to overseas entities, or the exporters. A high level of imports indicates robust domestic demand and a growing economy. If these imports are mainly productive assets, such as machinery and equipment, this is even more favorable for a country since productive assets will improve the economy's productivity over the long run.

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. If exports are growing, but imports have declined significantly, it may indicate that foreign economies are in better shape than the domestic economy. Conversely, if exports fall sharply but imports surge, this may indicate that the domestic economy is faring better than overseas markets.

For example, 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. However, the U.S.’s chronic trade deficit has not impeded it from continuing to have one of the most productive economies in the world.

However, in general, a rising level of imports and a growing trade deficit can have a negative effect on one key economic variable, which is a country's exchange rate, the level at which their domestic currency is valued versus foreign currencies.

Impact on Exchange Rates

The relationship between a nation’s imports and exports and its exchange rate is complicated because there is a constant feedback loop between international trade and the way a country's currency is valued. The exchange rate has an effect on the trade surplus or deficit, which in turn affects the exchange rate, and so on. In general, however, a weaker domestic currency stimulates exports and makes imports more expensive. Conversely, a strong domestic currency hampers exports and makes imports cheaper.

For example, 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. Neglecting shipping and other transaction costs such as importing duties for now, the $10 electronic component would cost the Indian importer 500 rupees.

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 does not increase the price of the component, its price would increase to 550 rupees ($10 x 55) for the Indian importer. This may force the Indian importer to look for cheaper components from other locations. The 10% appreciation in the dollar versus the rupee has thus diminished the U.S. exporter’s competitiveness in the Indian market.

At the same time, assuming again an exchange rate of 50 rupees to one U.S. dollar, consider a garment exporter in India whose primary market is in the U.S. A shirt that the exporter sells for $10 in the U.S. market would result in them receiving 500 rupees when the export proceeds are received (neglecting shipping and other costs).

If the rupee weakens to 55 rupees to one U.S. dollar, the exporter can now sell the shirt for $9.09 to receive the same amount of rupees (500). The 10% depreciation in the rupee versus the dollar has therefore 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 has 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 has made imports of electronic components more expensive for Indian buyers.

When this scenario is multiplied by millions of transactions, currency moves can have a drastic impact on a country's imports and exports.

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. Whether or not this results in a stronger currency or a weaker currency is not clear.

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. So if the interest rate differential between two different countries is two percent, then the currency of the higher-interest-rate nation would be expected to depreciate two percent against the currency of the lower-interest-rate nation.

However, the low-interest-rate environment that has 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. This has had the effect of strengthening currencies that offer higher interest rates.

Of course, since these investors have to be confident that currency depreciation will not offset higher yields, this strategy is generally restricted to the stable currencies of nations with strong economic fundamentals.

A stronger domestic currency can have an adverse effect on exports and on 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.