My Say: Exports and imports go hand in hand

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This article first appeared in Forum, The Edge Malaysia Weekly, on March 7 - 14, 2016.


I have always wanted to be a (consulting) detective. I grew up reading Sherlock Holmes. My parents gave me my first Sherlock Holmes book at the age of nine. Alas, my dreams of being a detective did not quite work out and I ended up being an economist instead.

This is not half bad. A big part of why I was drawn to the field was a 1999 essay entitled “The Economist as Detective” by Claudia Goldin, a Harvard professor of economics and former president of the American Economic Association. Because of the essay, I clung (and am still clinging) to the supposition that I was indeed, at least partially, a detective.

Over the past two weeks, I have been reading books that take that notion even further. Marshall Jevons (a pen name) wrote four books in which a Harvard economics professor, Henry Spearman, solves classic “whodunnit” crimes using economic theory. They are highly enjoyable reads and, I believe, add to the detective literature.

Sherlock Holmes has his deductive reasoning, Hercule Poirot has his grey cells, and Henry Spearman has his economic theory. For those with an interest in both economics and murder mysteries, I would highly recommend these books. Not only do they spin a good yarn, they are also very instructive and approachable in their treatment of economic theory and its application to life (and death).

In The Mystery of the Invisible Hand, Henry Spearman pontificates that, “One of the myths that economists from Adam Smith to the present have been unable to demystify is that exports benefit a nation and imports harm a nation.” That rings very true.

If economists had been much better at selling the truth — that imports are actually good for a nation — we would not have seen such a strident defence of a depreciating ringgit in Malaysia by our government. Previously, I had argued twice in this column against a depreciating ringgit. First, a depreciating ringgit is not necessarily good for exports as that would depend on the elasticity and complexity of our exports, and second, there are potentially adverse distributional consequences to a depreciating ringgit on members of our society.

This is my third argument on why a depreciating ringgit is sub-optimal for the Malaysian economy. Imports are an important tool for, firstly, improving the standard of living for citizens and, secondly, for increasing competitiveness among firms, which then increases the quality of production. Given that a depreciating ringgit will bring about lower imports, it also means that it may significantly stunt increases in the standard of living as well as economic competitiveness. These are some very dire consequences.

To see this, let me first try to highlight why imports have typically been given an unfair shake in conventional wisdom. There are two main reasons for this. Firstly, there is the misconception that gross domestic product (GDP) is a good representation of a nation’s economic welfare. GDP should be viewed as — as British economist John Kay puts it — “a measure of material output, not welfare”.

However, with the Malaysian government (and others, in fairness) placing a high primacy on economic growth — indeed, GDP or gross national income targets are how high-income economies are defined — it can be difficult to disentangle the perception of GDP as economic welfare. This matters for imports as, in GDP calculations, imports reduce GDP. The standard GDP accounting equation, familiar to all students who have taken introductory macroeconomics, is:

GDP = Consumption + Investment + Government Expenditure + Exports – Imports

An increase in imports necessarily means a reduction in GDP. This is because GDP measures the domestic output of an economy for a given time period and imports are not domestic outputs. However, because GDP is commonly interpreted as welfare, higher imports imply lower GDP, which implies lower perceived “welfare”. Hence, imports get a bad name.

The second reason is home bias. In financial economics, home bias is the tendency for investors to invest in a large amount of domestic equities despite the purported benefits of diversifying into foreign equities. This is also largely true of products.

Exports and imports are political in nature. Countries around the world have campaigns for their citizens to “buy local”. How many of us felt good about ourselves when we supported a local milk product, for example, versus buying an international brand, even if the local milk product was more expensive? This also applies to the issue of foreign workers.

It is natural, even rational, for governments and citizens to feel strongly about domestic production — leading to things such as infant industry protection — and to discourage foreign production. We have all heard of import tariffs and quotas; we rarely hear of export taxes or export quotas.

However, this view is highly mistaken. When we import a good, we are essentially importing either a good (or service) that is not produced domestically, or is produced more cheaply abroad. The former increases the choice set of consumers while the latter reduces the cost of final goods and services for domestic consumers.

Increasing choices for consumers, be it different types of goods or different levels of quality for the same type of good, increases consumer welfare and thus improves the standard of living. Similarly, importing cheaper goods (and services), be it final or intermediate goods (used as inputs for production), also implies lower final costs for the consumer. Thus, if we can enjoy more choices in the economy at lower prices, this increases overall welfare.

While I am saying that imports are good, I am not saying that exports are bad. Exports are good. Increasing the complexity of our exports is positive for the economy. Higher value-added exports imply greater productivity, which therefore implies higher wages and income.

Furthermore, higher value-added exports also mean greater international trade returns to fund our imports.

As per Adam Smith — via Henry Spearman — exports are the “costs” of imports. We need to produce competitive and valuable products because we need to acquire goods and services that we cannot acquire cheaply or even acquire at all here in Malaysia. This is the main reason why overly large trade deficits are bad — not because it means that a country is importing too much but because it means a country is exporting too little. It is not exporting enough to fund greater welfare for itself.

Thus, exports and imports go hand in hand. An increase in imports generally comes with an increase in consumer welfare. Only by increasing the complexity and reducing the elasticity of our exports can we ensure that our exports have enough value to fund our imports.

A depreciating ringgit is bad for imports and, thus, is welfare decreasing. An appreciating ringgit, on the other hand, may be bad for exports but not if our exports are sufficiently inelastic, which is a result of greater complexity. We should disavow ourselves of the notion that imports are “bad” or that we need imports (of inputs) for our exports. It should be the other way round — we need exports for imports.

Nicholas Khaw is an economist with the Khazanah Research and Investment Strategy division