Net export spending

'Net' exports refer to the value of a country's export earnings on the sale of goods and service abroad, minus its expenditure on imported goods and services.

Net exports form a key component of the aggregate demand equation:

AD = C + I + G + (X - M)

Net exports as an injection

If net exports are positive, then they are an injection into the circular flow of income. However, if import spending is greater than export earnings, net exports are negative, and the effect is that spending leaks out of the circular flow of income.

net exports into or out of an economy

Factors affecting net exports

    Net exports can be affected by several factors, including:

  1. Changes in national income

    In the simple model of national income, exports are assumed to be exogenously determined - that is, determined 'outside' of the model, which in this case is the 'cross' model. However, import spending is determined by changes in national income, with the import line sloping upwards.

    an increase in confidence shifts the demand for investment curve to the right

    An increase in national income will result in an increase in imports. The gradient of the import line is the marginal propensity to import (mpm). Exports will be left unaffected in the current time period as they depend upon changes in foreign income. Hence there is a tendency for net exports to move towards a deficit during a period of domestic growth. A large or rising deficit could be a sign of an 'over-heated' domestic economy.

  2. Exchange rates

    Both import spending and export revenue are affected by changes in exchange rates. An increase in a country's exchange rate will, potentially, raise the prices of its exports abroad. For example, an increase in the exchange rate of GB pounds to US dollars [from £1=$1.20, to £1=$1.40] is likely to raise the price of UK exports in the US, assuming the new exchange rate passes through to prices in the US. If it does, the higher price in the US will cause a contraction of demand, as shown.

    an increase in confidence shifts the demand for investment curve to the right

    An increase in the exchange rate will mean that import prices are likely to fall, resulting in an increase in demand for imports. However, this will not necessarily increase or decrease the value of exports and imports (and net exports) given that it depends on the price elasticity of demand for imports and exports. The more elastic the demand the more likely a change in the exchange rate will affect the value of net exports. It also depends on whether the increase in the exchange rate is passed through to cheaper import prices. On this point, given that exchange rates can be volatile, producers may prefer not to atler prices and adopt a longer term view.

  3. Interest rates

    Interest rates can influence net export demand in several ways.

    Firstly, interest rates can affect household spending and investment spending, and therefore affect aggregate demand. Assuming aggregate supply is relatively elastic, increases in aggregate demand can raise equilibrium GDP, which in turn can increase demand for imports - given that import demand is a function of national income [m=fY].

    Secondly, interest rates affect the flow of funds into an economy to purchase financial assets. If the exchange rate in an economy increases relative to other rates, international fund holders can transfer funds in the expectation of making a short term gain. The significant point here is that it is 'real' interest rates that influence decisions to speculate, and hence the the rate of inflation is also a factor in influencing financial flows. These 'interest rate sensitive' flows are referred to as 'hot money'.

  4. Relative inflation

    Relative inflation will affect both import and export demand. If a country experiences a period of inflation its exports are likely to suffer, and it is likely to increase demand for relatively cheaper imports. As with the effect of exchange rates changes, the impact will depend upon relative price elasticities of demand.

  5. Trade barriers

    Trade barriers, including quotas and tariffs, can limit the openness of an economy, and result in a reduction in trade. This may increase or decrease net exports depending on the relative strength of the barriers that exist, and the type of barrier.

  6. Export subsidies

    Export subsidies are a type of trade barrier but require a special mention. By subsidising exports, export price falls and exporters can derive a short-term advantage in terms of price competitiveness. If this results in import penetration such subsidies can also provide a long-term advantage.

    However, countries may retaliate, or indeed may not be allowed to provide state aid if they are a member of a trading bloc, such as the EU which has rules limiting state aid by its members. Of course, the trading bloc as a whole may support its industries with subsidies. This appears to be the case with the EU aviation sector which is heavily subsidised - prior to the additional subsidies to deal with the fall-out from the COVID-19 pandemic.

The effect of an increase in net exports

An increase in net exports will shift the aggregate demand curve to the right.

an increase in confidence shifts the demand for investment curve to the right

If this happens the effect in the next time period is that exports (X) may decrease, and imports (M) increase. To some extent short term deficits and surpluses are self-correcting. A rise in GDP cause by an increase in net exports will bring the trade balance back towards equilibrium as a result of the rise in the level of prices, and the rise in imports as a result of growth.

The self-correcting nature of trade imbalances is one reason why many economists do not favour aggressive interventions to try to engineer a trade balance.


Consumer spending

Consumer spending and aggregate demand

Consumer spending
Investment spending

What determines export spending?

Investment
Supply-side policy

How effective is supply-side policy?

Supply-side policy