Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday 11 April 2017

The Brexit depreciation and exports

I’ve read a number of people say, observing the lack of growth of UK exports, that this illustrates how depreciations have little impact on trade flows these days. This is a classic case of reasoning from a price change. I think the phrase ‘never reason from a price change’ was popularised by Scott Sumner, although I got it from Nick Rowe.

The depreciation of sterling happened because of Brexit. Some of the depreciation might have been a result of the expected cut in UK interest rates, which means it should be temporary. The rest was to compensate for the impact of Brexit on UK trade. In both cases, therefore, exporting firms in aggregate get a temporary boost to their competitiveness (or profitability of trading), which will come to an end when interest rates rise again or Brexit actually happens, perhaps imposing tariffs or other costs that reduce competitiveness.

The temporary boost to competitiveness/profitability will be good for firms that already compete in overseas markets. But I learnt many years ago when I estimated aggregate trade equations that a lot of the effect from a depreciation comes from firms trading in new markets that they had previously considered unprofitable. To do that requires some investment: in distribution and marketing, for example. A firm is unlikely to make that investment if the gain in competitiveness is temporary.

This helps explain an otherwise puzzling feature of aggregate trade following a depreciation that - unlike Brexit - leads to a permanent improvement in competitiveness. It takes many months before the full improvement in trade volumes comes through. If it was just a matter of goods getting cheaper and people buying more of them you would expect a fairly instantaneous impact, but if firms are having to invest to expand markets, the full impact will take longer to come through. [1]

In the case of Brexit the gain to competitiveness is temporary. It is a mistake to start with the depreciation, and then be disappointed by the lack of any reaction. Once you ask why there has been a depreciation, it becomes clearer why any gain to exports is likely to be modest. [2]

[1] As tariff changes are perhaps likely to be more permanent than exchange rate changes, this may also help explain the puzzle discussed here.

[2] This argument apart, one other thing you quickly learn if you monitor aggregate trade is how erratic it is. We will not know for sure what the impact of the Brexit depreciation has been until well after Brexit itself.  


  1. I have just read "BBC ‘Brexit bias’ claims need to be based on hard evidence" March 23, 2017 through your last post.

    Surely the graph showing 71% of politicians appearing on the TV news across the campaign were Tories puts an end to anyone claiming this fatuous referendum has anything like legitimacy.

    To the view that never have so many people voted for one movement in British politics, producing 51.8%, comes that resounding figure of 71% Tory, adequately explaining why World War Three versus immigrants with HIV was the best this country offered up.

  2. But exports have been boosted and the trade deficit has narrowed:

    "UK Current Account Deficit Falls to Lowest Level in Years as UK Exports Rise "

  3. I suspect Krugman is right with tariffs. They are a complete red herring. Import tariffs are paid by the consumers of the area running up the protection - particularly with floating rate exchange rates.

    If we have a government that says that the float will deal with any external imbalances - and stops paying income on capital assets to foreigners - then you will get the necessary adjustment. Dropping the external food tariff allows us to get our food from anywhere on the planet, and we then grow locally for security (which requires that you farm socially, not at market value. Much like you don't run an army at market value).

    As soon as one import nation works out the secret and
    starts using its currency power to get stuff in return for nothing,then the WTO will collapse. It is after all based upon the myth of free trade being good for everybody.

    It won't be the UK though. The Tory party is still in Victorian
    thinking mode and would defend free trade to the death - even though it only works when you're raiding other countries for their resources and have them locked in a Sterling standard.

    Keyne's highlighted it early on in one of his papers - surplus nations draining circulation from other nations. Post Keynesians want to solve it the way Keynes tried to - with a big international hug club. That won't work for the reasons the UN doesn't work and the reason the Libertarian 'non-aggression pact' won't work.

    The world needs a mechanism that a country can apply unilateral that gives it the necessary degree of freedom to pursue its own policy - in the face of sanction, currency manipulation and all the other tricks other countries can throw at a nation.

    There's a number of things you can do to stop asset hoarders draining your circulation that then allows them to keep their own exchange rate down and steal your aggregate demand.

    1) Taxation is one option. The rule could be that any country running a trade surplus to the UK is taxed at 100% on any UK investment income or capital gains in Sterling owned by its citizens. Which would deal with all the tax havens instantly.

    So essentially you can earn income from the UK as long as you don't save it or use it to drive up UK asset prices.

    2) Cancellation is another.

    3) 30 days notice to spend their £'s on UK goods and services or lose it.

    4) Or you can accommodate the " Sterling savings" via the UK government purchasing the goods and services the exporters to the UK doesn't want to buy. Then deploying it for the public good and public purpose.

    Option 4 is of course the MMT approach.

    The point being you make it as uncomfortable as possible for trade surplus nations to hoard your assets.

  4. Thank you for this post. Is it really true that currency depreciation doesn't facilitate export growth? The effective exchage of the Pound and export growth are highly (negatively) correlated. So some (temporary) Impact seems to be there..

  5. I bought a lot of €URO the day before the referendum.
    Did you?
    If not - why not ???

  6. I believe we are missing the whole point Prof.
    In my opinion (1) the recent value of the sterling isn't a depreciation but rather a correction; we can talk about depreciation once we see parity with the under extinction euro, (2) for Brexit to have any meaning we should be expecting parity.

  7. Simon, have you commented on Ben Broadbent's analysis? He agrees with you that the shift in the pound's exchange rate is a reaction to the NEGATIVE permanent terms-of-trade shock that is expected to hit in 2019. The economy will therefore rebalance with a shrinkage in the tradeables sector. Note though that this means that an actual or expected weakness in domestic demand is not the cause, and is not supported by data either.

    However, he thinks there is a greater chance that exporters, particularly less EU-focused ones, do take advantage of bumper profits and investment increases (though perhaps this will be to trade more with China, Japan, Korea, Canada, and the U.S. rather than the EU)


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