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.
