Yesterday Andrew asked why it was that UK exports haven’t grown more strongly, especially compared with the export growth that has been seen in Germany.
One point I find particularly interesting is that Germany has seen export growth despite the appreciaiton of the Euro. Following the depreciation of Sterling it seems counterintuitive that export growth has been so dismal: prices go down, sales go up, right?
This doesn't appear to be the case, but perhaps this is because price is not the only thing purchasing decisions are based upon. For the average consumer, loyalty (or inertia) plays a part: I might keep going to a particular coffee shop even though it gets more expensive and another is getting cheaper. And this might not even be because the coffee in this particular shop is better; I’m just used to going there. Used to the route I take to the shop. And the staff are used to me ordering the same thing.
Well inertia applies to exports too. The so-called J-curve charts a relationship between exchange rate depreciation and a (temporary) worsening in the current account balance. This is based around the idea is that straight after a depreciation customers don’t switch suppliers, because they’ve placed orders with them, or they’re used to that way of doing business etc. The current account worsens because importers are doing the same thing, only the imports are now more expensive.
Eventually – after a time lag – customers realise they could be getting a better deal and they switch suppliers, and net exports improve.
Or do they?
Let’s go back to my coffee shop scenario – I’m considering switching coffee shops: I’m a bit fed up with how much I’m paying. The problem is the price at the second coffee shop seems to change every day. It swings by enough to mean that sometimes the extra effort of walking the five minutes it takes to get there isn’t really worth it. How do I know if I really want to bother going to that shop?
The answer is: I don’t. And with the huge currency price-swings we’ve been seeing it means there’s a possibility of getting stuck in a long-term J-Curve situation.
This is not necessarily bad for manufacturers. If customers are less price-sensitive it means that if manufacturers choose to maintain relative prices (by increasing nominal prices) they will be able to increase their profit margins and benefit from the exchange rate depreciation in this way. Evidence from our Business Trends Survey showed that during the recession UK manufacturers were doing just this.
But what does this mean for export-led growth prospects? When we talk about rebalancing the economy, improving the external balance of exports less imports is a key factor. Can we really rely on the lower value of Sterling to boost exports, or will it take more than that?