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What’s it? Exporting means sending domestic goods and services to foreign markets for sale. In return, we receive foreign currency, say US dollars. Thus, exports have implications for the demand for domestic output and the exchange rate.
Exports work in reverse compared to imports. The latter refers to buying foreign products to meet domestic demand. The difference between the two we call the balance of trade. If exports exceed imports, we book a trade surplus. But, if imports exceed exports, we run a trade deficit.
Many countries, such as Japan, China, and South Korea, rely on exports to drive economic growth. They stimulate domestic production to meet demand in the international market. Consequently, increased exports spur economic growth, boost increased output, and contribute to creating more income and jobs in their economies.
Why do countries export?
Exports are significant for the modern economy, where economies between countries are increasingly connected. There are several reasons why a country exports. I will present two main ones.
First, exporting is one way to expand the market and increase sales. The overseas market offers a more significant size than the domestic market and provides more growth opportunities.
In addition, sales abroad are an alternative when there is excess production in the country. Having met domestic demand, companies export their products to achieve economies of scale and higher profits.
Meanwhile, companies might export, for example, because the domestic market is mature. All domestic consumers have used the product. Thus, to increase sales, they acquire new overseas buyers by shipping their products to international markets. By doing so, they ensure their business continues to grow.
Second, exports are a strategy to grow the economy (called export-led growth). Some countries, such as China, Ireland, South Korea, Singapore, and Vietnam, rely on exports to expand real GDP, employment, and income. As a result, they built an export-oriented industry.
China, for example, reported export growth by an average of 20.3% during 2000-2003 after growing 12.4% in the 1990s. This rapid growth made China’s economy stand out by an average of 9.0% during 1970-2003, far outpacing other countries.
Why exports matters
Exporting is usually a company’s first stage when it enters an international market. This strategy is lower risk than other foreign market entry strategies such as licensing, joint ventures, or direct investment.
Several reasons why exports are important. First, exports are a way to increase sales. The overseas market offers significant demand potential, much more significant than the domestic market.
Second, foreign markets offer diversification. They become essential as the domestic market matures. Thus, export sales offset the decline in domestic market sales.
In addition, companies can spread business risk by diversifying shipments to various destination countries. Thus, an increase in sales in one country can offset a decrease in another.
Third, companies can achieve higher economies of scale and reduce unit costs. This is because they can sell more output by exporting, allowing them to spread their high fixed costs over more output.
Fourth, exporting allows companies to acquire new skills and abilities. This becomes the basis for driving innovation within the organization to increase productivity and efficiency or develop new products.
Fifth, foreign sales stimulate domestic economic activity. The increase in exports reflects higher demand for domestic products, prompting businesses to increase production and recruit new workers. As a result, it stimulates economic growth, reduces unemployment, and creates jobs and incomes within the country.
Sixth, we collect foreign exchange reserves through exports. We obtain foreign currency, such as US dollars, as payment compensation when selling goods abroad. Then, we can use foreign currency to meet foreign obligations such as imports and debt.
Foreign exchange reserves are the key to maintaining exchange rate stability. It becomes a shock absorber when there is an unfavorable fluctuation in the exchange rate. And central banks use them to intervene in the forex market to keep exchange rates under control at certain ranges.
Types of exports
Depending on the product and the company’s involvement, exports can be categorized in various ways. Let’s delve into the different types of exports to understand the diverse landscape of international trade. We’ll explore how products are classified based on their form (goods or services), processing stage (raw materials, semi-finished, or finished), and the level of involvement exporters have in the process (active or passive, direct or indirect).
By product
Several ways to categorize exports. For example, based on the products we ship, exports could include:
- Goods
- Service
Goods represent tangible products, which we can see or touch because they have physical substance. For example, we send agricultural commodities such as soybeans and palm oil abroad, which become raw materials for manufacturing in the destination country.
Services represent intangible products. We can’t see or touch them, but we can feel their benefits. For example, a business consultant sells their services to an overseas company.
By processing stage
Exporting goods can also be divided into several categories, for example:
- Raw material
- Semi-finished goods
- Finished goods
Raw materials are used as inputs for further processing into semi-finished or finished goods. For example, we export iron ore and bauxite.
Semi-finished goods require further processing. For example, we process bauxite into aluminum plates domestically. Then, we send the plate to the destination country. The aluminum plate is an intermediate input and requires further processing to be a finished product, such as a car or airplane body.
Finished goods are for final use. We do not process them further to use them. They may be consumer goods such as canned food and soap or industrial goods such as heavy machinery and equipment.
By involvement level
A crucial factor to consider is the level of involvement a company has in the export process itself. This involvement spectrum determines the resources needed, the level of control exerted, and the potential rewards. Let’s delve into the two main categories of involvement: active vs. passive exporting, and then zoom in further to explore the nuances of direct vs. indirect exporting.
Passive vs. active export
We can also categorize exports based on how far the exporter is involved in the export process. They are:
- Active export
- Passive export
Under active export, companies take the initiative to expand their market by selling products overseas. For example, they are looking for intermediaries or export agents representing foreign customers. This is also known as indirect export because it is done through an intermediary.
This strategy is low risk with relatively low cost. Companies use services provided by intermediaries, agents, or traders who can search foreign markets and find buyers for their products.
Under passive export, the company is not actively looking for intermediaries. Instead, they may sell the product by chance. For example, they may only serve exports when there are orders from overseas buyers. Once the order is received, they ship the product to overseas buyers. They don’t really intend to expand sales to overseas markets.
In other cases, the company may sell its products to domestic buyers. The buyer then exports the product to an overseas buyer. This sale is indistinguishable from other domestic sales insofar as it is carried out by the original manufacturer.
Direct export vs. indirect export
Direct export requires exporters to directly handle every export process, from market research and planning to distribution, licensing, and handling overseas buyer contacts. This approach is more complex than indirect exports and, as such, requires significant commitment and resources to achieve good results.
A direct export is probably the best way to achieve maximum profit. This strategy offers higher profit margins because it does not involve intermediaries.
In addition, this strategy allows the company to have complete control over the process. Thus, it minimizes negative impacts such as negligence by intermediaries, which might damage the company’s reputation.
Then, experience in direct exporting is the first step before becoming an international company. For example, it may initially set up an export department within its own organization. Then, after exports grew significantly, the company set up sales and marketing offices in overseas markets to handle storage, distribution, sales, service, and marketing. And finally, the company builds a worldwide supply chain network and operates as a multinational company.
However, direct exports carry significant financial risks. This approach requires considerable resources and costs. In addition, the process is also complex, so the company may need a special team to handle exports.
Another drawback is the limited scale because it is done internally. In addition, the company may have low market knowledge and competition in the destination country, making it less competitive in that market.
Meanwhile, in indirect exports, companies rely on intermediaries. For example, they sell to these intermediaries, who then ship the goods overseas.
Indirect exports consume less cost than direct exports. In addition, the process is simpler than direct export. Thus, the company may not need or need only a few additional staff to handle the process.
In addition, intermediaries may have significant scale and good knowledge of the export market. Thus, the company can gain access to broader markets and distribution channels.
However, unlike direct exports, indirect exports offer lower profit margins. This is because companies must share profit margins with intermediaries. In addition, it may also make the price more expensive when the product arrives at the destination market.
Low control over the export process is another drawback. Because it relies on intermediaries, a company’s reputation is determined by how well the intermediary handles the process and serves the demand in the destination market. As a result, irregularities can destroy the company’s reputation and image.
The Relationship between exports and exchange rates
Exchange rates have a reciprocal relationship with exports. On the one hand, exports affect the exchange rate. On the other hand, the exchange rate affects exports.
Exports involve two different currencies in the transaction. When we export, we get foreign currency as payment and then exchange it into domestic currency for operational purposes.
Say you are in the eurozone, and your trading partner is the United States. When your exports go up, the euro appreciates, ceteris paribus. This is because Americans look for euros and exchange their dollars to pay for the products they buy. Thus, the larger the export, the greater the demand for the euro, making it more valuable when exchanged for US dollars.
The opposite effect applies when exports fall. A decline in exports results in a decrease in demand for the euro, making it less valuable when you convert it to US dollars, ceteris paribus.
However, the relationship between the exchange rate and exports also works in reverse, where the exchange rate affects exports. Depreciation makes domestic products cheaper for Americans, increasing the demand for your product (exports increase).
For example, you sell a product for 1 euro. Say the euro depreciates from EUR1 per US dollar to EUR2 per US dollar. So, when Americans exchange their 1 dollar, they get 2 euros, more than before (1 euro). Therefore, when they buy your product, they get 2 units, more than before (1 unit).
On the other hand, appreciation makes your product more expensive for Americans, reducing their interest in buying (exports fall). For example, the euro appreciates from EUR1 per US dollar to EUR0.5 per US dollar. Consequently, Americans have to exchange 2 US dollars to get your product.
Factors affecting exports
Several factors affect exports, including:
- Price
- Quality
- Exchange rate
- Global economic growth
- Government policy
- Tastes and preferences
Price. Foreigners demand more when domestic products are cheaper than international markets, increasing exports. Conversely, if they are more expensive, exports fall. And in the aggregate, prices are reflected by the inflation rate.
Quality. In addition to price, quality determines the domestic products’ competitiveness in international markets. When domestic products are of better quality than products from other countries, overseas buyers will be more interested in them. The opposite applies when the quality is lower.
Exchange rate. Depreciation makes domestic products cheaper for foreign buyers, boosting exports. But, on the other hand, appreciation makes them more expensive, lowering the demand for exports.
Global economic growth. As the global economy expands, more demand is created in international markets, increasing exports. In contrast, the global recession weakened exports.
Government policy. For example, trade protection in partner countries weakens exports. Partner countries may impose import controls, either through tariffs or quotas. Or they impose non-tariff barriers, such as product safety and health standards.
On the other hand, trade liberalization stimulates trade between countries. For example, some countries form economic unions, as the European Union countries do, and allow goods and services to flow freely between member countries without trade barriers.
Tastes and preferences. Changes in consumer tastes and preferences in the global market affect the demand for domestic products. These changes may be influenced by cultural, environmental, or social factors. Purchasing power and income level can also be other determinants.
