Net exports are equal to exports minus imports. Exports represent foreigner purchases for domestic goods and services. Imports are purchases of foreign products and services by local consumers. Also known as a trade balance.
How do we calculate net exports?
To get net export, we must deduct export value to import value.
Net export = Value of exports – Value of imports
For example, in April 2019, Indonesia’s export value was USD12.6 billion, and the import value was USD15.1 billion. Therefore, Indonesia’s net export is minus USD 2.5 billion.
A positive value of net exports (trade surplus) means that a country is a net exporter for goods and services. This surplus increases aggregate demand and GDP, thereby driving domestic economic growth.
In contrast, a negative value of net exports (trade deficit) means a country is a net importer. This deficit reduces GDP and discourages domestic economic growth.
Which factors affect net exports
Several variables can affect the value of trade balance, six of which are:
- The economic growth of trading partners
- Domestic economic growth
- The relative prices of domestic vs. foreign
- Exchange rates
- Production cost
- Trade barriers
The economic growth of trading partners
We track economic growth from real GDP growth.
If the economic growth of trading partners expands, we expect demand for domestic goods to increase. Hence, the value of net exports should increase or improve, ceteris paribus.
And conversely, when their economic growth weakens, exports are likely to fall, reducing trade balance and discourage domestic economic growth.
Domestic economic growth
High domestic growth usually increases the demand for imported goods. Producers increase their purchases of capital goods or raw materials from abroad. Likewise, consumers eagers to buy imported goods as the prospect of income and employment improves.
As a result, trade balance declined, ceteris paribus. The opposite condition applies if domestic economic growth is contracting.
Relative prices of domestic vs. foreign goods and services
More expensive domestic goods make foreign goods more competitive for domestic consumers. The demand for imports increased because more consumers prefer to choose foreign goods. In international markets, domestic goods also less competitive, hence reducing their demand.
Conversely, falling prices make domestic goods more competitive. This situation will lead to higher foreign demand for domestic goods, thereby increasing exports. In another side, domestic consumers prefer local goods since it is cheaper.
Currency exchange rates
When the domestic currency depreciates, the price of domestic goods becomes cheaper for foreigners, which increases exports. At the same time, foreign goods are more expensive for domestic consumers, reducing imports. Thus, depreciation leads to an increase in net exports.
Conversely, currency appreciation reduces net exports. Import increase as foreign goods cheaper for domestic consumers and exports decreases as domestic goods are more expensive for foreigners.
Production costs have implications for selling prices. Lower production costs make domestic goods and services cheaper. It will lead to an increase in net exports because domestic goods are relatively more competitive. Higher production costs have the opposite effect.
Trade barriers such as import quotas, safety standards, import licenses, local content requirements, etc. affect a country’s trade balance. But, the impact depends on which barrier is governments adopt.
Also, trade barriers could trigger retaliation from trading partners. Further battles might lead to a trade war that will harm the overall economy.
Net exports implication on aggregate demand and gross domestic product (GDP)
Aggregate demand is the sum of demand for goods and services in the economy. The demand comes from domestic and foreign consumers. Domestic consumers consist of the household sector, the business sector, and the government sector. Meanwhile, foreign consumers also comprise these three sectors.
Exports drive up aggregate demand. In contrast, imports reduce aggregate demand. Hence, positive trade balance increase aggregate demand. And, the opposite, negative trade balance lower aggregate demand.
Impact on GDP
GDP refers to the market value of goods and services produced domestically. Exports drive domestic production to increase. Meanwhile, imports hurt domestic production because their supply comes from abroad.
Further, net exports are a component of gross domestic product (GDP), which represents net demand from the external sector. Positive net exports (trade surplus) increase GDP, and negative net exports decrease GDP.