Indirect Effects of Export Demand

Today let us be thankful for multiplier and accelerator effects. And in any case let us at least be aware of multiplier and accelerator effects. In particular, if you want to talk about the potential role of export demand in preventing a US recession, the story you tell should mostly be about multiplier and accelerator effects rather than direct effects. If you tell the story without mentioning multiplier and accelerator effects, the prospect looks pretty dismal, as in the following from an otherwise excellent commentary by Martin Wolf:

But exports are only some 12 per cent of GDP. They must grow by considerably more than 10 per cent a year, in real terms, if the contribution of net trade to the rate of growth is to be as much as 1 percentage point. It is likely to be much less.

“Much less” than 1 percentage point sounds like a pretty feeble force to set against the likely effects of a meltdown in housing and a collapse of credit, given the apparent importance of credit and of the “wealth effect” in maintaining consumer spending. But borrowing and wealth effects have never been the primary elements used to explain consumer spending: rather, they are factors that help explain deviations from the normal relationship between spending and income. That relationship has certainly not disappeared, and income is still the primary factor. The personal savings rate may be unusually low, but this doesn’t mean that consumption has started to follow a path independent of income. And when income rises, as it would from an increase in exports, we can expect consumption to rise also.

A little quick Keynesian arithmetic should make the point. Let’s suppose that the marginal propensity to consume is 0.7. That is, for every dollar in new income that households receive, they increase their consumption by 70 cents. (There may be other things happening simultaneously that reduce their consumption, so I don’t necessarily expect consumption to grow at 0.7 of the growth rate of income, but 0.7 seems plausible to me as an estimate of the direct effect of income. It’s certainly a lot more conservative than what we would get from the rule of thumb that takes the average propensity to consume as an estimate of the marginal propensity.) Then, as the familiar story goes, people in the export industry will spend 70% of their new income; then the people from whom they buy will spend 70% of their new income; and the people from whom those people buy will spend 70% of their new income; and so on. The sum of that infinite series is 1/(1-0.7) or 3.3. The total effect of that hypothesized 1 percentage point contribution from export growth becomes 3.3 percentage points. Suddenly I’m glad the actual export contribution is unlikely to be that high: I wouldn’t want the Fed to have to raise interest rates dramatically to prevent overheating.

I’ve ignored the effect of taxes, because I think 0.7 might be a reasonable guess at the marginal propensity to consume out of gross income, including the effect of taxes. US consumption shows a striking tendency to gravitate toward about 70% of GDP, though the mechanism might be something completely different. Anyhow, I’ll leave it to real economic modelers to sort out the details. The point is just that the multiplier effect is quantitatively important, and if one tries to discuss the effect of exports without it , one will miss more than half the picture.

But let’s not forget the accelerator effect either. After the last 5 or 25 years, the US is probably not geared up to be an export powerhouse. Recent export growth has nonetheless been impressive. But with few economists predicting a significant recovery in the dollar any time soon, the important question for businesses is not how much they can export immediately but how much they can export over, say, the next 10 years. The process of gearing up becomes a worthwhile proposition in itself. Thus it is to be expected that export demand should induce a significant increase in the category of nonresidential investment (although, as with consumption, it may be partly offset by other factors causing a decline in nonresidential investment). Then there is the interaction between the multiplier and accelerator effects: some investment will also be needed to support the new consumption that results from export demand, and so on.

It may have gone out of fashion to talk about multiplier and accelerator effects as such. But we still read statements like, “Gains in employment and income will support growth in consumer spending.” The gains in employment and income don’t come out of nowhere; there has to be some underlying source of demand. A scenario under which exports provide an underlying source of demand, and the indirect effects offset weakness in other areas, seems quite possible to me.


[UPDATE: I forgot to include the hat tip to Mark Thoma for that Martin Wolf commentary.]