Monday, November 26, 2012

ECO 303: Clarification on our need for imports

I have a suspicion my example in Development today was less than crystal clear, so please let me try again.

I posed the question why it was a mistake to think that shutting off all imports was a key to growth based on the claim that Y=C+I+G+EX-IM, so *obviously* lowering imports is good.

If you missed the quiz, take a moment to think about the answer before looking below the fold.

The second answer I gave was that everything we import is either consumed or invested, so if you reduce imports, you also reduce consumption or investment and GDP is unchanged.

The first answer suggested by the class was that we can't export if we don't import. There's a political/psychological logic to this: other governments will punish your government if you block imports from their country.

There's a second logic called "With what money?" Instead of using the US and Nigeria (my default example), let's use Ethiopia and Nigeria. That will get rid of some of the confusion.

Suppose you want to sell something made in Nigeria (rubber) to an Ethiopian. The Ethiopian offers you Birr in exchange. You look at it and then look at him and say no. You can't use Birr. What use would you have for it? He needs to pay you in Naira.

Now IF we also import from Ethiopia, then at some point we have given some people in Ethiopia Naira in exchange for their goods, they have sold the Naira to the bank for Birr, and so our Ethiopian friend can go to his bank to sell Birr and buy Naira. He will then give you Naira in exchange for your exports. Everyone is happy.

IF, however, we block imports from Ethiopia, our Ethiopian friend can't get his hands on Naira. He can't buy our stuff because he doesn't have our currency. Our exports drop because of currency problems. They would love to buy our stuff, but "With what money?"

I normally try to argue that exports are the price we pay for imports because we forgo the stuff we made in order to buy stuff someone else made. It's a wonderful thing to get more imports at the cost of fewer exports. I guess this is a case of imports being the price we pay to export.

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