Imports impact the economy in several aspects. For example, at the micro level, imports affect competition by increasing supply in the domestic market. Consequently, there is more pressure on prices and profitability in the domestic market.
On the other hand, imports increase choices for consumers. This is because they have more alternatives other than local products. Thus, they are more likely to get cheaper or higher quality products, according to their preferences.
Meanwhile, at the macro level, imports can affect indicators such as inflation and exchange rates. They also represent a leakage where income created in the domestic economy flows out and cannot be used to produce further goods and services.
Impact of imports on competition
Imports increase competition in the market. Domestic producers must deal with foreign players through the products they ship to the domestic market. As a result, domestic producers don’t just compete among themselves. But they also have to compete with imported products.
Imported products force domestic producers to increase competitiveness. Therefore, they should innovate to create cheaper or higher quality products. On the other hand, for example, they are at a disadvantage if they operate at a high cost. As a result, domestic consumers are likely to choose imported products because they are cheaper.
Likewise, consumers may choose imported products because they are more unique. They offer other features or attributes which are superior to local products. As a result, local products are challenging to match, shifting demand from local producers to them.
Impact of imports on prices
As explained earlier, imports add to supply in the domestic market, in addition to those from domestic producers. Thus, an increase in imports increases market supply. As a result, the market price will fall, as the law of supply says.
Conversely, a decline in imports reduces supply. If domestic producers cannot increase supply to compensate for the shortage, market prices will rise.
Impact of imports on profitability
Imports bring new supplies to the domestic market, lowering prices and depressing profitability. The situation may force domestic producers to lower prices to compete effectively with imported products. Without doing so, consumers will turn to imported products.
Lower prices result in lower profit margins. As a result, domestic producers earn lower profits than before.
Likewise, domestic producers must invest more in research and development when imported products are of higher quality. In addition, they must make their products unique to lure domestic consumers to keep buying. Without such investment, consumers turn to imported products because they are more attractive.
However, such investment costs money. Thus, domestic producers may offer unique, as competitive as imported products. However, they may not be as efficient as overseas producers.
Impact of imports on consumers
Imports have become our way to fulfill our needs and wants. For example, domestic producers may not produce our needed goods or services. So, we have to buy it from abroad. Long story short, we can improve our quality of life by fulfilling what we need and want through imports.
Imports give us more choices. We can get cheaper or higher quality goods than domestic products. So, we get what we like.
In addition, imports force domestic producers to increase competitiveness by innovating. They have to lower costs or improve product quality to attract domestic customers and secure their market position. As a result, these innovations ultimately contribute to more cheap or quality domestic products.
Impact of imports on technology
Imports are a channel for technology and knowledge transfer. For example, when domestic producers buy capital goods such as high-tech machines, they are not just purchasing physical goods. But, they also import know-how, ensuring the machines are used properly.
However, not all technology and know-how related to these machines are imported. For example, we only import knowledge about how to use machines efficiently.
But we don’t import how to make machines. Such knowledge is not easily transferred. In fact, it can’t be done at all because manufacturers of high-tech machines will often protect their products too. They try to prevent importers from stealing their product ideas.
Impact of imports on aggregate demand
Aggregate demand represents spending by four macroeconomic sectors: households, businesses, government, and the external sector. Economists formulate it as follows:
- Aggregate demand = Household consumption + Business investment + Government spending + Net exports (exports – imports)
Even though the above formula has a negative sign, imports do not decrease aggregate demand. Instead, it is negative because we relate it to how much output the domestic economy produces, so the aggregate output will equal aggregate demand.
In macroeconomics, aggregate demand represents spending on domestic goods and services – for this reason, it will equal aggregate output (represented by GDP). These expenditures can come from domestic economic actors (households, businesses, and the government) and foreign economic actors (including the three economic actors).
However, not all demands by domestic economic actors are met through domestic production. Therefore, we must import some because they may not be available in the domestic market. Or imports become a more economical option than producing goods and services domestically. So, we prefer imported products over local products.
Thus, imports only represent the way we meet our needs. We supply the products we need from abroad. And that doesn’t mean reducing our demand. In other words, for example, increasing imports does not necessarily mean lowering our demand.
On the other hand, an increase in imports could indicate an increase in our demand. Domestic production is insufficient, so we must supply it by importing foreign products.
Impact of imports on economic growth
Imports reduce our dependence on domestic production. Indeed, when we increase imports, the increase in output does not occur at home but abroad. As a result, increased imports stimulate production and economic growth in the partner country (as opposed to exports).
However, an increase in imports does not necessarily mean a decrease in economic growth. On the other hand, increased imports may indicate more robust domestic demand and economic growth in the short term.
For example, when the domestic economy operates above full employment, aggregate output (real GDP) exceeds potential output (potential GDP). As a consequence, there is a positive output gap. And domestic production does not meet aggregate demand. So, to cover the gap, we increase imports.
Impact of imports on long-run output
Some people view imports negatively. They have an argument about it. For example, imports weaken business activity, entrepreneurship development, and job creation in the domestic economy. Instead, they create additional demand for the partner country’s economy and create jobs and income there.
This opinion is not entirely wrong or right. It’s just that we have to look back at what we imported. As I explained earlier, imports only represent the way we supply goods.
While the goods we buy are mostly consumer goods, high dependence on imports may have a negative impact. For example, it causes local industries to not develop because we prefer imported goods over domestic goods. The domestic industry can die when it lasts too long, leaving more unemployed.
However, suppose imports are mostly capital goods, such as machinery and equipment. In that case, the increase contributes positively to long-run aggregate output. The domestic economy accumulates capital. Some are to compensate for depreciation, and others are to increase production capacity.
Thus, when the domestic economy imports more capital goods, we expect the productive capacity of the economy to increase. An increase in capacity shifts the long-run aggregate supply curve to the right. As a result, the potential output increases. And we can produce more goods and services without generating inflationary pressures.
For this reason, several countries have introduced import substitution policies to build their domestic industries and reduce dependence on imports. They support these policies through subsidies, taxes, or trade protections. They are trying to shift domestic demand from imported products to local products.
Despite increasing potential output, import substitution policies are controversial in international relations and not always successful. For example, trade protection by raising import tariffs could trigger a trade war. Because it is detrimental, partner countries will take similar actions in retaliation.
Donald Trump’s “Make America Great Again” policy is a good case. It underscores how he is trying to build domestic industry, create more jobs in the United States, and reduce dependence on imports. But unfortunately, the policy sparked a trade war with China and risked good relations with partners like Canada.
Impact of imports on the gross domestic product (GDP)
Imports do not have a direct impact on GDP. As explained earlier, an increase in imports does not necessarily mean a decrease in GDP, an economic growth indicator.
On the other hand, an increase in imports may signal a growing economy. Thus, we need more imported supplies to meet demand.
Economists teach us how aggregate expenditure equals aggregate output and income through the circular flow model. Starting from this, we can write GDP as follows:
- GDP = Household consumption + Business investment + Government spending + Net exports (exports – imports)
What is GDP? It is the total market value for aggregate output in a given year. Or in other words, it represents how many dollars of final goods and services the domestic economy produces during the year.
Due to the focus on domestic aggregate output, we subtract imports from the GDP calculation. Instead, we add exports to the calculation. Why do we do both? Adding exports and subtracting imports into GDP ensures we only count domestic production.
Take a simplified example. For example, let’s say we buy an imported product for $100. Our expenses are reported as household consumption. As a result, household consumption increased by $100, and imports increased by $100. And we get a GDP equal to zero.
Such purchases do not increase domestic output because we buy them from abroad. Instead, it only increases production in the partner country.
Import impact in the circular flow model
Imports represent leakage in the circular flow model of income. When importing goods, money flows from the domestic economy to the partner country. In other words, the income is pulled out of the circular.
What is the impact? Because it is withdrawn, the money we spend on buying imported goods no longer circulates in the economy. In other words, it does not become income for domestic producers. Thus, it reduces the money available to businesses to finance further output production.
Impact of imports on exchange rates
The relationship between imports and exchange rates is a bit complicated. Why? Both have a reciprocal relationship. On the one hand, imports affect the exchange rate. On the other hand, the exchange rate also affects imports.
For this article, we focus on the first, namely, how imports affect exchange rates.
Exports and imports don’t just exchange physical goods and services. But, it also involves two different currencies as payment.
For example, when eurozone people export their products to the United States, the demand for euros increases because Americans have to exchange U.S. dollars for euros to pay for the goods they buy. Conversely, when they import, the demand for U.S. dollars increases because Europeans have to exchange euros for U.S. dollars to pay for the goods they import.
Long story short, exports increase demand for the Euro, pushing its price against the U.S. dollar up, ceteris paribus. Conversely, imports increase demand for the U.S. dollar, causing its price against the Euro to increase. The price of 1 euro against the U.S. dollar we call the exchange rate. In other words, the exchange rate represents how many U.S. dollars we get when we exchange the euros in our hands.
Thus, when imports exceed exports, more U.S. dollars are demanded than are received from exports. As a result, the exchange rate of the Euro against the U.S. dollar weakened in value. As a result, Europeans saw their currency depreciate.
On the other hand, because U.S. dollars are more valuable when converted to euros, Americans see their currency appreciate. This is because they can earn more Euros when they exchange 1 dollar.
Impact of imports on the inflation rate
You may have heard of the term imported inflation. That is inflation caused by an increase in the goods we import. The term underscores how inflation in partner countries or international markets can spread to the domestic economy through imports.
For example, the domestic economy buys raw materials from abroad. Therefore, their price increase increases the cost of production. And domestic producers will pass the increase to selling prices because they are interested in maintaining profitability. As a result, prices in the domestic market rose.
And suppose the price increase occurs broadly, not just for one or two goods. In that case, high inflation rates in partner countries result in upward pressure on domestic inflation. The impact can be more significant when we are highly dependent on imports. Or when what we import affects most domestic goods and services, as in the case of oil.