RDP 9310: Explaining the Recent Performance of Australia's Manufactured Exports 5. Conclusion

This paper has attempted to explain recent manufactured export growth by a simple addition to the so-called standard model. The sunk-cost model explains firms' export success in terms of their cost structures, in particular their sunk cost structures. This consideration of sunk costs has been a fruitful exercise, both from a theoretical and empirical point of view.

Theoretically, the net of possible causes of hysteresis has been cast further to include world demand and domestic demand. Changes in these determinants of exports, or in the exchange rate, can permanently alter market structure. These hysteretic effects can be magnified if the initial entry into a market is made by an export vanguard that reduces sunk costs for subsequent entrants. The existence of these positive externalities is a theoretical aspect of the oft-cited ‘internationalisation’ of Australia's manufacturing sector. Another aspect is the access to cheaper imported inputs which, to the extent that sunk costs are important, could help explain the discrete surge in exports.

Empirically, the sunk cost model has received some support on a macroeconomic level by the existence of bands of inaction and on a microeconomic level by the testimony of individual firms. It appears that the historic depreciation in the mid-1980s enabled many firms to cover their sunk costs and export for the first time. The claim that the most recent recession, in contrast to the 1982/83 recession, has encouraged export growth makes sense in the hysteretic framework. Even though the 1982/83 recession was of a comparable magnitude, the higher value of the exchange rate at that time meant that there was insufficient incentive to pay the sunk costs. The tariff reductions in the early 1970s, as well as being somewhat sudden, may not have induced a supply shock large enough to force firms to incur the sunk costs necessary for exporting. The gulf of opportunities between selling domestically and selling abroad did not widen until later.

The catalytic role of the exchange rate in the process of structural change cannot be overstated. As well as causing an increase in the number of exporting firms in the mid-1980s directly, the other macroeconomic shocks became effective in changing market structure in the late-1980s because the exchange rate had depreciated. Furthermore, the increased volatility in the exchange rate observed since the float is seen to be of less consequence when sunk costs are important. Small fluctuations in the exchange rate will not motivate firms to become exporters, even if they do motivate existing exporters to change the level or destination of their output. Nevertheless, the model does not support the view that exchange rate depreciations or recessions are necessary to motivate firms to pay sunk costs. If increasing exports were a policy objective, further tariff reductions, or government assistance to cover firm's sunk costs, would accomplish the same thing.

Whatever the nature of the shock, the assertion that hysteresis occurred in the late-1980s is equivalent to the assertion that a structural change occurred to Australia's balance of payments. Hysteresis, like structural change, implies a measure of resilience in the face of adverse shocks. If the late-1980s saw exporters establish beachheads around the world for Australia's manufactured exports, and, if this was aided by tariff reductions which will not be undone, it is to be expected that neither ebb nor flow of internal and external shocks will easily uproot them.