RDP 9312: A Re-examination of the Determinants of Australia's Imports 6. Conclusion

The trend rise in import penetration in Australia has renewed interest in the determinants of import volumes. In this paper, an attempt has been made to explain the growth in Australia's imports in terms of the increased openness of the economy. A traditional import demand function was augmented with a term for the effective rate of assistance, with the latter as a proxy for openness. Whilst this term did not help explain the growth in aggregate imports, it did prove to be a significant explanator of consumption and intermediate imports which account for the bulk of the nation's total imports. In fact, it was shown that a substantial share of the growth in these imports can be explained by the reduction in protection. This result was attributed to the effect that changes in protection have on both the demand for imports and the supply of domestic substitutes. In particular, evidence was presented that the dismantling of protection has been accompanied by a fall in the supply of domestic substitutes so that supply side constraints may have influenced the import decision.

Identifying a role for protection as a possible supply side factor has been useful in several respects. First, it has demonstrated that changes in the equilibrium volume of imports may not always result from a shift in demand. Instead, a formulation that permits identification of the long-run determinants of both the demand and supply of importables may be a more appropriate vehicle for explaining import behaviour.

Second, it has been shown that the inclusion of a term for protection markedly reduces the income elasticity of demand for consumption and intermediate imports. This result lends support to the view that high income elasticities for imports have been ‘confounded’ by supply side factors (Krugman 1989). It suggests that although economic activity remains the principal determinant of import volumes, the strength of this link may be less pronounced than commonly thought. This has important practical implications for our understanding of the relationship between import volumes and the business cycle and, indeed, the extent to which structural trade imbalances may arise as national income increases over time.

Finally, finding a role for protection satisfies the intuition that increased openness must explain at least some of the growth in import volumes since the local peak in protection in 1984. In fact, since then, reductions in protection have emerged as the most important factor other than income that explains the growth in non-capital import volumes. This result provides a useful insight into the reasons for continued growth in import penetration, especially in the current environment of subdued economic activity. It supports the conventional wisdom that the process of international integration has been accompanied by greater specialisation in trade and production.