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Terms of Trade. Impacts of changes in ToT for economically LDCs.
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Impacts of changes in ToT for economically LDCs • DCs usually produce a larger variety of g&s for export and the same applies to some ‘middle-income’ developing countries that have diversified their production for export. In these countries it is unlikely that all or most of their export goods will face a similar change in ToT at the same time.
Changes in the ToT are more important for developing countries, specially if their production is mainly focused on a few commodities for export. This makes these countries more vulnerable: if prices of these commodities experience long-term trends in one direction or wide and abrupt fluctuations over short periods of time, effects are felt more strongly.
Short term fluctuations • Often related to ‘commodity booms’, or sudden large increases in commodity prices, followed by abrupt declines. • They are the result of abrupt changes in global demand or supply of commodities. Due to low PED and low PES, such changes have strong effects on commodity prices.
Effects of short-term fluctuations: • They create uncertainties and can be highly destabilising. Producers and consumers are unable to plan. • Changing relative prices affect the signalling function of prices and result in poor resource allocation outcomes and inefficiency. • Windfall gains from higher export prices are often spent on increased imports of consumer goods rather than on investments in domestic manufacturing or imports of needed capital goods.
Windfall gains also increase domestic income inequalities through short-term transfers of income towards those who gain from higher prices and away from those who lose from lower prices. • Windfall gains may further increase social tensions due to infighting over who will capture the most gains. • Effects on the banking system: large growth of bank deposits in times of rising prices and large withdrawals in times of falling prices.
Unstabel government spending and inadequate fiscal policies, especially when commodity production is under public ownership. • Rapid and large improvements in the ToT do not favour policies that promote diversification of production and exports. The increases in export revenues work to reinforce the dependence of the economy on just those few commodities that provide the windfall gains.
Long term deterioration • Empirical research shows that developing countries which are non-oil commodities exporters have experienced deteriorating ToT over long periods of time. (Oil exporters have been experiencing improving ToT). • In the period 1980-2000, the prices of key agricultural commodities fell on average by 50%.
Figure 1 - A. Real agricultural commodity price trends (1980 = 100) (deflated by the price index of manufactured exports of industrial economies) On average, prices of key agricultural commodites fell by 50% between 1980 and 2000.
In the case of certain products, including sugar and cotton the fall has been even greater.
Reduces possibilities for investment and diminishes the quantity of imports needed for production • Empirical research shows that developing countries which are non-oil commodities exporters have experienced deteriorating ToT over long periods of time.
Causes • Low YED for primary products (as compared to high YED for manufactured products). • Food has a low PED • Some non-food primary products (rubber, cotton) face competition from synthetic alternatives, leading to low YED for these products, which puts downward pressure on the prices. • As Y↑, in relative terms, a lower fraction of the increase is spent on primary products and a higher fraction on manufactured products.
D for primary products has slower growth and prices of these products tend to fall relative to prices of manufactured products. • Technological advances in agriculture. Slow demand growth and increased supply resulting from technological progress have caused prices to decrease even further.
Protection of agriculture in DCs. In order to protect farmers’ income, governments in DCs: • impose tariff and other trade barriers on imports of agricultural commodities, which restricts world D for protected agricultural products • grant export subsidies, which increase world supply Effect is ↓p.
Oligopolistic mkt structures in more DCs • Manufactured goods in DCs often produced by oligopolistic firms with more mkt power • Primary pdts in LDCs produced in more competitive mkts, with low degree of mkt power. • Therefore, prices of manuf pdts tend to increase relative to prices of primary good exports.
Impacts of deteriorating ToT • A transfer of income away from countries experiencing deterioration in their terms of trade, and towards those whose ToT are improving occurs. • Increasing quantitites of exports are needed in order to maintain a certain amount of imports. • Lower opportunities for importing badly needed capital goods and other inputs.
Diversification becomes more difficult as scarce domestic resources must be transferred to production for export. • Falling export earnings mean increasing BoT deficits and BoP problems. • Growing trade deficits forces countries to resort to borrowing to obtain the necessary foreign exchange. • Falling export earnings mean falling rural incomes and increasing poverty, which means...
Less government revenue with which the gov can make necessary investments in infrastructure and provide needed merit goods. • Worse growth & development prospects. • Countries may become trapped in poverty cycles.
