Terms of Trade Analysis: Impacts on Developing Countries

1. Terms of Trade Analysis:Impacts on Developing Countries Shigehisa Cape Kasahara UNCTAD February 2010 shigehisa.kasahara@unctad.org

2. Objectives of the Presentation • Introduction of the concept of terms of trade (barter terms of trade vs income terms of trade) • Historical review of the terms-of-trade analysis • Assessment of recent movements: Inter-regional comparisons • “China Syndrome”

3. I TERMS OF TRADE: INTRODUCTION

4. Different Formulae • Net barter terms of trade (NBTOT): Px/Pm, (2) Gross barter terms of trade (GBTOT): Qm/Qx • Only when the two trading countries (in a two-country model) maintain the balance-of-trade equilibrium as in barter trade, i.e., PxQx=PmQm, NBTOT and GBTOT are identical. Normally, GBTOT is seldom used. (3) Income terms of trade (ITOT): Px.Qx/Pm

5. Different Formulae(1) Net barter terms of trade (NBTOT): Px/Pm The ratio of the unit value index (or movements of the price levels) of exports to that of imports.

6. Different Formulae(2) Gross barter terms of trade (GBTOT): Qm/Qx the ratio the quantity index (or movements of the quantity levels) of imports and exports. • Only when the two trading countries (in a two-country model) maintain the balance-of-trade equilibrium as in barter trade, i.e., PxQx=PmQm, NBTOT and GBTOT are identical. Normally, GBTOT is seldom used.

7. Different Formulae(3) Income terms of trade (ITOT): Px*Qx/Pm the index of the purchasing power of the export earnings (PxQx) in terms of quantity of imports.

8. An Example • Situation: Over a period since a base year, a country’s Px has fallen by 5% and Pm has risen by 10%, while its export volume has increased by 20%. • NBTOT= Px/Pm = 0.95/1.1 = 0.8636 (TOT Deterioration by about 0.14, or 14%) • ITOT= (Px.Qx/Pm) = (0.95)(1.2)/1.1 = 1.0363 (TOT Improvement by about 0.036, or 3.6%)

9. II HISTORICAL REVIEW

10. Historical Review (1) Prebisch-Singer Thesis: • The secular downward trend in the prices of primary commodities relative to those of manufactures Implications: the deterioration in the terms of trade of developing countries (commodity producers/exporters) vis-a-vis Developed countries (manufacture producers/exporters)

11. The nominal and real prices: Non-fuel primary commodities (1960–2005, 2000=100)

12. Major Reasons for the Terms-of-Trade Deterioration • Differences in income elasticity of global demand • Different effects of productivity gains (whether more on the price levels of final products, or on wage/profit levels) • Technological progress in manufacturing (implication: reduced use of primary commodity inputs)

13. Major Reasons for the Terms-of-Trade Deterioration(i) • Differences in income elasticity of global demand

14. Major Reasons for the Terms-of-Trade Deterioration(ii) • Different effects of productivity gains (whether more on the price levels of final products, or on wage/profit levels)

15. Major Reasons for the Terms-of-Trade Deterioration(iii) • Technological progress in manufacturing with the implication of reduced use of primary commodity inputs

16. Historical Review of Analytical emphases/approaches • Prices of primary commodities versus prices of manufactures (surrogate for exports from developing countries versus exports from developed countries); • Prices of manufactures exported by developing countries versus prices of manufactures exported by developed countries; • Prices of certain primary commodities versus prices of certain manufactures. • Export earnings of different exporters • Rapidly growing demand of China for industrial raw materials and energy combined with slow supply response (and growing importance of speculative investment on commodity exchanges) have caused a rise in prices for some primary commodities.

17. Historical Review (2) Manufacture-oriented analysis: Export price comparison of Manufactures from developing countriesvs Manufactures from developed countries

18. Historical Review (2) Manufacture-oriented analysis: Export price comparison between manufactures from developing countriesand manufactures from developed countries TOT deterioration has continued

19. Historical Review (2) Manufacture-oriented analysis: Reasons for the TOT deterioration (i) Due to a rise in global supply of labour-intensive manufactures caused by the integration of highly populated low-income countries and an associated increase in participation of low-skilled workers in world trade.

20. Historical Review (2) Manufacture-oriented analysis: Reasons for the TOT deterioration (ii) Due to the fact that the role of innovation in income growth is much greater in developed countries than in developing countries.

21. Historical Review (3) Sector specific analysis between certain primary commodities and certain manufactures TOT deterioration has continued

22. Historical Review (3) Sector specific analysis: Reasons for TOT deterioration (i) • For some countries, strong growth in export volume compensates for decline in export prices, i.e., a rise of the income terms of trade.

23. Historical Review (3) Sector specific analysis: Reasons for TOT deterioration (ii) • Due to the fact that Prices of some primary commodities (energy, most metals, some food/agricultural products) are rising while those for some manufactures (labour-intensive ones such as clothing, basic electronics) are declining.

24. Historical Review (3) Sector specific analysis: Reasons for TOT deterioration (iii) • Due to the fact that the evolution of a country’s terms of trade depends heavily on the composition of its export and import baskets, as well as the pace of its export growth.

25. Historical Review(5) Major Findings in Recent Analyses • The evolution of the terms of trade strongly differs across developing regions and individual countries; • Much of this difference depends on the composition of a country’s exports and imports; • Differences in the impact of terms-of-trade changes on the evolution of the purchasing power of exports depend on the pace of export volume growth.

26. III INTER-REGIONAL COMPARISON

27. NBTOT and ITOT in developing regions( 1980-2004)

28. Terms of trade (NBTOT)in selected groups of developing countries(2000-2005)

29. IV CHINA SYNDRAME

30. What is China Syndrome? The effects of Chinese economic activities on the terms of trade of other countries. How? • China Syndrome Part 1: Rapidly growing demand of China for industrial raw materials and energy combined with slow supply response (and growing importance of speculative investment on commodity exchanges) have caused a rise in prices for some primary commodities. • China Syndrome Part 2: Increasing participation of low-skilled Chinese labour in world trade have caused a fall in prices for some manufactures. (Note: A rise in the share of low-skilled workers in global export-oriented labour force from 64% in 1975 to 70% in 2000.)

31. China Syndrome Part 1 Contribution to recent and future growth of global consumption of some commodities (2002-2005) (%)

32. Shares in world imports : China (and India)

33. Intensity of energy use, selected countries, 1965–2003(Tons of oil equivalent per GDP in million, PPP-adjusted dollars) Source: UNCTAD Trade and Development Report 2005.

34. Future Outlook of China Syndrome Part 1 • Agriculture (future evolution very uncertain): While even small changes in China’s food self-sufficiency ratios strongly affect its agricultural trade balance, it is uncertain how the new emphasis on rural development will affect productivity in agriculture, and its agricultural imports. • Minerals and metals (impact likely to last): China’s import growth of mineral and metals is likely to remain strong for several years to support both industrialization and infrastructure development (urban and rural). • Energy (impact most likely to last): The future development of China’s energy use depends on opposing trends: one of continued rapid industrialization, rising living standards and improvements in transport infrastructure all of which tend to support strong demand, and the other of considerable potential for energy-saving technologies that may be explored.

35. China Syndrome Part 2 • The increase in the low-skill segment in the total export-oriented labour force of the world has contributed to a decline in the unit value of world trade in labour-intensive manufactures • But part of this decline is due to by-passing of middlemen in Hong Kong China .

36. Global export-oriented labour force

37. Market shares in United States total apparel imports, 1995–2006 (%)

38. Future outlook of China Syndrome Part 2 Key questions: • Will production move to hinterland or will more low-wage labour move to the coast? • Will increasing domestic purchasing power absorb much of production? • Will China’s export basket upgrade to include more skill-intensive manufactures? • Which countries will supplant China as the world’s workshop (South Asia plus a few other countries)?

39. Implications for development strategies of China Syndrome Key questions: • Is there still potential for a wide range of countries to develop large-scale export-oriented labour-intensive manufacturing activities? • What other activities could provide opportunities for employment and productivity growth (resource-based development, services)?

40. Additional Policy challenges in the primary sector of developing countries • Need of amending bad policies and weak institutions that have contributed, directly or indirectly, to inadequate investment in the primary sector; • Need of ensuring that a reasonable share of earnings from primary commodity exports provides income for the exporting country (rather than profits for multinational firms); • Need of making sure that the export earnings contributes to economic development (enhance transparency of extractive industries; finance productivity-enhancing investment and minimize risk of Dutch disease); • No complacency about industrialization and diversification.

41. India Syndrome?The possible role of the services sector for national development • Can countries other than India benefit from services outsourcing on a large scale? • The distinction between manufactures and services regarding the impact on income growth and productivity development has become blurred: • Both “hard” infrastructure (electricity, transport) and “soft” (information and telecommunication) services have assumed a growing role as intermediate inputs to manufacturing activities. • But to what extent has the expansion of manufacturing activities been facilitated by prior existence of services?

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