Introduction
The concept of terms of trade (ToT) is essential in international economics, representing the rate at which one country’s goods are exchanged for another country’s goods. It helps assess a country’s trading strength and its welfare from international trade. Various forms of ToT exist, and many economists, including Raul Prebisch, have analyzed their implications, especially for developing countries.
Concepts of Terms of Trade
There are several different ways of expressing ToT based on the nature of trade and the factors involved.
1. Net Barter Terms of Trade (NBTT)
Also known as the commodity terms of trade, this is the ratio of export prices to import prices:
NBTT = (Index of Export Prices / Index of Import Prices) × 100
If the NBTT rises, it means a country can import more for every unit of its exports, indicating an improvement.
2. Gross Barter Terms of Trade (GBTT)
It measures the ratio of quantity of imports to quantity of exports:
GBTT = Quantity of Imports / Quantity of Exports
It helps in understanding the physical flow of goods rather than their prices.
3. Income Terms of Trade (ITT)
This considers the purchasing power of exports in terms of imports:
ITT = NBTT × Volume of Exports
It shows how many imports can be purchased with export earnings.
4. Single Factoral Terms of Trade (SFTT)
This adjusts NBTT by considering productivity in export sectors. It represents the amount of imports a country can obtain per unit of domestic factor input used in exports.
5. Double Factoral Terms of Trade (DFTT)
This considers productivity changes in both export and import sectors, giving a fuller picture of exchange efficiency.
Prebisch’s Theory on Terms of Trade
Raul Prebisch, an Argentine economist, along with Hans Singer, put forward the Prebisch-Singer hypothesis in the mid-20th century. It argues that the terms of trade tend to deteriorate over time for developing countries that export primary goods and import manufactured goods.
Key Arguments of Prebisch
- Developing countries are primarily exporters of primary commodities like agricultural goods and minerals.
- Developed countries export manufactured goods.
- Over time, the prices of manufactured goods tend to rise faster than those of primary commodities.
- Thus, developing countries must export more and more to import the same quantity of industrial goods — leading to a deterioration in ToT.
Reasons for Deterioration of ToT
- Low income elasticity of demand for primary goods — demand doesn’t increase much with global income rise.
- Technological advances in developed countries reduce dependence on raw materials from developing nations.
- Market structure differences: Developed country manufacturers have pricing power, while primary exporters face perfect competition.
- Volatility in commodity prices affects stability of export earnings.
Implications for Developing Countries
- Persistent trade deficits
- Dependency on external borrowing
- Slower growth and vulnerability to global price shocks
- Need for structural transformation and diversification
Criticism of Prebisch’s Theory
- Empirical data has been mixed — in some decades, ToT for primary exporters improved.
- Assumes a rigid trade structure that doesn’t account for industrialization efforts in developing countries.
- Technological progress has also occurred in agriculture and commodities.
Modern Relevance
Despite criticisms, Prebisch’s insights are still relevant in explaining the need for export diversification, value addition, and reducing dependency on low-value exports. Institutions like UNCTAD continue to highlight structural issues in global trade that echo Prebisch’s concerns.
Conclusion
Understanding different types of terms of trade helps in analyzing trade patterns and policy impacts. Prebisch’s analysis shed light on the inherent disadvantages faced by commodity-exporting nations. While global trade dynamics have evolved, the core message — the need for structural change and equitable global trade — remains highly relevant for developing economies.