Question

2. Define 'terms of trade' as applied by Raul Prebisch and others. What was Prebisch attempting to explain? In other words, what were the dynamics of the terms of trade from the perspective of the periphery countries? Explain. Your essay must include at least two elasticity-based explanations for the dynamics of the terms of trade and two additional, non-elasticity based explanation.

4. Write an essay that summarizes, then compares and contrasts the article by Amartya Sen, "Development: Which way now?" and the article by Albert Hirschman, "The Rise and Decline of Development Economics".

Answer 1

Question2.  Terms of Trade: -

An increase in economic growth across several Southern economies has forced several commentators to rethink on the relevance of Raul Prebisch. Given the fact that in some of these economies, growth is to an extent that the very idea of Center- periphery seems to be turning a full circle, where peripheral economies seems to be occupying a central position. Raul Prebisch is well-known for his path breaking contribution in the 1950s with his terms of trade deterioration thesis – now known as Prebisch-Singer Thesis – and his recommendations that the developing countries should adopt import-substitution – oriented industrialization strategies to reverse the secular declining trend in their terms of trade with the developed countries. He was essentially a structuralist and sought long-term structural solutions to the development problems rather than advocating monetarist’s short-term adjustment measures.

One of the most famous and most controversial components of Raúl Prebisch’s thinking was his conviction that there had been a centuries’ long deterioration in the terms of trade of commodities and food vis-à-vis industrialized goods. Since the developing countries specialize in commodities and food, the downtrend in the value of these products would lead to a worsening of their terms of trade.

There is empirical evidence related to the fact that the terms of trade have been continuously moving against the developing countries. Based on exports statistics concerning the United Kingdom between 1870 and 1940, Raul Prebisch demonstrated that the terms of trade had secular tendency to move against the primary products and in favor of the manufactured and capital goods.

This viewpoint has been strongly supported by H. W. Singer. The essence of Prebisch-Singer thesis is that the peripheral or LDC’s had to export large amounts of their primary products in order to import manufactured goods from the industrially advanced countries. The deterioration of terms of trade has been a major inhibitory factor in the growth of the LDC’s. Prebisch and Singer maintain that there has been technical progress in the advanced countries, the fruit of which have not percolated to the LDC’s. In addition, the industrialized countries have maintained a monopoly control over the production of industrial goods. They could manipulate the prices of manufactured goods in their favors and against the interest of the LDC’s.

Except the success of OPEC in raising the prices of crude oil since mid-1970’s, there has been a relative decline in the international prices of farm and plantation products, minerals and forest products. Consequently, the terms of trade have remained unfavorable to the developing countries.

Assumptions of Raul Prebisch are as follows-

1. As income rises in the advanced countries, the pattern of demand shifts from primary products to the manufactured products due to Engel’s law.
2. There is slow rise in demand for products in the developed countries.
3. The export market for product of LDC’s is competitive.
4. The export market for products of developed countries is monopolistic.
5. Wages and prices are low in LDC’s.
6. The appearance of substitutes for products of LDC’s reduces demand for them.
7. The benefit of increased productivity is not passed by the producers of manufactured products in advanced countries to the LDC’s through lower prices.
8. The economic growth in the LDC’s is indicated by income terms of trade.

As per the hypothesis of secular deterioration of terms of trade for them in two ways. Firstly, a high proportion of proceeds from exports are not available for imports. Secondly, there is an increased pressure upon the LDC’s to raise exports in order to repay external debts on account of IMF-induced adjustment polices. These pressures make the debt- ridden LDC’s to compete with other poor countries to enlarge their export earnings. It results in decline in the prices of export products of these countries.

The studies made by Morgan, Ellsworth, Haberler, Kindelberger and Lipsey have not supported the secular deterioration of terms of trade hypothesis, Lipsey has observed, “Although there have been very large swings in U.S. terms of trade since 1879, no long term trend has emerged. The average level of U.S. terms of trade since World War II has been almost the same as before World War I.” This objection of lack of empirical support against the Prebisch-Singer hypothesis is not very sound. Several more recent empirical studies have, in fact, gone in favor of this hypothesis.

However, many objections raised against the Prebisch-Singer thesis, the empirical evidence has accumulated in support of it. The studies made by UNCTAD for 1950-61 and 1960-73 periods showed that there was a relative decline in the terms of trade of LDC’s vis-a-vis the developed countries. A study attempted by Thirlwall and Bergevin for the period 1973-82 indicated that there was an annual decline of terms of trade of LDC’s for all the primary commodity exports at the rate of 0.36%

Since their study related to exports of manufactured products for LDC’s to the advanced countries during 1970-87 period, Singer and Sarkar found that the terms of trade of LDC’s declined by about 1% per annum. Even the World Development Report 1955 recognised that the world prices of primary products declined sharply during I980’s and the terms of trade of LDC’s deteriorated during 1980-93 period.

According to the 1997 Human Development Report of UNDP, the terms of trade for the least developed countries declined by a cumulative 50% over the past 25 years. According to South Commission, compared with 1980, the terms of trade of developing countries had deteriorated by 29% in 1988. The average real price of non-oil commodities had declined by 25% during 1980-88 period compared with the previous two decades. The terms of trade of non-oil developing countries had deteriorated during 1980-88 period by 8% compared with 1960’s and 13 % compared with 1970’s.

In the 1970s, the developing countries moved to quadrant A of sustainable convergence by attaining an elasticity-ratio and a relative growth ratio that is greater than 1. However, the seemingly sustainable growth path proved unstable once the external shocks of interest-rate hike and severe terms of trade deterioration hit the developing countries, pushing them into a balance of payments crisis that then turned into a debt crisis. Further in the 1980s, there was sustainable divergence once again (quadrant C), with the developing countries growing at relatively much lower rates constrained under the unfavorable elasticity ratios. Payments for the debt accumulated during the 1970s contributed to the sharp contraction in growth rates as the developing countries sought ways to simultaneously increase their exports for earning enough foreign exchange. As the relative prices of their exports continued to collapse during this period, the fallacy of composition effect reinforced losses from international trade. In all, the unfavorable external shocks of the 1970s were indeed responsible for the “lost decade” of divergence during the 1980s. The uncoordinated policy responses from the IMF and the World Bank only made the situation worse. In the 1990s, the developing countries moved to the situation of unsustainable convergence (quadrant B). However, the convergence rate was rather low in this case compared to that of the 1970s, and the elasticity-ratio was less than unitary. Even though the elasticity-ratio might seem quite close to 1, leading one to expect a rather small adverse impact on balance of payments and growth is seen in ratio much lower for the majority of primary commodity exporters equal to 0.77 and higher for the manufacture-exporters 1.21, relative to the overall ratio of 0.92. The rise in the income elasticity ratios between these two groups of developing countries underlines the degree of divergence within the South that has been growing since the last few decades.

However today in changing time with impact of economic lockdown the magic of the market had long been renounced where the creation of money was concerned. Experience had shown that it could not be left to the guidance of the profit incentive. Monetary regulation by the State through the central banks is to be imposed. Efficacious as was this macroeconomic regulation in former times, it now must give place to other forms of regulation in order to prevent inflation.