Reasons for Secular Deterioration of Terms of Trade | Economics

The secular deterioration in the terms of trade of the developing countries has occurred on account of the following reasons: 1. Absence of Qualitative Improvement of Products 2. Distribution of Gains from Technical Progress 3. Immiserizing Growth 4. Low Income Elasticity of Demand 5. Impact of Import on the Import- Competing Industries 6. Large Surpluses of Farm Products and a Few Others.

1. Absence of Qualitative Improvement of Products:

According to Raul Prebisch, the principal reason for the lower prices of primary products relative to those of manufactured goods is that the LDC’s continue to produce and export goods like coal, iron ore, tea, coffee, copper, rice, sugar etc. The quality of those products has remained roughly the same as fifty years back.

In contrast, there has been tremendous improvement in the quality of manufactured goods almost in every industry. Consequently, the demand for the latter has maintained a strong upward trend and their prices relative to the prices of primary products have remained high. This argument has, however, been refuted by the writers like Lipsey, J. Viner and H.G. Johnson on the ground that the empirical evidence has not supported it.

2. Distribution of Gains from Technical Progress:

In the opinion of H.W. Singer, the secular deterioration in the terms of trade in the LDC’s can be attributed to the fact that the gains from technical progress in the developing countries have been passed on to the consumers in the advanced countries though exports of primary products at lower prices.

In contrast, the gain from technical progress in the latter has been retained by the producers themselves in the form of higher incomes. Singer could not provide proper explanation for this phenomenon. A.M. McLeod has pointed out that the less developed countries are relatively less organised.

They compete among themselves for the limited primary products and give away the gains from increased productivity, in a substantial measure, to the developed countries through lower prices. On the opposite, the advanced countries exercise a greater degree of monopolistic control. The emergence of regional economic groupings among the advanced countries has also contributed in their retention with themselves the gains from increased productivity.

3. Immiserizing Growth:

The worsening of the international terms of trade in the case of less developed countries may be on account of the process of “immiserizing growth” explained by Jagdish Bhagwati. The excessive emphasis on ultra- export biased growth and the lack of complementary resources for the expansion of import-competing industries tend to lower not only the consumption equilibrium but also cause the deterioration in the terms of trade.

4. Low Income Elasticity of Demand:

The deterioration in the terms of trade of the LDC’s can be explained also in terms of Engel’s law. There is predominance of the production of food crops in these countries. As the income elasticity of demand is low, the aggregate expenditure as the proportion of national income incurred on the agricultural products falls relative to the proportion of spending on manufactured goods.

This results in large exportable surplus, which is disposed of in the foreign markets at relatively lower prices. The increasing demand for manufactured goods results in more imports of such products at relatively higher prices. Consequently, the terms of trade remain unfavourable for the developing countries.

5. Impact of Import on the Import- Competing Industries:

The worsening of the terms of trade for the LDC’s has resulted also from the destructive effect of foreign imports upon the indigenous import-competing industries. For instance, the competition from cheap mill-made cloth from Britain in the 19th century caused the decline of India handicrafts.

As the surplus labour fell back on agriculture, the exports of primary products increased. The excessive dependence on exports of primary goods as a source of income depressed the prices of these products relative to the prices of manufactured imported goods.

6. Large Surpluses of Farm Products:

The advanced countries have large surpluses of farm products such as foodgrains, cotton, oilseeds and dairy products. These products are transferred on a larger scale to the scarcity-ridden countries of Asia and Africa. It has depressing effect on the international prices of agricultural products. As a consequence, the terms of trade remain persistently unfavourable for the developing countries.

7. Shortage of Intermediate Goods:

S.B. Linder has attributed the adverse terms of trade in LDC’s to the shortages of intermediate goods. As a result of lesser availability of intermediate products, the process of diversification and transformation remains hindered in these countries. In view of the increased pressure of demand for such products to push ahead the process of expansion, the imports of such products have to be made at relatively higher prices. The higher import prices relative to export prices make the terms of trade unfavourable for these countries.

8. Impact of Foreign Investment:

According to Singer, the opening of the economies of LDC’s to trade and foreign investment has resulted in the cumulative multiplier effect upon the economies of advanced countries in the form of large scale expansion of exports of intermediate and producer goods and heavy remittances of profits from these investments.

The foreign direct investments in LDC’s have been directed to plantation industries and mining sector and have not contributed in the growth of manufacturing industries. Apart from depressing the overall growth process, they have reinforced the secular deterioration of the terms of trade of the LDC’s.

9. Growth of Synthetic Products:

The technological developments in both the advanced and LDC’s have resulted in the production of synthetic rubber, artificial silk, rayon, plastic products etc. That has hit hard the production of traditional items of exports of the LDC’s. As the prices of traditional exports have declined relative to imports of manufactured goods, the terms of trade have turned against the LDC’s.

10. Regional Economic Groupings:

The growth of regional economic groupings among the advanced countries such as the European Union has promoted trade among themselves. As a result, the growth of exports of LDC’s has slowed down, worsening their terms of trade.

11. Protectionist Policies:

As some of the developing countries have started developing their industries, the advanced countries have adopted the protectionist policies. They have raised tariffs against the manufactured products of the developing countries. Consequently, the terms of trade have turned against the developing countries.