The Terms of Trade and Economic Development

THE long-run development of the terms of trade is a recurrent subject for economic analysis in which a succession of theories has been put forward.' It was once believed that the terms of trade would inevitably turn in favor of primary products and against manufactures because the extractive industries were subject to diminishing returns, manufacturing to decreasing costs. This view gave way to another, that world investment moved in large cycles, and that the terms of trade favored primary products when investment expanded, manufacturing when contraction set in. A third hypothesis suggests that productivity increases about equally in primary products and manufactures, but that with the growing real income it brings, Engel's law leads to smaller increases in demand for agricultural products than for manufactures and services, so the terms of trade will favor the latter. Lately the same shift of the terms of trade against countries producing primary products has been discerned by Singer2 and Prebisch 3 but attributed to monopolistic practices on the part of industrial countries. The most recent discussion bearing on the subject was initiated by Hicks,4 who suggested that the terms of trade are affected by differences in the rate of productivity increase between the leading industrial country and all other countries. The leader's terms of trade will turn in its favor or against it depending on whether its innovations are import biased or export biased. Hicks considered that British innovation in the nineteenth century was export biased, but that United States innovation currently tends to be import biased. His theorem has been criticized 5 mainly in relation to the equilibrium mechanism in the balance of payments, with only limited attention to the factual connection between innovation and the terms of trade, though attempts have been made to forecast the terms of trade between manufactures and primary products for I960, and once for I975.6 My contention is that few generalizations on the terms of trade between world manufactures and world primary products are valid but that they tend to turn against underdeveloped and in favor of developed countries.