Terms of Trade

Real exchange ratio of four selected European countries.

As real exchange ratio (also import exchange ratio or international exchange ratio , English terms of trade abbreviated TOT) is the economic measure of the ratio between export good price levels and import gutpreisniveau one state or group of states designated.

Concept history

The English term terms of trade was coined by the American economist Frank William Taussig in his work International Trade , published in New York in 1927 . The concept was, however, already in England in 1844 by Robert Torrens in The Budget: On Commercial and Colonial Policy and in the same year by John Stuart Mill in his (according to his information already written in 1829/30) essay Of the Laws of Interchange between Nations; and the Distribution of Gains of Commerce among the Countries of the Commercial World (in Essays on Some Unsettled Questions of Political Economy ) and systematized. The English term terms of trade is, however, ambiguous, as it also generally stands for the terms and conditions of a commercial transaction .

definition

In the simplest case, the real exchange ratio of a country is determined by the quotient of the export goods price level and the import goods price level: ${\displaystyle T}$ ${\displaystyle E}$ ${\displaystyle I}$

${\displaystyle T={\frac {E}{I}}}$

The standard model of trade derives a relative world supply curve from the production possibilities and a relative world demand curve from the preferences . The quotient of export and import prices, i.e. the real exchange ratio of a country, lies at the intersection of these curves. With otherwise constant conditions, an increase in the real exchange ratio in Germany leads to welfare gains , a decrease to a deterioration. The terms of trade improve for a country when the export value derived from the prices exceeds the import value.

The real exchange ratio expresses the quantities of imported products a country can acquire by releasing one unit of its export products. Here, a distinction must be made from the exchange rates that express the price of one currency in prices of another currency. Exchange rates establish a relationship in terms of value between goods, whereas the real exchange relationship creates a relationship in terms of quantity. Exchange rates are sometimes subject to additional influences and do not realistically reflect the exchange ratios.

To determine the import and export price levels required for the real exchange ratio, a representative shopping basket is usually used as the basis, since the various goods are to be appropriately weighted and included in the formation of the price level. If the home country receives more units of the imported goods for a unit of quantity of its export goods than before, then its real exchange ratio will improve. In other words, the home country then experiences an increase in the amount of available goods without any change in factor endowment or technology. The real exchange ratio increases when the prices of exported goods rise faster than those of imported goods or when the domestic currency appreciates . The real exchange ratio is a measure of the benefits a country derives from international trade.

In development theory, the development of the real exchange relationship serves as an indicator of the economic prosperity of a country. If the real exchange ratio deteriorates with simultaneous economic growth, one speaks of impoverishment growth .

An improvement in the real exchange ratio is advantageous for every economy, because this means that for a given amount of export goods, a larger amount of goods can be imported that can be used for consumption and investment.

The definition, operationalization and evaluation of the collected data for the real exchange relationship are controversial in the specialist field. So z. For example, the theory of the secular deterioration of the terms of trade ( Raúl Prebisch ) , which is particularly widespread in developing countries, is countered by the fact that they do not change in terms of trends, but in wave movements and overall to a varying extent according to space and time.

example

Suppose Germany exports a machine worth 5,000 euros to Poland and buys 100 kg of potatoes for 200 zloty. The exchange rate is 1 euro = 5 zloty.

${\displaystyle \left({\frac {5000\,{\text{Euro}}}{40\,{\text{Euro}}}}=125\right)\cdot {\frac {100\,{\text{kg Kartoffeln}}}{\text{1 Maschine}}}=12.500\,{\frac {\text{kg Kartoffeln}}{\text{Maschine}}}}$

So Germany receives 12,500 kg of potatoes for one machine. By creating a suitably weighted basket of goods from all exported and imported goods, the real exchange relationship arises from such individual goods exchange relationships.

Influencing factors

The question arises as to what determines the real exchange relationship. It generally depends on the change in supply and demand for the individual goods. With the establishment of continuous foreign trade relationships, in addition to static or one-off effects, a dynamic effect on the domestic economy can be assumed, since domestic providers are subject to greater competitive pressure. On the one hand, this leads to the adaptation of production structures to the price ratio determined by the world market (improvement in productivity and specialization in favor of export goods) and, on the other hand, it creates an incentive for investments in research and development (technological progress).

An increase in the quantity offered on the world market - for example through improved production conditions - leads, ceteris paribus, to falling prices and thus to lower export revenues. Assuming that the increase in supply on the world market occurs particularly frequently in raw materials and poorly refined goods, this negative income effect primarily affects less developed economies. The economist Jagdish Bhagwati coined the term impoverishment growth for this phenomenon .

If the influence of exchange rate changes is disregarded, then the real exchange relationships are mainly determined by the price elasticities of the (export) demand for the traded good: A low price elasticity of the export demand means “that the countries that demand this good do not are dependent on the export goods and can relatively easily substitute them for other goods ”. In addition, if the price elasticity is less than one, the price decline cannot be compensated for by a possible increase in demand. Due to the deterioration in the real exchange ratio, the exporting country would have to export more and more, assuming the import level is assumed to be constant, as long as the decline in prices continues. As a possible counter-strategy, the country can try to reduce its import demand, for example by producing the goods itself (strategy of import substitution). Conversely, countries that offer goods with high price elasticities can improve their real exchange ratio through higher prices.

Assuming that the data on the general equilibrium of a growing country such as factor endowments, structure of needs, etc. remain unchanged, the effect of trade policy, in particular of customs policy measures, on the real exchange ratio can be analyzed. The country levies tariffs so that fewer goods are imported from abroad and domestic production increases (so-called production effect). Due to the import duty, the domestic price of the imported goods differs from the world market price by the amount of the duty. The higher domestic price leads to a decrease in demand (trade effect), which in turn leads to a cheaper price for the goods abroad, which ceteris paribus improves the real exchange ratio for the domestic market if the export sector is not taken into account (falling import level). This effect is also known as the “terms-of-trade argument” for a tariff. State subsidies to promote domestic import-competing industries also have an influence on the real exchange ratio. These can be granted directly to the quantity or value of the entire production or only to the exported part. Indirect forms, such as tax breaks, are also conceivable. As a result, a larger quantity can be offered and exported at the same (domestic) price (production effect). With corresponding price elasticities (> 1) of the goods, the greater supply - despite falling prices - leads to higher foreign demand and higher export revenues.

Assuming that the trade policy of a growing country remains unchanged, the influences of the data change can be analyzed. Economic growth in the country leads to an increase in the national product and national income . This causes a consumption effect (increase in overall demand for imported goods) and a production effect (increase in the supply of export goods). This results in an increase in the total demand for imported goods and the total supply of export goods. For the domestic market this results in a decrease (deterioration) in the real exchange ratio.

Economic growth (as a change in data) consumption effects and production effects increase in import demand and export supply deterioration in the real exchange ratio . ${\displaystyle \rightarrow }$ ${\displaystyle \rightarrow }$ ${\displaystyle \rightarrow }$

variants

Exchange ratio

The concept of the commodity terms of trade , often also abbreviated terms of trade, considers the quotient of the export and import goods price index.

${\displaystyle T={\frac {p^{\text{ex}}}{p^{\text{im}}}}}$

Since this model does not take into account other effects that determine domestic prosperity, the meaningfulness of the development of the profitability of trade is limited: A decline in the exchange of goods does not always result in a deterioration in the country's prosperity: If the price reduction for export goods is below Productivity increase (technical progress, increase in factor productivity), higher export earnings can be achieved in total.

Income exchange ratio

The income terms of trade extends the exchange of goods ratio to include the quantity index of export goods. They are calculated by dividing the export revenues by the import prices.

${\displaystyle T={\frac {p^{\text{ex}}\cdot q^{\text{ex}}}{p^{\text{im}}}}}$

A country's prosperity and competitiveness can be better assessed with the income exchange ratio than with the commodity exchange ratio. From the time course of this index it can be seen whether the import volume has increased or decreased as a counterpart to the export, i.e. whether the country receives more or fewer units of quantity of an imported good.

Simple factor exchange relationships

The concept of the single factoral terms of trade takes into account the productivity changes in the domestic and foreign export sector. As productivity increases in the domestic export sector, so does the amount of imported goods that can be purchased in one hour worked in the export sector.

Double factor exchange ratios

The double factor exchange ratio (English double factoral terms of trade ) also takes into account production progress in the import sector such as B. simple factor exchange relationships. Changes in a country's relative competitive position also play a role.

Influence of international transfer

International transfer is the shift of purchasing power from one country to another. If the domestic demand for the imported goods exceeds the supply, the real exchange ratio deteriorates; if the demand is less than the supply, it improves.

example 1

The home country makes a transfer payment to another country . ${\displaystyle A}$ ${\displaystyle Y}$ ${\displaystyle B}$

• In domestic A, income falls and imports fall . ${\displaystyle Y}$ ${\displaystyle a\cdot Y}$
• Abroad B income increases and imports increase . ${\displaystyle Y}$ ${\displaystyle b\cdot Y}$

Since export (A) = import (B).

• 1st case :: Improvement of the terms of trade. ${\displaystyle a\cdot Y+b\cdot Y>Y\Rightarrow (a+b)>1}$
• 2nd case :: Worsening of the terms of trade. ${\displaystyle a\cdot Y+b\cdot Y<Y\Rightarrow (a+b)<1}$
• 3rd case :: The terms of trade do not change. ${\displaystyle a\cdot Y+b\cdot Y=Y\Rightarrow (a+b)=1}$

Example 2

A country depends on the export of oil. If the price of oil rises, the country can afford a larger amount of imported goods for the same amount of exported oil (increase in welfare).

Influence of changes in exchange rates

If the domestic currency is revalued, the import prices in the domestic currency fall. In return, export prices in the foreign currency rise. The effect on the real exchange ratio differs from case to case.

A small country with constant production conditions is considered. If the exporters import a good in the foreign currency cheaper than the offer price, the export price will fall. The import price in foreign currency will remain unchanged. Domestic demand for foreign goods declines and the real exchange ratio deteriorates. This means that a country's export activity must be increased and import activity must be restricted in order to maintain a current account balance.

A devaluation (revaluation) will always improve (worsen) the exchange ratio if the product of the elasticities of domestic demand for imported goods and the foreign demand for domestic export goods is greater than the product of the elasticities of the export / import supply.

example

Consider two different countries: Germany (currency euro) and a developing country (assumed currency dollar). In this case, Germany exports a locomotive and imports coffee. If the dollar depreciates against the euro, the real exchange ratio “coffee for locomotive” becomes less favorable for the developing country.

Let's say the sack of coffee costs $ 5 and the locomotive costs € 100,000. If a euro is worth 1.2 dollars, this results

${\displaystyle 100.000\,\mathrm {\euro} =120.000\,\$=24.000{\text{ Sack Kaffee}}}$

The real exchange ratio is therefore 24,000 sacks of coffee for one locomotive. If the dollar now devalues ​​against the euro, so that one euro is worth 1.5 dollars, the result is

${\displaystyle 100.000\,\mathrm {\euro} =150.000\,\$=30.000{\text{ Sack Kaffee}}}$.

30,000 bags of coffee are now required for a locomotive.

See also

• trade balance

literature

• Douglas A. Irwin : Against the Tide: An Intellectual History of Free Trade. Princeton University Press, Princeton 1996, ISBN 0-691-01138-9 .
• Anne O. Krueger , Hugo F. Sonnenschein: The terms of trade, the gains from trade, and price divergence. In: International Economic Review. 8, 1967, pp. 121-127.
• Gerhard Rübel: Basics of real foreign trade. Oldenbourg Wirtschaftsverlag, 2004, ISBN 3-486-27560-7 .
• Horst Siebert: Oliver Lorz: Foreign trade. Lucius & Lucius, Stuttgart 2006, ISBN 3-8252-8081-0 .
• Manfred Krüger: Growth and Terms of Trade. Issue 201, Duncker & Humblot, Berlin 1973, pp. 26-27.
• N. Gregory Mankiw: Macroeconomics , 6th edition, Schäfer-Poeschel Verlag Stuttgart, 2011, ISBN 978-3-7910-3100-2 , p. 173.
• Paul R. Krugman, Maurice Obstfeld: International Economy , Theory and Politics of Foreign Trade, 8th Edition, ISBN 978-3-8273-7361-8 , p. 156.

Web links

Commons : Terms of Trade  - collection of images, videos and audio files

• Federal Statistical Office : Index of import and export prices - summaries, terms of trade (May 2015) - data on the terms of trade since 1954 (p. 19ff)
• Graphic: Real exchange relationships (Terms of Trade) , from: Figures and facts: Globalization , Federal Agency for Civic Education / bpb
• Worsening of the terms of trade using the example of coffee

Individual evidence

1. ↑ Michael Hohlstein, Barbara Pflugmann, Herbert Sperber, Joachim Brink: Lexikon der Volkswirtschaft. Over 2200 terms for studies and work . 3. Edition. Deutscher Taschenbuchverlag, Vahlen 2009 ( limited preview in Google book search).
2. ^ Paul R. Krugman, Maurice Obstfeld: Theory and Politics of Foreign Trade. , 8th edition, ISBN 978-3-8273-7361-8 , p. 156.
3. ^ Terms of Trade . In: Duden Wirtschaft from A to Z. Basic knowledge for school and study, work and everyday life. 2nd Edition. Bibliographisches Institut & FA Brockhaus, Mannheim 2004. Retrieved on May 10, 2009 (licensed edition Bonn: Federal Center for Political Education 2004).
4. ^ Gerhard Rübel: Basics of real foreign trade. Oldenbourg Wirtschaftsverlag, 2004, ISBN 3-486-27560-7 , p. 102.
5. ^ Gerhard Rübel: Basics of real foreign trade. Oldenbourg Wirtschaftsverlag, 2004, ISBN 3-486-27560-7 , p. 180.
6. ↑ Michael Rauscher: Real Foreign Trade , Lecture Notes 2007
7. ↑ See Heinz-J. Bontrup: Economics. Basics of micro and macro economics. 2nd Edition. Oldenbourg Wirtschaftsverlag, 2004, ISBN 3-486-24233-4 , p. 730.
8. ↑ Konrad Bommas, Renate ear: welfare effects of foreign trade. In: WISU. No. 7 1997, pp. 671-676
9. ↑ ^{a b c} Thieß Petersen: Impoverishment growth. In: WISU. No. 2 2010, pp. 200-206.
10. ↑ ^{a b} Britta Lübcke: Tariff and non-tariff trade barriers and the effects of a customs union. In: WISU. No. 5 2000, pp. 667-670
11. ↑ Manfred Krüger: Growth and Terms of Trade. Issue 201, Duncker & Humblot, Berlin 1973, pp. 26-27.
12. ^ Commodity Terms of Trade. In: Gabler Wirtschaftslexikon. February 19, 2018, accessed October 11, 2018 . 
13. ^ Gerhard Rübel: Basics of real foreign trade. Oldenbourg Wirtschaftsverlag, 2004, ISBN 3-486-27560-7 , p. 104.
14. ↑ ^{a b} Eckhart Koch: International economic relations. 3. Edition. Vahlen Verlag, 2006, ISBN 3-8006-1593-2 , p. 15.
15. ↑ Axel Sell: Introduction to International Business Relations . Oldenbourg Wissenschaftsverlag, 2003, ISBN 3-486-27370-1 , p. 183 ( excerpt from Google book search).