The Prebisch-Singer and Myrdal thesis of deteriorating terms of trade

The Prebisch-Singer and Myrdal thesis of deteriorating terms of trade

According to Gunnar Myrdal, the conditions in underdeveloped countries are such that “spread” effects of trade are more than offset by the “backwash” effects.

For example, widening of markets that accompanies foreign trade benefits in the first instance the rich and progressive countries whose manufacturing industries have the lead and are already fortified by the surrounding external economies while the underdeveloped countries face the danger of seeing the extinction of their industries (since their small- scale industries and handicrafts are priced out by cheap imports from the industrial countries).

The historical experience of many underdeveloped countries confirms this as the period of colonial domination of these countries was characterised by a large-scale destruction of their handicrafts and small- scale industries. These countries were converted into exporters of primary goods.

The disadvantages of this conversion were many as the primary goods exports often meet inelastic demands in the international market, a demand trend that is not rising rapidly, and excessive price fluctuations. The advantages of any technological improvements in their export production (leading to cheapening of production) also tend to get transferred to the importing countries.

On account of these reasons, Myrdal argues that the pattern of production in the underdeveloped countries reflects the ‘backwash effects’ of international trade rather than any true comparative advantage. Therefore, international trade strengthens the forces maintaining stagnation and regression in the underdeveloped countries.

The debate on terms of trade of developing countries really began with the report of the first session of the Sub-Commission on Economic Development of the UN Economic and Employment Commission which argued that rise in the prices of capital goods had made the task of economic development more difficult for the developing countries.

The report called for a careful study of relative prices of capital goods and primary products. In response to this request, the UN Department of Economic Affairs published a report entitled “Relative Prices of Exports and Imports of Underdeveloped Countries,” in December 1949.

The major finding of this report was that index of the ratio of prices of primary products to those of manufactured products shows a declining trend, from 147 for the period 1876 to 1880 to 100 to 1938. The declining trends as noted above in the terms of trade for primary products of the developing countries gave rise to the famous Prebisch-Singer thesis.

On the basis of the figures presented by the UN Department of Economic Affairs in 1949, Raoul Prebisch questioned the mutual profitability of international trade as promised by the traditional free trade theory. Concentrating on the development experience of Latin American countries, he argued that their deteriorating terms of trade had inhibited their economic development.

He divided the world into industrial ‘centres’ and ‘peripheral’ countries and argued that under the nineteenth century scheme of things, the specific task assigned to peripheral (i.e., underdeveloped) countries was to produce food and raw materials for the great industrial centres.

Under this scheme of things there was no provision for the industrialisation of the underdeveloped countries. This arrangement only ensured their economic exploitation at the hands of the industrial centres.

Technical Progress and Terms of Trade.

According to Prebisch, the trend towards external imbalance in the developing countries is mainly due “to the disparity between the rate of growth of their primary exports and the rate of growth of their imports of industrial goods. While primary exports, with certain exceptions, develop fairly slowly, demand for industrial imports tends to accelerate.

This is a spontaneous feature of economic development. Now, argues Prebisch, the slow growth of primary exports is an inevitable result of technological progress in the industrial centres as it leads to the increasing substitution of synthetics for natural products and is also reflected in one way or another in the smaller raw material content of finished goods.

Another important characteristic of technical progress is that it has been confined to industrial production for a long time and spread to the agricultural sector very late. When it did reach the agricultural sector finally, the benefits were again limited to USA and Europe for a number of years.

The enormous increase in agricultural output that ensued in the major industrialised countries further weakened the export trade in a number of agricultural products of the developing countries.

Moreover, in a bid to guarantee domestic consumer market for the increased agricultural output, the developed countries frequently resorted to restrictions on imports from developing countries. Thus, in a bid to solve their own domestic problems, the industrialised countries have aggravated the problems of the developing countries.

The Income Elasticity of Demand for Products, Balance of Payments and Terms of Trade. In addition to technical progress leading to deterioration in terms of trade for developing countries, Prebrisch also considers the balance of payments effects of differences in the income elasticity of demand for different types of products.

It is generally recognised and agreed that the income elasticity of demand for most primary commodities is lower than that for manufactured products. In fact, the income elasticity of demand for primary products is less than unity so that a decreasing proportion of income is spent on these products as income increases (commonly knows as Engel’s law in Economics).

Since developing countries are the exporters of primary products and developed countries are the exporters of manufactured products, this means that “for a given growth of world income the balance of payments of primary-producing, developing countries will automatically deteriorate vis-a-vis the balance of payments of developed countries producing and exporting industrial goods.”