The terms of trade express the rate at which the goods one party sells exchange for the goods it buys — conventionally an index of export prices divided by an index of import prices. When the ratio falls, more must be exported to obtain the same imports, and real income is transferred to the trading partner without any change in the volume of trade. The concept is thus the point at which price economics becomes a sociology of power: terms of trade record who captures the value produced in an exchange relationship.
Where it comes from
Raúl Prebisch and Hans Singer argued independently in 1950 that the terms of trade of primary-producing countries tend to decline over the long run against manufactures — the Prebisch-Singer thesis. Their reasoning was structural. Demand for food and raw materials grows slowly as incomes rise, while demand for manufactures grows faster. Productivity gains in industry are retained by organised labour and oligopolistic firms as higher wages and profits, whereas gains in primary production, where producers are numerous and unorganised, are passed on as lower prices. Synthetic substitutes further weaken commodity demand. The thesis became the analytical foundation of dependency theory and of import-substituting industrialisation.
Points of debate
Applied within a national economy, the same idea produces the Indian debate on the intersectoral terms of trade between agriculture and industry. One position holds that administered prices, controlled procurement and protection of industry turned the terms of trade against agriculture, squeezing the peasantry to finance industrialisation. The opposing position holds that from the Green Revolution onward, a politically organised farm lobby secured support prices and heavy input subsidies that moved the terms of trade in favour of agriculture — though the gain accrued to surplus-producing large farmers, not to net purchasers of food among the rural poor. Critics of the international thesis note that trends are sensitive to the period chosen and to quality change in manufactures.
For the UPSC answer
Define the ratio precisely, attribute the secular-decline thesis to Prebisch and Singer with their structural reasoning, and then transpose it to India as the agriculture-industry terms of trade debate. The best answers add the class point: a movement in agriculture's favour benefits marketed-surplus producers, not labourers or deficit farmers who buy food.
References & further reading
- Prebisch, R. (1950). The Economic Development of Latin America and Its Principal Problems. United Nations, ECLA.
- Singer, H. W. (1950). The Distribution of Gains between Investing and Borrowing Countries. American Economic Review.
- Thamarajakshi, R. (1969). Intersectoral Terms of Trade and Marketed Surplus of Agricultural Produce. Economic and Political Weekly.