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Deteriorating TOT

The significance of deteriorating terms of trade for developing countries

The developing countries have suffered a worsening of their terms of trade over a long period of time. At the heart of this situation is their over dependence on primary commodities. Exports of primary commodities tend to be income inelastic, so that, as world incomes grow, there is a less than proportionate increase in demand for primary commodities. This is in contrast to the demand for manufactures and services which tend to be highly income elastic - as world incomes increase, there is a more than proportionate increase in the demand for the latter. Thus, there has been a constant upward demand pressure on the export prices of the rich countries and a constant downward pressure on the export prices of the primary goods of the developing countries.

The situation is no better on the supply side. The manufactured goods of the developed countries are largely produced by large multinational corporations who exert a great deal of monopoly power in their markets and have the ability to fix price and output in their favour. In contrast to this, the supply of primary commodities is likely to fluctuate considerably due to factors, such as the weather, that are outside the control of producers. The price of coffee, for example, tumbled due to Vietnam entering the market as a major producer, causing over-supply.

As a result, the prices that the developing countries obtain for their exports of primary commodities have risen less rapidly than the prices that they have had to pay for their imports of manufactured goods.

This puts them in the situation of 'getting nowhere fast' - they have to export ever greater quantities of primary commodities to be able to import a given amount of manufactured goods.

Michael Marley, the former President of Jamaica, described the situation of the developing countries as being akin to a person "trying to walk up the down escalator". He illustrated his point using the example of the deteriorating terms of trade for Jamaica in relation to sugar and tractors. In 1965, it took 21 tons of Jamaican sugar to buy one Ford tractor. By 1979, the equivalent tractor cost 58 tons of sugar. This deteriorating trend has continued since 1979 for the developing countries as a whole and therefore has impacted adversely on their incomes, living standards and efforts to develop. The long run decline in the terms of trade of developing countries is a crucial barrier to their development (this links to the section 'Barriers to economic growth and / or development').

Moreover, the short term volatility of commodity prices, largely due to supply side changes associated with the weather, droughts, floods etc, mean that significant changes can occur on the current accounts of the developing countries. All this makes the formulation of development plans extremely difficult, as the uncertainties governments face make it hard to make accurate predictions about the future.