Economic Growth,Terms of Trade and Welfare in an Open Monetary Economy*

The authors investigate the impact of growth on terms of trade, absolute prices and welfare using a two-country, monetary model. Under flexible exchange rates export-biased growth would lead to a decline in the terms of trade if the two countries are ‘similar’. Under fixed exchange rates a weaker condition than the barter condition of export-biased growth is sufficient, namely, for the import commodity the demand creating effect of growth dominates the supply effect while for the exported commodity the opposite holds. Secondly, substitutability between money and commodities indicates that no necessary relation holds between the terms of trade and the trade balance. Thirdly, the introduction of money creates a real balance effect so that decline in terms of trade is no longer a necessary (or sufficient) condition for immiserization. Finally, the paper concludes by questioning two policy conclusions drawn in earlier models: one, that the declining terms of trade of less developed countries was due to a bias in the growth strategy and, two, that monetary models of trade support the ‘monetarist’ proposition that growth and a deteriorating trade balance can only co-exist if the domestic monetary policy is nonneutral.     

Adjustment costs and factor demands in Canadian manufacturing industries

This paper examines whether there is a relationship between the commodity terms of trade (the price of primary commodities relative to the price of manufactures) and the net barter terms of trade of 42 Sub-Saharan African countries. For most countries, there is little evidence of a stable, long-run relationship between the two terms of trade series. Accordingly, the practice in the literature of proxying for movements in any given country's terms of trade by using an aggregate index of relative commodity prices is inappropriate, and is likely to engender misleading policy conclusions.     

International risk sharing and commodity prices

Abstract Cole and Obstfeld (1991) exposited a classic result where equilibrium movements in the terms of trade could make ex ante risk‐sharing arrangements unnecessary: a unity elasticity of substitution across goods and production specialization. This paper extends their model to N countries and M commodities (N > M). Here the terms of trade provides insurance against commodity‐specific shocks, not country‐specific shocks. Using commodity‐level production data at the national level and world commodity prices, we document significant terms of trade variability and positive responses of nation‐specific production to terms of trade improvements. The endogenous terms of trade insurance mechanism highlighted in CO is virtually non‐existent.     

Calibrating spatial models of trade

Empirical spatial models of trade that are based on a mathematical programming specification often exhibit a large discrepancy between the equilibrium solution and the observed demand, supply and levels of trade flows among countries. This discrepancy may be due to several causes. Assuming, however, that a trade model is not misspecified – in the sense that behavior of the economic agents involved in the specific commodity markets has been included in the study and that the relevant policy instruments have been properly taken into account – the cause of discrepancy may be traced either to imprecision of unit transaction costs or to imprecision in the measurement of the demand and supply functions' parameters, or both. Policy assessments based on this type of imprecise models are distorted. This paper presents a methodology for calibrating mathematical programming spatial trade models of increasing complexity, from the one-commodity case to a multi-commodity model with asymmetric slope matrices of demand and supply functions. The proposed calibration procedure identifies corrections of imperfectly measured parameters. The calibrated models generate solutions that exactly reproduce quantities produced and consumed in all countries, as well as trade flows among all pairs of countries, observed in a given base year. Such models may then serve as a springboard for assessing the impact of various policy changes on economic agents in the countries under study.     

On the conversion of ruble trade flows into dollars

A simple approach is developed for analyzing the possible bias involved in converting CMEA countries' statistics on transferable ruble (TR) trade into dollars. This bias is a function of the degree of price distortion in TR trade and whether the conversion is made “backward” using the TR/dollar rate set by the CMEA, or “forward” using the country's official cross rate between the TR and the dollar. Illustrative calculations of conversion bias for the European members of the CMEA for 1983 show considerable differences in “forward” conversion bias among some of these countries, given identical hypothetical price distortions in each country's TR trade.     

Trade balance dynamics and exchange rates: In search of the J‐curve using a structural gravity approach

This paper uses a structural gravity approach, specifying currency movements as trade cost component to derive an empirical trade balance model, which incorporates multilateral resistance terms and accounts for the cross‐country variation in the exchange rate pass‐through into import and export prices. The model is estimated using quarterly bilateral trade flows between 47 countries over the period 2010Q1 to 2017Q2, disaggregated into 97 commodity groups. Our results support the existence of an “aggregate” J‐curve, pooled over commodity groups; at the same time they point to considerable heterogeneity in the trade balance dynamics across industries below the surface of aggregate data.     

General equilibrium with trade balance and real interest rate parity

This paper demonstrates, in the context of a two-sector OLG neoclassical growth model, conditions under which international trade in consumption goods alone may be sufficient for the equalization of real returns to physical capital across countries; that is, under which commodity arbitrage is sufficient for real interest rate parity (RIRP). This role for repeated commodity arbitrage is established via a dynamic extension of the factor price equalization (FPE) theorem which is valid at all dates comprising the equilibrium path as well as its steady state. The results are at odds with the conventional view regarding RIRP which arises from open one-sector growth models, in which case steady state trade balance and RIRP are irreconcilable, and are also a contradiction to frequent assertions of lon-run specialization in two-sector frameworks. An equilibrium path for an integrated world economy yields an endogenous, time-variant cone of diversification which implies sufficient conditions for the dynamic paths of a cross-section of economies to exhibit FPE, and hence RIRP with trade balance, at all points in time. These conditions require that the savings rates and initial capital-labor ratios of individual countries do not deviate too significantly from world averages, and that both sectors absorb capital easily. The first of these requirements is sufficient to establish steady state FPE and RIRP in the general specification. The first two requirements are sufficient for the entire equilibrium path to be characterized by FPE and RIRP in a log-linear example. Received: September 22, 1998; revised version: February 10, 2000     

Inflation persistence and exchange rate regime: Implications for dynamic adjustment to shocks in a small open economy

The paper examines implications of inflation persistence for business cycle dynamics following terms of trade shock in a small oil producing economy, under inflation targeting and exchange rate targeting regimes. It is shown that due to the ‘Walters critique’ effect, the country’s adjustment paths are slow and cyclical if there is a significant backward-looking element in the inflation dynamics and the exchange rate is fixed. It is also shown that such cyclical adjustment paths are moderated if there is a high proportion of forward-looking price setters in the economy, so that when the Phillips curve becomes completely forward-looking cyclicality in adjustment paths disappears and the response of the real exchange rate becomes hump-shaped. In contrast, with an independent monetary policy, irrespective of the degree of inflation persistence, flexible exchange rate allows to escape severe cycles, which results in a smooth response of the real exchange rate.     

North–South Trade and Pollution Migration: The Debate Revisited

The paper examines the effect of freer North–South trade in goods on pollution, commodity terms-of-trade and national welfare, utilizing a factor endowment framework. North and South are distinguished in terms of the relative endowment of a pollution causing natural resource: South is relatively more resource abundant. Compared to the analysis of Copeland and Taylor (1994)—which is the central work so far on this subject—this paper internalizes the commodity terms-of-trade impact of individual environment policies. It is derived that if countries specialize completely in the free-trade equilibrium, both are induced to reduce their pollution as compared to autarky. It is interesting and paradoxical that the South also reduces its pollution, despite specializing in the pollution-intensive good. Again, contrary to common perception, free trade may entail an overall terms-of-trade loss for the North, while South will always have a positive change in the terms-of-trade. Finally, inspite of better environment, free trade may cause both the countries to gain or lose in terms of aggregate welfare. This research has benefitted from comments received at the conference on International Dimension of Environment Policy organized by the European Science Foundation and Tilburg University, October 7–12, 2000 Kerkrade, The Netherlands and the International Conference on Environment and Development organized by CITD, School of International Studies, JNU, April 7–8, 2005, New Delhi, India, as well as those received from two anonymous referees. A small section of this research was published in Mehra and Das (2002).     

Output/Endowment and Commodity/Factor Price Relationships and Welfare in a Multilateral Trade Model with Partial Factor Mobility

A multilateral model of trade with both commodity flows and partial mobility of factor flows is set up. This model is used to develop factor endowment/output relationships as well as commodity/factor price relationships. Welfare consequences of these parametric shifts are examined. The model is built on the customs union framework which involves three countries and both commodity and factor flows. Owing to spillover effects in multilateral trade models, many nontraditional results are obtained. Many developed countries accept skilled and unskilled migrants from other countries. These migrants are generally accepted on a quota system. Moreover, it has been established that an increase in the migrant quota in the presence of factor mobility may raise or lower the output and welfare in the country not receiving migrants. In fact it is shown that the non‐migrant receiving country could be immiserized due to loss of capital. The main message of this paper is that in a multilateral trade framework there exist international spillover effects which must be taken into consideration in national policymaking.     

Macroeconomic effects of terms of trade fluctuations in commodity exporting advanced economies

The paper examines the impact of world commodity prices on national output and trade balances in Australia, Canada, New Zealand, and Norway, OECD economies that, unlike other advanced economies, are heavily dependent on commodity exports. Contrary to Dutch disease theory based on real exchange rate adjustment, it highlights the relative price effects of terms of trade (ToT) changes on gross domestic product and net exports with reference to the experience of this unique set of OECD countries. The econometric analysis verifies key predictions of this alternative perspective that ToT fluctuations should (i) have no significant short-run impact on GDP and that (ii) due to relative price effects a strong positive relationship between the ToT and net exports is unlikely.     

From endogenous growth to stationary state: The world economy in the mathematical formulation of the Ricardian system

We analyse international trade in a Pasinetti–Ricardo growth model in the world economy scenario in which several small trading countries coexist and international commodity prices are determined by the interplay of supply and demand amongst them. We demonstrate that all the trading countries eventually reach the stationary state, though this process is not monotonic and the dynamics of capital and population may actually push some countries towards the stationary state and others away from it. We also use our model to assess an argument which Malthus employed in the second edition of An Essay on the Principle of Population (1803) to support a policy of agricultural protectionism.     

State of the “life span revolution” between 1980 and 2000

Using data for 163 countries, state of the “life span revolution” over the period 1980–2000 is studied in terms of measures of cross-country inequality and through least-squares and quantile-regression estimation of simple convergence models. Four main points are noted. First, dynamics of the cross-country distribution of life expectancy during these 20 years seem markedly different from those for the preceding decades: instead of the sharp “convergence” noted until the 1980s, there is lack of convergence and an indication of “divergence”. Second, the divergence is particularly marked during the 1990s. Third, spread of HIV/AIDS has probably been a significant factor in generating divergence during the 1990s. Fourth, besides the sizable temporal heterogeneity, quantile-regression estimates of convergence models reveal a substantial heterogeneity across the top and the bottom quartiles within each period.     

The law of one price and the modelling of disaggregated trade flows

This paper argues that the application of a differentiated good model to disaggregated commodity trade, and in particular to primary commodity trade, is feasible. Price data for as narrowly defined a commodity as wheat are shown to violate the law of one price. An Armington-type model which allows prices of a commodity to vary by supplier is then applied to world wheat trade. Two issues concerning the Armington model are addressed. First, it is shown that the theoretical implications of the model are plausible in the case of a disaggregated commodity. Second, as an example, 1973–1974 wheat trade flows and prices forecast by an Armington-type model are shown to be consistent with actual trade patterns and prices.     

Trade facilitation and country size

It is argued that compared with large countries, small countries rely more on trade and therefore are more likely to adopt liberal trading policies. The present paper extends this idea beyond the conventional trade openness measures by analyzing the relationship between country size and the number of documents required to export and import, a measure of trade facilitation. Three important results follow. First, trade facilitation does improve as country size becomes smaller; that is, small countries perform better than large countries in terms of trade facilitation. Second, the relationship between country size and trade facilitation is nonlinear, much stronger for the relatively small than the large countries. Third, contrary to what existing studies might suggest, the relationship between country size and trade facilitation does not appear to be driven by the fact that small countries trade more as a proportion of their gross domestic product than the large countries.     

Liquidity Constraints and Business Cycles in Developing Economies

Open economy extensions of real business cycle models, even if generally successful, have met some difficulties replicating a few important stylized facts. In particular, these models tend to predict excessive consumption smoothing and consumption correlations across countries. The observed negative correlation between the trade balance and output in developing countries, the variability of the trade balance and its correlation with the terms of trade have also proven difficult to reproduce. This paper considers how introduction of incomplete markets in the form of liquidity constraints can alleviate these problems. This analysis suggests that adding liquidity constraints helps predict the variability of consumption relative to output. It also improves our estimate of the correlation between the trade balance and output. The model correctly replicates the small positive correlation between the terms of trade and the trade balance. However, it slightly underpredicts the variability of the trade balance when 50% of the consumers are assumed to be liquidity constrained.Journal of Economic LiteratureClassification Numbers: E13, E32, E44.     

Habit persistence and the structure of international commodity trade

The paper analyzes the commodity structure of exports and imports of nine industrialized countries, using a dynamic version of the Linear Expenditure System. The hypothesis implied by this approach is that the structure of commodity trade can be explained by a combination of habit persistence and constant marginal expenditure shares. Application of the model to the trade composition of nine countries shows that there are considerable differences in the strength of habit persistence across countries and across commodity groups as well as between exports and imports. These are crucial for the explanation of the associated expenditure and price elasticities.     

An exceptional development pattern

This paper investigates India's exceptional development pattern, specifically the major importance of information technology services (ITS), and compares it with China's development pattern. Both countries want to develop capabilities for carrying out the innovation of technologies that compete at the state-of-the-art in the world market. The paper posits that technological/economic success in the contemporary world market requires the ability to innovate complex technologies and complex technology-related services. The share of trade represented by complex technologies is compared with the “high-tech” share. The trading patterns of the two countries are compared using United Nations data. Two case studies of Indian ITS companies are then compared with two case studies of Chinese manufacturing companies. Historical and cultural differences appear to explain some of the differences in the development patterns of the companies located in the two countries.     

Are shocks to the terms of trade shocks to productivity?

International trade is frequently thought of as a production technology in which the inputs are exports and the outputs are imports. Exports are transformed into imports at the rate of the price of exports relative to the price of imports: the reciprocal of the terms of trade. Cast this way, a change in the terms of trade acts as a productivity shock. Or does it? In this paper, we show that this line of reasoning cannot work in standard models. Starting with a simple model and then generalizing, we show that changes in the terms of trade have no first-order effect on productivity when output is measured as chain-weighted real GDP. The terms of trade do affect real income and consumption in a country, and we show how measures of real income change with the terms of trade at business cycle frequencies and during financial crises.     

Je t'aime, moi non plus: Bilateral opinions and international trade

This paper studies the relationship between bilateral trade patterns and opinions. It uses the Eurobarometer public opinion surveys published by the European Commission, which provide data on the share of the population in each EU15 member country in favour of each CEEC joining the EU. Our results first suggest that bilateral opinions have a statistically robust and relatively large effect on imports, even when standard and new covariates capturing proximity between countries are controlled for. We interpret this effect as reflecting a positive impact of “bilateral affinity” on trade patterns. We also show that it is possible to go some way towards explaining the variance in bilateral opinions among our sample. Last we provide some preliminary attempt to determine causality between bilateral opinions and imports.