Trade patterns and terms of trade

Patterns of trade

Trade patterns relate to how international trade is shaped over time.

Historically, trade has been shaped by two contradictory forces - the desire to make trade 'free' from constraints, and the desire to protect economies and industries from the adverse effects of free trade.

Factors affecting trade patterns

    Trade patterns are influenced by;

  1. The application of the principle of comparative advantage, where countries tend to specialise in producing those goods and services for which they have a comparative cost advantage.
  2. The globalisation of trade, which breaks down national barriers and also encourages the growth of powerful transnational companies.
  3. Increasing trade 'openness', with imports and exports forming a larger share of GDP.
  4. The rise of developing and emerging economies, such as China and India.
  5. Changes in global terms of trade, with industrialised countries benefiting at the expense of developing countries.
  6. The rise of powerful trading blocs, such as the EU, which can create free trade for there members, but erect considerable barriers to non-members.
  7. The popularity of bi-lateral trade agreements, at the expense of multi-lateral agreements.
  8. Changes in relative exchange rates, which impact on imports and exports.

The terms of trade

A country's terms of trade refer to the relative price of exports and imports.

The formula to work out the terms of trade is:

Index of export prices
Index of import prices
x 100 = Terms of trade

For example, if export prices rise by 8% in a given year, and import prices rise by 5%, the terms of trade are:

108
105
x 100 = 102.86

Here, the term of trade have improved by 2.86%.

Improving terms of trade

If a country’s terms of trade improve, it means that for every unit of exports sold a country can purchase more units of imports.

An increase in the terms of trade creates a benefit in respect of how many goods need to be exported to buy a given amount of imports. This can increase standards of living in the future.

However, improving terms of trade can also worsen the balance of payments, as imports may increase relative to exports.

Worsening terms of trade

If terms of trade worsen a country has to export more to purchase a given quantity of imports.

Generally, the global trend for terms of trade is that countries that export commodities and low value manufactured goods have suffered a worsening terms of trade, while those exporting high valued manufactured goods and services have experienced an improving terms of trade.

This has meant that developing countries have to produce and export increasingly more of their commodities to be able to import from industrialised developed economies. This is supported by the Prebisch-Singer hypothesis, which points to differential income elasticity of demand for consumer goods compared with commodities.

As global incomes have increases, demand for some commodities has fallen relative to demand for consumer goods.

However, the effect of globalisation may have been to benefit of some developing countries, or at least as prevented the gap between the developed and developing world widening further.