The Essentials of Terms of Trade (TOT)
Terms of Trade (TOT) measure the ratio between a country’s export prices and its import prices. These indexes are often calculated by subtracting the value of total imports from total exports. To derive TOT, you can simply divide the price of exports by the price of imports and multiply by 100.
When a country’s TOT is below 100%, more capital is leaving the country than entering. Conversely, if the TOT is above 100%, the country is accumulating more capital from exports than it is spending on imports.
Key Takeaways
- TOT is a critical gauge of a country’s economic well-being, based on its import and export dealings.
- The ratio is expressed by dividing export prices by import prices, then multiplying by 100.
- A TOT value over 100% or one that improves over time often signals a healthy economic trend, possibly due to higher export prices or stable, lower import prices.
Delving Deeper into Terms of Trade
Understanding the Determinants of TOT
Terms of Trade (TOT) provide a snapshot of economic health but can sometimes be misleading. Changes in both import and export prices affect the TOT, so it’s crucial to understand the underlying factors that cause these fluctuations. TOT measurements are often recorded in an index to monitor economic trends closely.
Factors Influencing TOT
TOT is affected by various elements, including exchange rates, inflation, and resource availability or scarcity. If a vendor has more goods to sell, they can generate more capital, which can further influence their purchasing power for imports. The size, quality, and cost of goods also play a significant role in shaping the TOT.
Impact of Improving or Deteriorating TOT
An improvement in TOT means a country can buy more imported goods for each unit of export sold. This can imply positive effects such as reduced prices for imported goods, which may help to combat cost-push inflation. However, adverse changes might reduce export volumes, affecting the balance of payments negatively.
The Prebisch-Singer Hypothesis
Emerging markets may experience declining TOT due to a generalized drop in commodity prices compared to manufactured goods, as indicated by the Prebisch-Singer hypothesis.
TOT in Real-World Example
In the early 2000s, developing countries saw a TOT increase during the commodity price boom. This allowed for higher purchases of consumer goods from abroad in exchange for commodities like oil and copper. However, increased globalization has subsequently reduced the price advantage of manufactured goods.
How to Calculate a Country’s Terms of Trade
To calculate TOT effectively:
- Divide the price index of exports by the price index of imports.
- Multiply this ratio by 100.
TOT = (Price of Exports / Price of Imports) x 100
What Rising Terms of Trade Imply
An increasing TOT usually signals that a country is exporting more relative goods than it’s importing, potentially leading to a trade surplus over time.
Strategies to Improve TOT
Improving the terms of trade can often be achieved by enhancing the competitiveness of domestic firms and managing currency exchange rates. Increased competitiveness leads to better international market positions, while favorable exchange rates make imports cheaper and boost export revenues.
Related Terms: Trade Surplus, Exchange Rate, Globalization, Balance of Payments.
References
- U.S. Bureau of Labor Statistics “Terms of Trade Indexes”.
- U.S. Bureau of Labor Statistics. “Terms of Trade Indexes”.
- U.S. International Trade Commission. “Prebisch-Singer Redux”. Pages 2-3.
- World Trade Organization. “Commodity Terms of Trade: The History of Booms and Busts”.
- SSRN. “Commodity Terms of Trade: The History of Booms and Busts”. Pages 13-15. Download PDF.
- International Monetary Fund. “Globalization: a Brief Overview”. Page 1.
- International Monetary Fund. “The Distribution of Gains from Globalization”. Pages 38-39. Download PDF.
