The Fundamental Determinants of the Terms of Trade

The determination of the terms of trade is, at one and the same time, an esoteric technical problem in the pure theory of international trade and a highly charged emotional issue in world politics. The apparent incongruity is removed once we replace Marshall’s England and Germany with the contemporary fashion of dividing the world economy into a rich, industrialised North and a poor, primary producing South. In this context the terms of trade between these regions is an integral part of the mechanism determining the global income distribution and it is therefore no longer surprising that the intersection of reciprocal supply and demand curves causes passions to rise. Within a national economy the effects of the operation of the price system on the allocation of resources and the distribution of incomes can be mitigated by labour mobility and redistributive fiscal measures, both of which are largely absent between nations. For the past three decades spokesmen for the developing countries have contended that there is a secular tendency for their terms of trade to move unfavourably and that there is a systematic bias in the distribution of the gains from trade that runs against them. The farreaching proposals for a New International Economic Order are often put forward as measures of restitution to the Third World for past exploitation through the mechanism of declining terms of trade.