the prebisch singer hypothesis

Prebisch-Singer Thesis: Assumptions and Criticisms | Trade | Economics

In this article we will discuss about:- 1. Introduction to Prebisch-Singer Thesis 2. Assumptions in the Prebisch-Singer thesis 3. Criticisms.

Introduction to Prebisch-Singer Thesis:

There is empirical evidence related to the fact that the terms of trade have been continuously moving against the developing countries. On the basis of exports statistics concerning the United Kingdom between 1870 and 1940, Raul Prebisch demonstrated that the terms of trade had secular tendency to move against the primary products and in favour of the manufactured and capital goods.

This viewpoint has been strongly supported by H. W. Singer. The essence of Prebisch-Singer thesis is that the peripheral or LDC’s had to export large amounts of their primary products in order to import manufactured goods from the industrially advanced countries. The deterioration of terms of trade has been a major inhibitory factor in the growth of the LDC’s.

Prebisch and Singer maintain that there has been technical progress in the advanced countries, the fruit of which have not percolated to the LDC’s. In addition, the industrialised countries have maintained a monopoly control over the production of industrial goods. They could manipulate the prices of manufactured goods in their favour and against the interest of the LDC’s.

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Except the success of OPEC in raising the prices of crude oil since mid 1970’s, there has been a relative decline in the international prices of farm and plantation products, minerals and forest products. Consequently, the terms of trade have remained unfavourable to the developing countries.

Assumptions in the Prebisch-Singer thesis:

The main assumptions in the Prebisch-Singer thesis are as under:

(i) As income rises in the advanced countries, the pattern of demand shifts from primary products to the manufactured products due to Engel’s law.

(ii) There is slow rise in demand for products in the developed countries.

(iii) The export market for product of LDC’s is competitive.

(iv) The export market for products of developed countries is monopolistic.

(v) Wages and prices are low in LDC’s.

(vi) The appearance of substitutes for products of LDC’s reduces demand for them.

(vii) The benefit of increased productivity is not passed by the producers of manufactured products in advanced countries to the LDC’s through lower prices.

(viii) The economic growth in the LDC’s is indicated by income terms of trade.

Singer has pointed out that the recent increase in debt problem of the LDC’s has imparted another twist to the hypothesis of secular deterioration of terms of trade for them in two ways. Firstly, a high proportion of proceeds from exports are not available for imports.

Secondly, there is an increased pressure upon the LDC’s to raise exports in order to repay external debts on account of IMF-induced adjustment polices. These pressures make the debt- ridden LDC’s to compete with other poor countries to enlarge their export earnings. It results in decline in the prices of export products of these countries.

Criticisms of Prebisch-Singer Thesis :

The Prebisch-Singer Thesis has come to be criticized on several grounds:

(i) Not Firm Basis for Inference:

The inference of secular deterioration of terms of trade for the LDC’s rests upon the exports of primary vis-a-vis manufactured products. In this regards, it should be remembered that the LDC’s export wide variety of primary products. Sometimes they export also certain manufactured products.

They, at the same time, do not import only manufactured products but also a number of primary products. It is, therefore, not proper to draw a firm inference about terms of trade just on the basis of primary versus manufactured exports.

(ii) Faulty Statement of Gains and Losses of Primary Exporters:

Jagdish Bhagwati has pointed out that the index of terms of trade employed in this thesis understates the gains of exporters of primary products. At the same time, there is over­statement of losses of primary producers.

(iii) Faulty Index of TOT:

The Prebisch- Singer hypothesis rests upon the index, which is the inverse of the British commodity terms of trade. This index overlooks the qualitative changes in products, appearance of new varieties of products, services like transport etc. The generalisation based on British terms of trade for the period 1870 to 1930, according to Kindleberger, is not true for the other developed countries of Europe.

(iv) Neglect of Supply Conditions:

In the determination of terms of trade, the Prebisch-Singer thesis considers only demand conditions. The supply conditions, which are likely to change significantly over time, have been neglected. The relative prices, in fact, depend not only upon the demand conditions but also on the supply conditions.

(v) Little Effect of Monopoly Power:

One of the arguments in support of this thesis was that the higher degree of monopoly power existing in industry than in agriculture led to secular deterioration of terms of trade for the developing countries. In this connection, it was also agreed that the monopoly element prohibited the percolation of benefits of technical progress to the LDC’s. The empirical evidence has not supported such a line of argument.

(vi) Inapplicability of Engel’s Law:

The secular decline in the demand for primary products in developed countries was attributed to Engel’s Law. But this is not true because this law is applicable to food and not to the raw materials, which constitute sizeable proportion of exports from, the LDC’s.

(vii) Benefits from Foreign Investment:

The deterioration of the terms of trade for the LDC’s is sometimes linked not to non-transmission of productivity gains to them by advanced countries through lower prices of manufactured goods, yet the benefits from foreign investments have percolated to the LDC’s through the product innovations, product improvement and product diversification. These benefits can amply offset any adverse effects of foreign investment upon terms of trade and the process of growth.

(viii) Difficult to Assess Variation in Demand for Primary Products:

The secular deterioration in terms of trade of the LDC’s during 1870 to 1930 period was supposed to be on account of the declining world demand for primary products. During that period, there were tremendous changes in world population, production techniques, living standards and means of transport. Given those extensive developments, it is extremely difficult to assess precisely the changes in world demand for primary products and the impact of those changes upon the terms of trade.

(ix) Export Instability and Price Variations:

The Prebisch-Singer thesis suggested that export instability in the LDC’s was basically due to variations in prices of primary products relative to those of manufactured products. Mc Been, on the contrary, held that the export instability in those countries could be on account of quantity variations rather than the price variations.

(x) Development of Export Sector not at the Expense of Domestic Sector:

In this thesis, Singer contended that foreign investments in poor countries, no doubt, enlarged the export sector but it was at the expense of the growth of domestic sector. This contention is, however, not always true because the foreign investments have not always crowded out the domestic investment. If foreign investments have helped exclusively the growth of export sector, even that should be treated as acceptable because some growth is better than no growth. It is far­fetched to relate worsening of terms of trade to the non-growth of domestic sector.

(xi) Faulty Policy Prescription:

Prebisch prescribed the adoption of protectionist policies by LDC’s to offset the worsening terms of trade. Any gains from tariff or non-tariff restrictions upon imports from advanced countries can at best be only short-lived because they will provoke retaliatory actions from them causing still greater injury to the LDC’s.

In the present W.TO regime of dismantling of trade restrictions, Prebisch suggestion is practically not possible to implement. There should be rather greater recourse to export promotion, import substitution, favourable trade agreements and adoption of appropriate monetary and fiscal action for improving the terms of trade in the developing countries.

(xii) Lack of Empirical Support:

The studies made by Morgan, Ellsworth, Haberler, Kindelberger and Lipsey have not supported the secular deterioration of terms of trade hypothesis, Lipsey has observed, “Although there have been very large swings in U.S. terms of trade since 1879, no long term trend has emerged. The average level of U.S. terms of trade since World War II has been almost the same as before World War I.” This objection of lack of empirical support against the Prebisch-Singer hypothesis is actually not very sound. A number of more recent empirical studies have, in fact, gone in favour of this hypothesis.

Despite all the objections raised against the Prebisch-Singer thesis, the empirical evidence has accumulated in support of it. The studies made by UNCTAD for 1950-61 and 1960-73 periods showed that there was a relative decline in the terms of trade of LDC’s vis-a-vis the developed countries. A study attempted by Thirlwall and Bergevin for the period 1973-82 indicated that there was an annual decline of terms of trade of LDC’s for all the primary commodity exports at the rate of 0.36 percent.

On the basis of their study related to exports of manufactured products for LDC’s to the advanced countries during 1970-87 period, Singer and Sarkar found that the terms of trade of LDC’s declined by about 1 percent per annum. Even the World Development Report 1955 recognised that the world prices of primary products declined sharply during I980’s and the terms of trade of LDC’s deteriorated during 1980-93 period.

According to the 1997 Human Development Report of UNDP, the terms of trade for the least developed countries declined by a cumulative 50 percent over the past 25 years. According to South Commission, compared with 1980, the terms of trade of developing countries had deteriorated by 29 percent in 1988. The average real price of non-oil commodities had declined by 25 percent during 1980-88 period compared with the previous two decades. The terms of trade of non-oil developing countries had deteriorated during 1980-88 period by 8 percent compared with 1960’s and 13 percent compared with 1970’s.

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Study Notes

The Prebisch Singer Hypothesis

Last updated 15 Jul 2024

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This study note for A Level and IB economics considers the Prebisch Singer Hypothesis

The Prebisch-Singer Hypothesis, formulated in the mid-20th century by Raúl Prebisch and Hans Singer, posits that the terms of trade for primary commodities relative to manufactured goods tend to deteriorate over time. This hypothesis has significant implications for the economic development of countries reliant on primary commodity exports.

Key Components of the Prebisch-Singer Hypothesis

• Terms of trade refer to the ratio of export prices to import prices. A deterioration means that a country has to export more to import the same amount of goods.
• According to the hypothesis, the terms of trade of primary commodities decline relative to manufactured goods over time.
• Technological Progress: Technological advancements in manufacturing lead to productivity gains that are not mirrored in the primary commodities sector.
• Income Elasticity of Demand: Demand for manufactured goods grows more rapidly than for primary commodities as incomes rise.
• Market Structure: Primary commodity markets tend to be more competitive, while manufacturing markets can be more oligopolistic, allowing firms to retain more benefits from productivity improvements.
• Countries that rely heavily on exporting primary commodities face declining terms of trade, reducing their ability to import necessary goods for development.
• This can lead to persistent trade deficits and hinder economic growth.

Application of the Prebisch-Singer Hypothesis

• In the mid-20th century, many Latin American countries experienced declining terms of trade, validating Prebisch's observations and leading to policy shifts towards industrialization and import substitution.
• Many Sub-Saharan African countries still rely on primary commodities and face similar issues with terms of trade deterioration, affecting their economic stability and growth prospects.

Contributions of Key Economists

• An Argentine economist who observed the adverse effects of declining terms of trade on Latin American economies and advocated for structural economic changes.
• A German-born British economist who independently reached similar conclusions about the long-term decline in commodity terms of trade and its impact on developing countries.
• Contributed to structuralist economic thought, emphasizing the need for industrialization in developing countries to overcome dependency on primary commodities.
• Critiqued neoclassical economics and contributed to the understanding of economic development issues, supporting the need for diverse economic strategies in developing countries.

Timeline of Key Economic Events and Policy Responses

• 1950: Publication of Prebisch's and Singer's seminal works on the declining terms of trade.
• 1950s-1960s: Latin American countries adopt import substitution industrialization (ISI) policies.
• 1970s: OPEC oil embargo highlights the vulnerability of primary commodity-dependent countries to terms of trade shocks.
• 1980s-1990s: Shift towards neoliberal policies and structural adjustment programs in many developing countries.
• 2000s: Rising commodity prices temporarily reverse terms of trade trends, but concerns about long-term sustainability persist.

Critique of the Model

• Empirical Validity: Some studies have shown periods where the terms of trade for primary commodities improved, challenging the hypothesis.
• Policy Implications: Import substitution industrialization (ISI) policies inspired by the hypothesis often led to inefficiencies and economic distortions.
• Simplistic Dichotomy: The model's focus on primary commodities vs. manufactured goods oversimplifies the complexity of global trade.
• Neglect of Services: The rise of the services sector in both developed and developing countries is not addressed by the hypothesis.
• Import Substitution Industrialization (ISI): A trade and economic policy which advocates replacing foreign imports with domestic production.
• Income Elasticity of Demand: The responsiveness of the demand for a good to a change in income.
• Oligopolistic Market: A market structure in which a few firms dominate the market.
• Primary Commodities: Raw materials and agricultural products that are typically exported by developing countries.
• Terms of Trade: The ratio of export prices to import prices.

Essay-Style Questions

• Discuss the main arguments of the Prebisch-Singer Hypothesis and its implications for developing countries.
• Evaluate the empirical evidence for and against the Prebisch-Singer Hypothesis.
• How did the Prebisch-Singer Hypothesis influence economic policies in Latin America in the mid-20th century?
• Analyze the relevance of the Prebisch-Singer Hypothesis in the context of the modern global economy.
• Compare and contrast the Prebisch-Singer Hypothesis with the Dependency Theory of economic development.

Recommended Articles and Papers

• Prebisch, R. (1950). "The Economic Development of Latin America and its Principal Problems." United Nations. https://repositorio.cepal.org/...
• Singer, H. W. (1950). "The Distribution of Gains between Investing and Borrowing Countries." American Economic Review, 40(2), 473-485. http://www.jstor.org/stable/18...
• Furtado, C. (1970). "Economic Development of Latin America: A Survey from Colonial Times to the Cuban Revolution." Cambridge University Press. https://www.cambridge.org/core...
• Thirlwall, A. P. (2011). "Economics of Development: Theory and Evidence." Palgrave Macmillan. https://www.palgrave.com/gp/bo...
• Ghosh, J. (2003). "Economic Globalization and Developing Countries: Which Way Now?" Economic and Political Weekly, 38(35), 3709-3711. http://www.jstor.org/stable/44...

These notes provide a comprehensive overview of the Prebisch-Singer Hypothesis, its key components, applications, critiques, and contributions from notable economists. They also offer additional resources, potential essay questions, and a glossary to deepen students' understanding of the topic.

• Prebisch-Singer Hypothesis
• Raul Prebisch

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Declining Terms of Trade

• The Terms of trade refer to the relative price of exports/imports.

• A decline in the terms of trade means the price of exports falls relative to imports. Imports become more expensive.
• Typically a country will have lower living standards and less ability to import.

Impact of decline in terms of trade on a developing economy

Suppose a developing country exports coffee beans and imports manufactured goods.

• A decline in the terms of trade will mean a country will see the price of coffee beans fall relative to the price of imported manufactured goods. This means it has to export relatively more coffee beans to get the same quantity of manufactured goods.
• A prolonged fall in the terms of trade could be seen as a problem because it can lead to declining living standards and lower GDP.
• It could also reduce export revenue and make it harder to pay foreign external debt. This would be a problem for developing economies with high external debt. TO meet the debt repayments may require a relatively higher percentage of national income on meeting repayments in foreign currency.

Cost of decline in terms of trade

World Bank estimates suggest that between 1970 and 1997 declining terms of trade cost non-oil-exporting countries in Africa the equivalent of 119 percent of their combined annual gross domestic product (GDP) in lost revenues. It will also be more difficult to earn more foreign currency to pay external debt. [1. State of Agricultural Markets FAO]

Many developing countries concentrate on producing primary products, but according to The Prebisch-Singer hypothesis, there is likely to be a fall in the terms of trade when you concentrate on primary products. This is because:

• Low income elasticity of demand. As incomes rise, demand doesn’t rise so much.
• Increased productivity (fertilizers e.t.c.) increases supply and reduces price.

Between 1961 and 2001, the average prices of agricultural commodities sold by LDCs fell by almost 70 percent relative to the price of manufactured goods purchased from developed countries [2. The State of Agricultural Markets 2004 FAO ]

• A decline in the terms of trade is not necessarily a bad thing. For example, a decline in the terms of trade may occur due to a devaluation in the exchange rate. This devaluation may enable a country to regain competitiveness and increase the quantity of exports. For example, the UK in 1992 benefited from a decline in the terms of trade.
• The impact of a decline in the terms of trade will depend on the elasticity of demand. If demand is elastic, the lower price of exports will cause a bigger % increase in demand.
• Some LDC’s have seen an improvement in terms of trade because of rising price of commodities and food post-2008. It is not always LDCs who see a decline in the terms of trade.
• It is important to distinguish between a short-term decline in terms of trade and a long-term decline. A long-term decline is more serious for reflecting a fall in living standards.
• Terms of trade and balance of trade
• Terms of trade effect in the UK

3 thoughts on “Declining Terms of Trade”

Discuss the secular declining hypothesis of terms of trade and its implication to project management. And, explain also how it is also connected with an informal network circumventing the overriding objective of government, market and NGOs.

Could you send me this question correct answer.

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