Russia: Goods and services trade with New Zealand

The NZ Parliamentary Library produced some data on the New Zealand’s trade with Russia. The most recent figures for the December 2021 quarter are:
Exports of goods and services to Russia – $75 million
Imports goods and services from Russia – $14 million

Total dairy exports to Russia were $168.9 million for the year ending June 2021. Of this total, butter represented $147.9 million, comprising 5.5% of New Zealand’s total for this commodity – Russia was New Zealand’s 4th largest butter destination in 2021.

Trade with Russia 2019 – 2021

Exports are mainly made up of dairy whilst imports are mineral fuels and oils – crude oil (well over 90%) and Russia was a moderately important source of crude oil imports (16% of New Zealand’s crude imports in 2020). With Marsden Point oil refinery coming offline in April, Korea and Singapore will in future become the main source of refined fuel. The last significant crude oil shipment from Russia was in January 2021. As at 31 March 2021 New Zealand’s total investment in Russia was worth $14 million, a decline from $48 million as at 31 March 2020. During the same period total Russian investment in New Zealand increased from $29 million to $40 million. The graphic on the right (click on it to expand) shows the origin of imports into New Zealand in 2020. Note that Russia has 0.53% of all imports into NZ.

The largest economic impact on New Zealand of the invasion would therefore be mainly indirect, through higher import fuel and commodity prices, instability of financial markets, and the impact on global economic activity.

Sources:

  • Potential impacts of the Russian Invasion of Ukraine on the New Zealand economy, February 2022. New Zealand Foreign Affairs.
  • New Zealand Parliamentary Library – Monthly Economic Review March 2022.

For more on Trade view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.

Economic Theory v Economic Reality

Invariably I get the question in class “Does this economic theory actually happen in the real world?” We then proceed to discuss upward sloping demand curves, trickle down theory, the GFC and the fact that few economists saw it coming and how Japan ran a massive stimulus programme but inflation was stagnant.

Most theories in economics rest on the premise that people, companies, and markets behave according to the abstract, two-dimensional illustrations of an introductory economics textbook, even though the assumptions behind those diagrams virtually never hold true in the real world. To understand economics you have to understand human nature.

Below is a table that I found in James Kwak’s book “Economism”. It takes theories found in most introductory economics textbooks and suggests what actually might happen to these theories in the real world.

For more on secondary school economics courses view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.

China and the economic centre of gravity

Very good FT video with Martin Sandbu and James Kynge discussing the fact that although the Chinese economy has grown at an alarming rate over the last 40 years, will it become the global superpower? Some of the main points:

  • Global economy is now becoming more regionalised
  • From 1979 to 2018 China’s GDP growth rate averaged 9.5%
  • 2,000 years ago everyone was poor – centre of gravity of global economy followed population size
  • Key change in the mid ’90s, when China began to allow the sons and daughters of farmers to migrate from the village to these big factory towns.
  • Liberalised global trade in 1980’s helped China access markets
  • China still very much a developing nations – ranks 61st in terms average per-capita income but got an excellent infrastructure.
  • China’s middle class approx 400m but that means approx 1bn of the population are poor
  • Middle income trap – getting from poor to middle income is a very different process from getting to middle income to high income.
  • Economy needs to change from a growth model based on accumulating labour and capital to a growth model led by technological development and technological progress.
  • China is either a global leader or at least close to the cutting edge, wind and solar power, online payment systems, digital currencies, aspects of artificial intelligence, 5G telecoms, drones, ultra-high-voltage power transmission.
  • Three major trading hubs – EU, US and China – with trade being more regionalised. China reluctant to lose export markets in EU and US as they are big drivers of exports
  • Three trading blocs will lead to protectionism and decoupling of supply chains. unless the EU, the US, and China can sort out their differences.

Maritime supply chain problems – mindmap

The maritime supply chain has been stretched to the limit over the last year and there have been a number of reasons for that. From a lack of containers to surges in global economy activity, as consumers shifting from buying services to buying goods, the freight time and cost have increased significantly. Below is a mindmap that looks at the major problems faced by the maritime supply chain last year.

Africa’s resource curse lingers on.

Africa may have enormous natural reserves of oil, but so far most Africans haven’t felt the benefit. In Nigeria, for instance, what’s seen as a failure to spread the country’s oil wealth to the country’s poorest people has led to violent unrest. However, this economic paradox known as the resource curse has been paramount in Africa’s inability to benefit from oil. This refers to the fact that once countries start to export oil their exchange rate – sometimes know as a petrocurrency – appreciates making other exports uncompetitive and imports cheaper. At the same time there is a gravitation towards the petroleum industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports. It is estimated that for every extra dollar in foreign currency earned from exporting resources reduces non-resource exports by $0.74 – Torfinn Harding of the NHH Norwegian School of Economics and Anthony Venables of Oxford University.

Economists also refer to this as the Dutch Disease which makes reference to Holland and the discovery of vast quantities of natural gas during the 1960s in that country’s portion of the North Sea. The subsequent years saw the Dutch manufacturing sector decline as the gas industry developed. The major problem with the reliance on oil is that if the natural resource begins to run out or if there is a downturn in prices, once competitive manufacturing industries find it extremely difficult to return to an environment of profitability.

According to the UN a country is dependent on commodities if they are more than 60% of its physical exports – in Africa that makes up 83% of countries. One of the major concerns for resource rich countries is the wild fluctuations in commodity prices which can lead to over investment – Sierra Leone created two new iron-ore mines in 2012 only for them to close in 2015 as prices collapsed. However the amount of jobs created in the mineral extraction industry is limited – across Sierra-Leone of 8m people, about 8,000 work in commercial mines. A major problem in these countries is that when there is money made from resources it tends to go on government salaries rather than investing in education. infrastructure and healthcare etc.

Norway – has a different approach.
In Norway hydrocarbons account for half of its exports and 19% of GDP and with further oil fields coming on tap Norway could earn an estimated $100bn over the next 50 years. Nevertheless there is a need to wean the economy off oil and avoid not only the resource curse that has plagued some countries – Venezuela is a good example as approximately 90% of government spending was dependent on oil revenue – but also the impact on climate change. Norwegians have been smart in that the revenue made from oil has been put into a sovereign wealth fund which is now worth $1.1trn – equates to $200,000 for every citizen. This ensures that they have the means to prepare for life after oil.

Source: The Economist – ‘When you are in a hole…’ January 8th 2022

AS Revision – Tariffs and Protectionism

Just completed a 3 day CIE AS Revision Course.  I talked about Tariffs and Protectionism which is in Unit 4 of the AS course and how it can be a popular ‘Discuss’ question in the essay paper (Paper 2). However you will be expected to know this at A2 level also. Remember the following reasons for barriers to trade:

Why Protectionism?
a) Safeguard home country employment
b) Correct balance of payments disequilibria
c) Prevent labour exploitation in developing countries (or other political – not economic – goals)
d) Prevent Dumping
e) Safeguard infant industries

Below is useful mindmap that I use for revision of the topic.

Source: CIE A Level Revision – Susan Grant

Record Terms of Trade for New Zealand – Q2 2021

New Zealand’s terms of trade rose by +3.3 % in the June quarter 2021, reaching a new record high.

Terms of Trade – Q2 2021

  • NZ terms of trade rose by +3.3%
  • Export prices rose by +8.3% due to increases in commodity prices dairy +15.3% and forestry prices +12.7%. were
  • Import prices rose by +4.8% due to commodity prices like fuel +27.1% and metals +12.5%

NZ’s high Terms of Trade highlights how NZ’s role as a food exporter will likely provide the NZ economy with some buffer as the global economy is rocked by the COVID-19 pandemic. But it is the general inflationary aspects of trade prices that is a concern as the 4.8% increase in goods import prices adds to inflation pressure. This is especially prevalent with import prices of consumption goods increasing by 6.3%. This price rise is driven by higher prices offshore rather than fluctuations in the NZ$ which was fairly flat during early part of the year.

What is the Terms of Trade.
The terms of trade index measures the value of a unit of exports in terms of the number of imports it can buy, or the purchasing power of our exports. This is similar to comparing the number of sheep exports that will buy a typical imported family car, from one time to another.

Formula: Terms of Trade (TOT) =

Export Price Index (Px)           x   1000 (base year)
Import Price Index (Pm)

  • An increase in the TOT (e.g. from 1050 to 1200) is called “favourable”
  • A decrease in the TOT (e.g. from 1050 to 970) is called “unfavourable”

A “favourable” (increase) in the TOT may come about because the average:

– export price rose and import price stayed the same
– export prices rose faster than import prices
– export prices stayed the same and import prices fell
– export prices fell but import prices fell faster

The index number that results tells us whether merchandise export price movements have been favourable relative to import price movements. An increase in the terms of trade from 1000 to 1100 represents an increase in the purchasing power of our exports of 10% which means, other things being equal, we would be able to buy 10% more from overseas. As a country we would be wealthier. A decline in the terms of trade would result in the opposite situation.

Limitations of the Terms of Trade

Terms of trade calculations do not tell us about the volume of the countries’ exports, only relative changes between countries. To understand how a country’s social utility changes, it is necessary to consider changes in the volume of trade, changes in productivity and resource allocation, and changes in capital flows.

The price of exports from a country can be heavily influenced by the value of its currency, which can in turn be heavily influenced by the interest rate in that country. If the value of currency of a particular country is increased due to an increase in interest rate one can expect the terms of trade to improve. However this may not necessarily mean an improved standard of living for the country since an increase in the price of exports perceived by other nations will result in a lower volume of exports. As a result, exporters in the country may actually be struggling to sell their goods in the international market even though they are enjoying a (supposedly) high price. An example of this is the high export price suffered by New Zealand exporters since mid-2000 as a result of the historical mandate given to the Reserve Bank of New Zealand to control inflation.

In the real world of over 200 nations trading hundreds of thousands of products, terms of trade calculations can get very complex. Thus, the possibility of errors is significant.

Evaluation

  • 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.
  • 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 Less Developed Countries (LDCs) 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.



Will China’s dominance be more regional than global?

Below is a very good video with FT’s global China editor James Kynge and FT economics commentator Martin Sandbu. They discuss whether China will dominate global commerce or whether the world economy could split along regional lines. They also give a good account of the growth of China since the 1970’s. The main points from the video follow.:

  • China – major player in the global economy forever more but not the centre of a global economy, partly because other parts of the world will not be keen to let it and global economy starting to become more regionalised rather than globalised.
  • China growth – 1979 to 2018, GDP growth averaged 9.5 per cent a year.
  • Global centre of gravity – last 40 years has moved towards China
  • How did China grow? – late ‘70s market reforms and attracting foreign direct investment. Significant reason was in mid ‘90s, when the sons and daughters of farmers were allowed to migrate from the village to big factory towns. Western countries were pursuing globalisation at the time so China’s cheap production costs were a popular option
  • China still a poor country – ranks 61st and the world in terms of countries by their average per-capita incomes. China is still very much a developing nation. But it’s a very different type of economy, from the type of developed country that we can see elsewhere in the world. China’s middle class – 400m people. But there are a billion Chinese that are much less well-off.
  • China and the middle income trap – getting from poor to middle income is a very different process from getting to middle income to high income.
  • Chinese consumers last year spent about $7.3tn – greater than the entire GDP of the Japanese economy. But now I think we’re entering a very different phase. And that one is characterised by China’s emergence as a technological power.
  • China leads the world in many technologies. – wind and solar power, online payment systems, digital currencies, aspects of artificial intelligence, 5G telecoms, ultra-high-voltage power transmission.
  • Within the world trading system there are three hubs – Germany – China – USA. However trade relationships seem to be more regional within these hubs and it is suggested that China will become more dominant on a regional basis rather than global.

New Zealand looks to UK and EU for export markets

Concerned with a dependence on the Chinese market for its exports, New Zealand has agreed to the implementation of trade deals with the UK and the EU. Negotiations have been going in the background of rising tensions in the Pacific especially between China and Australia. However being too reliant on one market is a risky business as is depending on one resource to generate export income – the resource curse.

Background to New Zealand’s trade with China
On 7th April 2008 New Zealand became the first OECD country to sign a free trade deal with China. However this is not the only first with regard to the relationship between the two countries. New Zealand was the first to negotiate a WTO accession agreement with China as well as the first to recognise China as a “market economy”. With this in mind, the Chinese government have acknowledged the support of New Zealand by granting them the first bi-lateral agreement with a western nation.

Today China is New Zealand’s largest trade partner, accounting for NZ$19bn (US$13.5bn) exports in the year to the end of March, a quarter of its total exports. The deal with the UK would involve tariff cuts on New Zealand farm exports including dairy, lamb and beef but this would be a concern for UK farmers especially as they have now left the protectionist EU subsidies.

New Zealand trade destinations – March 2020 – March 2021

Source: FT

New Zealand’s export risk exposure to China.

On 7th April 2008 New Zealand became the first OECD country to sign a free trade deal with China, an economy which in the 1970’s was one of the poorest countries in the global economy. Today China is the world’s second largest economy and the fastest growing at a rate around 7% per year. China is now comfortably New Zealand’s largest export market, accounting for the largest share of our exports in all but a few sectors.

Source: Westpac Bank

In 2017, China surpassed Australia and became our largest export market. But as exporters’ focus has switched to China, New Zealand’s exports have become less diversified, exposing exporters to concentration risk.

Westpac Bank reported in their November 2020 Quarterly Overview that while the New Zealand-China trade relationship is strong, China could in the future choose to disrupt New Zealand exports. Recently Australian exports into China had the following restrictions imposed on them:

  • 80% tariff on Australian barley exports
  • ban on Australia’s biggest grain exporter
  • suspension of beef imports from five major meat-processing plants
  • China has also launched an anti-dumping investigation into Australian wine exports
  • Chinese cotton mills were told not to process Australian imports

At a high level, NZ-China trade flows reflect each economy’s comparative advantage and because of this trade relationship New Zealand faces less risk exposure. The risk exposure really depends on how important New Zealand’s export supply is to China and the other markets where the product/service can be sourced which includes other countries as well as domestically.

More Options = More Risk

China exposure risk by export sector

Westpac Bank

High risk
It seems that tourism, seafood, and gold kiwifruit have the highest exposure. For these exports, essentially China has options (including domestically) for alternate supply. Education (universities and English language schools) also faces similarly high risk.

Also kiwifruit as New Zealand only account for 4.5% of China’s total fruit imports. China does have a competitive domestic horticulture industry which has started to grow Zespri’s Sungold kiwifruit variety.

Medium risk
Wood and wider fruit sectors – have medium exposure risk. New Zealand accounts for a relatively significant share of global meat and wood exports, so China is reliant on New Zealand.
Meat – China also recognises New Zealand as a reliable and safe exporter. Looking at the wider fruit sector, exporters remain relatively diversified and thus less reliant on China.

Low risk
Dairy – in a strong position as China imports around 50% of its dairy produce from New Zealand.
Wine – China is a small market for New Zealand, so the sector’s reliance on China is also small.

Overall the complementary nature of the NZ China trade relationship means New Zealand’s risk exposure is less than the outright level of exports would suggest.
China needs New Zealand’s food (and wood) as it cannot produce enough (efficiently) on its own – while New Zealand remains the most competitive supplier. New Zealand needs China’s manufactured goods – while China remains the most competitive supplier.

Source: New Zealand’s exports to China: where is New Zealand most exposed? Westpac Economic Bulletin – 8 October 2020

Is China still influencing the value of the yuan?

I have blogged quite a bit on this topic and refer back to a very good video clip from PBS Newshour on how the Chinese authorities influenced the value of the yuan back in 2010.

Basically at 9.15am the Peoples Bank of China (Central Bank) and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the Renminbi to the US$ for today. When companies sell goods overseas the US$ etc that they acquire are then exchanged for Renminbi with the Central Bank – therefore the Central Bank accumulates significant amounts of US$.

Today it could be said that China has done well economically relative to other countries largely due to its large trade surplus. However one would think that with a large trade surplus the yuan would increase in value as there is a greater demand for the currency in order to buy China’s exports. This raises the question as to whether China has been manipulated its currency in order to maintain its competitive edge in the export market.

  • When a country’s currency is getting too strong the governments/central banks sells its own currency and buys foreign currency – usually US$.
  • When a country’s currency is getting too weak the governments/central banks sells its foreign currency – usually US$- and buys its own currency.

For two decades until mid-2014 China’s prodigious accumulation of foreign-exchange reserves was the clear by-product of actions to restrain the yuan, as the central bank bought up cash flowing into the country. A sharp drop in reserves in 2015-16 was evidence of its intervention on the other side, propping up the yuan when investors rushed out. Since then, China’s reserves have been uncannily steady. This year they have risen by just 1%. Taken at face value, the central bank seems to have refrained from intervening. That is certainly what it wants to convey, regularly describing supply and demand for the yuan as “basically balanced”.
Source: The Economist – “Caveat victor” – October 31st 2020

With the surge in China’s trade surplus the yuan has remained fairly stable and with this you would expect that there would be an increase in foreign exchange reserves with Chinese authorities buying foreign exchange with yuan.

A couple reasons why this may not be the case:

  • Commercial banks foreign assets have increased by US$125bn since April. The commercial banks are state owned so it is plausible that the government has used them as a substitute. Adding these foreign reserves to the offical figures suggests invention to keep the yuan at an artificially lower rate. There is the possibility that the central bank has special trading accounts at the state banks. Also exporters have wanted to keep their US$ as they are worried that the disharmony with the US could damage the yuan.
  • The central bank made it cheaper to short the yuan in forward trades – shorting a currency means that the trader believes that the currency will go down compared to another currency.
  • Chinese officials want the yuan to be volatile but within a narrow range in order to convince other countries that they are not intervening whilst persuading people in the market that they will intervene if necessary.

Caught between a rock and a hard place

The Peoples Bank of China (PBOC) are trying to protect domestic producers by keeping a weak yuan so to make Chinese products attractive to overseas buyers. At the same time they are trying to prevent domestic capital from flowing too quickly out of China to stronger currencies. However a longer term scenario is that China would like the yuan to be more prevalent as a currency in the global market. The yuan currently accounts for approximately 2% of global foreign exchange reserves, although by 2030 it is estimated that it will account for 5% to 10% of global foreign exchange reserve assets.

Source: The Economist – “Caveat victor” – October 31st 2020

US Farm subsidies and EU dump cost New Zealand farmers

Donald Trump’s subsidies to US farmers (see below) could be above what is allowed under international trade rules and it has been suggested that subsidies in 2020 will make up 36% of farm incomes.

US farm subsidies

  • 2018 – US$12bn
  • 2019 – US$16bn

This year US farm incomes are set to drop 15% even after the payment of subsidies and billions of dollars have been set aside to assist the farming sector. New Zealand officials are concerned that the subsidies given to US farmers will exceed the US$19billion which is the WTO’s limit. They want formal notification of payments in 2020 and how the US plans to reduce this assistance to farmers. The EU, China, India and China are asking similar questions of the US.

Source: Tutor2u

Subsidies distort trade and entice farmers to keep producing even though prices are falling – see graph . This output tends to be inefficiently produced and would not be competitive in a normal market free of subsidies.What the subsidies did in New Zealand was to encourage people to develop land that was not really suitable for any agricultural use. However as they got a subsidy from the government efficiency or quality didn’t feature as a major factor in maintaining competitiveness. With subsidies prices take longer to recover their former levels while excess supply is worked through as was the case in 2018 and 2019 when the EU dumped subsidised skim milk powder on the global market. But the support package to the US farmers is very significant and has the potential to negatively impact those countries that have unsubsidised farmers.

The Dairy Companies Association of NZ’s (DCANZ) executive director Kimberly Crewther says while other countries had propped up their farmers since the start of the pandemic the US was “way out in front” with the size of its support programmes. 
That was concerning given the growth trajectory the US dairy industry was currently on.
“They have the potential to become the world’s largest dairy exporter, but that is going to come at a high cost to unsubsidised producers and not just exporters like NZ if that growth is coming from subsidies,” she said.

EU dumping has NZ Farmers lose $500m
The dumping of subsidised skim milk powder (SMP) by the EU in 2018 is estimated to have cost New Zealand farmers $500m. In 2016 the EU moved nearly 25% of its production into storage before dumping it on the market in 2018 and 2019 at discounted prices. The purchasing of SMP by the EU was done with the intention of putting a floor price under the low EU farm gate milk prices.
EU stocks – 378,000 tonnes in 2017 – 16% of global supply. Release of stocks onto the market had the estimated impact on prices:

World Price

Source: Tutor2u
  • 2018 – SMP prices down by 3.6%
  • 2019 – SMP prices down by 8.7%

US farm gate prices

  • 2018 – SMP prices down by 1.7%
  • 2019 – SMP prices down by 3.9%

The cost to NZ farmers is estimated at 30c per kg of milk solids in 2018 or 4.7% of the payout. The Eu was able to undercut competitors and increase its share of of the global SMP market from 30.6% in 2016 to 42.3% in 2019. New Zealand’s share fell from 23.5% to 16.3% over the same period.

Source: Farmers Weekly – November 9, 2020

AS Economics – Economic Integration

Although in the CIE syllabus only three stages of economic integration are mentioned there are actually six stages between nations, ranging from the relatively weak to more complex and stronger associations.

1. Preferential Trading Area – weakest form of integration. Nations agree to give preferential access to certain products from overseas countries. The EU (European Union) and countries of the ACP (African, Caribbean and Pacific) have formed Preferential Trading Area.

2. Free Trade Area – most common type of integration. Nations permit an agreed list of products to be traded tariff free. However those nations can set their own tariffs between themselves and nations outside the agreement. EG. NAFTA, EEA and APEC

3. Customs Union – same as FTA but all member nations agree a set of standard tariff levels between themselves and outside nations. This is known as the Common External Tariff (CET).

4. Common Market – same as Customs Union but is more complex in that it involves the establishment of common laws relating to the economy, trade, and employment and a common form of taxation between member nations.

5. Economic and Monetary Union – one trade barrier that a Common Market does not eradicate is the presence of different currencies although Economic and Monetary Union does not necessarily involve a single currency. It is where member nations irrevocably fix their exchange rates to one another.

6. Complete Economic Integration – all of the above but also includes considerable political integration as well. Nations embark on harmonization of economic policies and there tends to be the development of a supranational state making decisions on behalf of member nation’s governments.

Economic integration has the potential to benefit all parties involved and create additional economic welfare. It also brings nations together politically and culturally which again, can be a positive.

Examples of Regional Trade Agreements (RTAs):

  • The number of RTAs has risen from around 70 in 1990 to over 300 today
  • The European Union (EU) – a customs union, a single market and now with a single currency
  • The European Free Trade Area (EFTA)
  • The North American Free Trade Agreement (NAFTA) – created in 1994
  • Mercosur – a customs union between Brazil, Argentina, Uruguay, Paraguay and Venezuela
  • Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA)
  • Common Market of Eastern and Southern Africa (COMESA)
  • South Asian Free Trade Area (SAFTA) created in January 2006 and containing countries such as India and Pakistan

Record Terms of Trade for New Zealand – Q2 2020

New Zealand’s terms of trade rose by 2.5 percent in the June quarter, reaching a new record high.

Terms of Trade – Q2 2020

  • Export prices rose by 2.4 percent – forestry product prices rising by 11.1%, and dairy product prices by 4.1%.
  • Import prices fell by 0.1 percent in the quarter, driven by lower petroleum and petroleum product prices. This is despite higher prices for cellphones, televisions and laptops.

NZ’s high Terms of Trade highlights how NZ’s role as a food exporter will likely provide the NZ economy with some buffer as the global economy is rocked by the COVID-19 pandemic.

What is the Terms of Trade.
The terms of trade index measures the value of a unit of exports in terms of the number of imports it can buy, or the purchasing power of our exports. This is similar to comparing the number of sheep exports that will buy a typical imported family car, from one time to another.

Formula: Terms of Trade (TOT) =

Export Price Index (Px)           x   1000 (base year)
Import Price Index (Pm)

  • An increase in the TOT (e.g. from 1050 to 1200) is called “favourable”
  • A decrease in the TOT (e.g. from 1050 to 970) is called “unfavourable”

A “favourable” (increase) in the TOT may come about because the average:

– export price rose and import price stayed the same
– export prices rose faster than import prices
– export prices stayed the same and import prices fell
– export prices fell but import prices fell faster

The index number that results tells us whether merchandise export price movements have been favourable relative to import price movements. An increase in the terms of trade from 1000 to 1100 represents an increase in the purchasing power of our exports of 10% which means, other things being equal, we would be able to buy 10% more from overseas. As a country we would be wealthier. A decline in the terms of trade would result in the opposite situation.

Limitations of the Terms of Trade

Terms of trade calculations do not tell us about the volume of the countries’ exports, only relative changes between countries. To understand how a country’s social utility changes, it is necessary to consider changes in the volume of trade, changes in productivity and resource allocation, and changes in capital flows.

The price of exports from a country can be heavily influenced by the value of its currency, which can in turn be heavily influenced by the interest rate in that country. If the value of currency of a particular country is increased due to an increase in interest rate one can expect the terms of trade to improve. However this may not necessarily mean an improved standard of living for the country since an increase in the price of exports perceived by other nations will result in a lower volume of exports. As a result, exporters in the country may actually be struggling to sell their goods in the international market even though they are enjoying a (supposedly) high price. An example of this is the high export price suffered by New Zealand exporters since mid-2000 as a result of the historical mandate given to the Reserve Bank of New Zealand to control inflation.

In the real world of over 200 nations trading hundreds of thousands of products, terms of trade calculations can get very complex. Thus, the possibility of errors is significant.

Evaluation

  • 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.
  • 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 Less Developed Countries (LDCs) 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.



Do imports slow GDP growth?

A book published this year ‘Fully Grown: Why a Stagnant Economy Is a Sign of Success’ Dietrich Vollrath addresses the issue – is growth the best way to measure economic success — and does a slowdown indicate problems in an economy?

He discusses that the slowdown (Pre-Covid) is an indicator of economic prosperity. The economy has already provided much of what we need in life – comfort, security and luxury – that we have turned to new forms of production and consumption that enhance our well-being but do not contribute to growth in GDP. One chapter looks at the increase in imports from China and how it doesn’t necessarily have any connection with the level of GDP or growth rate. It is commonly portrayed in the media that imports from China have a negative effect on US GDP and you can say that they do impact on employment levels in certain sectors – e.g. manufacturing industry. This can lead to a slowdown in growth if workers didn’t find alternative employment. According to Vollrath the size of imports from China looks too small to account for the growth slowdown.

There is an assumption that imports lower GDP but most introductory economics courses refer to GDP with the following:

Y = C + I + G + (X-M)

Y = GDP, C = Consumption, I = Investment, G = Government spending, (X-M) = Exports – Imports
With this equation if imports are higher, it must be that GDP is lower. The right hand side of the equation is just a way of accounting for GDP; it does not determine the size of GDP. Vollrath now puts imports on the other side of the equation so you have:

Y + M = C + I + G + X

The above equation helps given the common way that people understand the relationship if they imagine that M goes up, they’ll jump to the conclusion that one of the items on the right (C + I + G + X) must have gone up as well.

Y + M is the total goods and services available in a given year which we can purchase. The other side of the equation represents the purchasing of these goods and services whether it is consumption goods, capital good, government purchases and foreign purchases. An increase in imports means that there are more goods and services to purchase. But there is no necessary mechanical effect of having more imports on the size of our own production, GDP.

Domestic tourists needed to bolster GDP in NZ

Although in New Zealand the containment of the Covid-19 has so far been successful, with no international visitors the tourism sector has seen a sharp downturn. Those that have suffered most are the smaller operators and bars, restaurants, accommodation providers. Even with the wage subsidy a lot of these firms have been forced out of business. Domestic tourism will be essentially for the survival of a lot of the tourist spots around the country. The return of overseas visitors is some way off and even when restrictions are lifted visitor numbers are likely to be limited.

Visitor arrivals in New Zealand

Source: Westpac Economic Overview – May 2020

Before Covid-19, Tourism was New Zealand’s largest export industry in terms of foreign exchange earnings. It directly employed 8.4 per cent of the New Zealand workforce. For the year ended March 2019:

  • the indirect value added of industries supporting tourism generated an additional $11.2 billion, or 4.0 percent of GDP.
  • tourism as whole generated a direct contribution to gross domestic product (GDP) of $16.2 billion, or 5.8 percent of GDP.
  • international tourism expenditure increased 5.2 percent ($843 million) to $17.2 billion, and contributed 20.4 percent to New Zealand’s total exports of goods and services.

As the economy struggles along people will be concerned about job security and look to be a lot more cautious with spending. However having been restricted during the lockdown there is the hope that New Zealanders will want to travel domestically.

Source: Tourism New Zealand