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Explain the Terms of Trade

  • Facts and figures
  • Which area are increasing/decreasing
  • Between Australia and China, Japan, UK, US, Germany, India, Indonesia, Korea.
  • Factors affecting this trade

In international economics the word “terms of trade” is the “ratio between the prices of goods export by a country over the price of import”.  Or in other words, the country which is specialised in certain products exported to other countries in order to earn money which is then used to import goods from other countries. Terms of trade is denoted as index price of export X 100  

Terms of trade (TOT) is used to check how strong the country’s economy is, which sometimes cause analyst to illustrate inaccurate conclusion. It is highly important to understand the reason why exports roses in relation to imports, because the changes that occur in prices of export and import mainly depend upon the terms of trade. If a country having advancement in terms of trade, in this case they can export their goods per unit in order to buy additional units of imported goods. Hence, increases in terms of trade provide benefits to countries that how many goods should be exported in order to import specific amount of other goods. It may also create a positive effect on domestic cost-push inflation, thus it drops the import prices in relation to export prices. On the other hand, some countries facing dramatic decrease in their export volume which causes deterioration in terms of trade. In this case countries have to export more goods in order to import certain quantity of products. (ECONOMICS ONLINE, 2008) According to prebisch-singer hypothesis, in many developing countries there is a decline of commodity prices as compare to manufactured goods. The prices of manufactured goods tends to decreases over last 15 years thanks to globalisation, the advantage which developed countries had over developing countries maybe started to decrease. (ECONOMICS, 2014)

From 1970 china’s development has inevitably increases from rural to urban areas which lead to accelerate in investment and manufacturing groundwork. This action accelerates in demand for certain things which include materials for building, power for electricity and transport followed by, raw material for manufacturing process. Australia was there to fulfil all the desired demand in china, as it was a ready market for Chinese manufactured goods. At present, china is the enormous trading partner of Australia in both term of import and export. However, Australia is the 6th largest trading partner of china; “it is China's fifth biggest supplier of imports and its tenth biggest customer for exports. Twenty-five per cent of Australia's manufactured imports come from China; 13% of its exports are thermal coal to China”. Thus, the relationship of investment exchange between china and Australia is also growing. The urbanisation in china expands its growth from manufactured goods from domestic consumption to complex goods and services; however the Australian demand growth rate will remain adequate. The resources which is exported to china are possible to grow but in a slow-moving rate, with substituting natural gas to coal. Other products such as; wool and wheat and minerals will probably do well when the income rises in china. Terms of trade for Australia is subject to fall as the new coal, iron ore and gas capacity in Australia and rest of the world comes in stream followed by, predication is being made that Australian dollar will decrease. On the contrary, there is a half reversal of immense rise in standard of living which Australia is experienced in the last decade. As a result, it will enhance the competitiveness of other goods and services which have suffered the currency strength, maybe china become the market for them. (Holmes, 2013)

Terms of Trade Between Australia and UK

From 19th century Australia and Japan are doing trading and coal was the 1st registered traded commodity in 1865 from Australia to Japan after that both countries showed the interest in trade and they laid the foundation of trade. In 1887 and 1906 Australia export the goods to Japan and there is a small arise of number in Australia export from 0.03% to 1.74% similarly, Japan reported 0.11% of import from Australia in the years 1887-1891. At that period, Australia imported textile, furniture, sulphur, rice etc from Japan whereas, Australia exported gold, lead, wool and flour to Japan. From 1907-1921-1926 and in 1930s when the tariff and biased licensing was imposed by Australia the trade started to fall with Japan. In 1936, “trade diversion policy” was created by Australian government the aim of this policy is to boost the export of primary goods and employment in industries. However, certain restrictions were imposed on importing goods in order to stimulate the domestic industries. Australia prohibited its iron ore too and it leads to declined in Australian exports to almost 50%, at the same time, the import of wool and wheat by Japan is also decreased, due to pacific war the restriction on iron ore export was ceased till 1960s. Thus, from the (Table 5.5) one can conclude there is a notable rise in the export of Australia which includes metal elements and coal to Japan.

Table 5.5—Value of Australia’s major exports to Japan from 1968–69
to 1979–80 

Description

1968–1969

1969–1970

1970–1971

1971–1972

1972–1973

1974–1975

1976–1977

1977–1978

$m

$m

$m

$m

$m

$m

$m

$m

Meat and meat preparations

20.1

31.6

41.4

78.4

189.0

45.2

172.9

207.3

Cereal grains

77.2

65.2

92.0

158.5

111.5

314.9

316.0

262.1

Sugar and honey

27.0

36.6

47.0

62.2

74.3

109.0

275.4

218.1

Textile fibres

264.4

259.1

199.9

221.3

500.7

233.9

455.9

357.0

Metalliferous ores

215.2

328.2

446.5

424.9

505.0

758.1

992.4

992.8

Coal

114.8

155.9

173.0

198.6

260.9

508.6

1,048.6

1,091.5

Non-ferrous metals

21.8

41.9

41.6

32.1

(a)

70.8

74.2

78.0

In the below (Table 5.6) we can clearly see from 1980-1985 coal was vital export of Australia to Japan.

Table 5.6—Value of Australia’s main export commodities to Japan, 1980–85

Description

1980–81
$m

1981–82
$m

1982–83
$m

Meat and meat preparations

350.3 (4)

323.4 (5)

397.4 (4)

Cereal grains

307.7 (6)

342.8 (4)

246.9 (5)

Sugar honey

308.9 (5)

141.1 (7)

85.4 (8)

Textile fibres

468.3 (3)

506.5 (3)

501.9 (3)

Metalliferous ores

1,019.1 (2)

1,113.5 (2)

1,321.3 (2)

Coal

1,404.3 (1)

1,563.5 (1)

2,004.6 (1)

Fish

113.8

158.0 (6)

177.5 (7)

Thus, from 1980 the import design of motor vehicle almost remained sustained in Japan however, it share 20.75% of Australia’s total import market. From the starting of 1990’s Japan is considered to be the biggest sources of Australia’s imports, both countries have grown massively after war and their trade relationship is turned into friendly and interactive profitable partnership. Australia trading pattern considerably benefited to japans’ economic welfare for over 40 years. (Australia and Japan—A trading tradition, 1999)

According to Australian Government Department of foreign affairs and trade in 2016 Uk was ranked 5th at Australia's top two way trading partners, which increased from year 2015 25.5% , moreover ranked 5th at Australia's top export markets which growth from year 2015 71.8%  and still  ranked 6th at Australia's top import markets. Australia's relationship with the UK has stabilized both its strategic outlook and its broad economic interest in trade. Including negotiations on global conflict with the United States. However, after the establishment of Brexit, Australia's trade and investment relations with the United Kingdom There may be changes in the risk of bilateral free trade and the competition between Australia and The UK is more intense than the US. In addition, considering the political future uncertainty that may arise, Australia takes into account the various ways in which it can be used to negotiate and invest in enhancing UK competitive opportunities. This will affect Australia's financial stability. In the past decade because the Australian stock market is investing in the EU more than almost twice in the UK which represents more than one-fifth of total ownership in the Australian financial market.This is a reason that why Australia should show to the UK that it is still a trading partner, even if UK is coming out of the EU and  believe that Australia should focus on free trade agreements with the EU as well.

The trade agreement between Australia and the United States lasted a long time. In 2005, the Australia-United States Free Trade Agreement (AUSFTA) was signed. Over the past 5 years the importance of the United States to Australia as a source of imports slightly to decease down from 22% of all imports in 1998 to 16% in 2003. Australia imports goods and services from USA and not to export. Australia's trade deficit with the USA has increased steadily since 1998, from a peak of $14.2b and decrease to $12.5b in 2003 untill the lowest in 2001 at$10.7b. Australia and USA are an important trading partner for import and export, Australia has a major import from the US such as Food and live animals, Beverages and tobacco, Crude materials, inedible, except fuels, Mineral fuels, lubricants and related materials, Animal and vegetable oils, fats and waxes, Chemicals and related products, Manufactured goods classified chiefly by material and so on. These were worth $4.3b in 2002 and $3.3b in 2003.The worst thing was the import of computers and parts, almost 50% from $ 1.933 billion in 1998 to $ 978 million in 2003, partly due to the continuing downturn in computer prices. However, Australia has a many important export goods such as Beef, Beef has been the most important australia's product for a long time. Since 1998, the volume of beef exports to the United States increased by 30%, while the value of beef Exports increased 81%. The second most important australia's export was wine its worth $ 837 million in 2003. Nowadays, the United States has a relatively low tax rate. wine imports range from US8.4c and US22.4c per liter, depending on package and type under the proposed free trade agreement tariffs are divided into sections more than 11 years. In addition, the result from the appreciation of the Australian currency cause of Australia's important exports have decreased in value in the past two year. For instance, In June 2003, US $ 583 million of crude petroleum was exported, down 50% from US $ 1,166 million in 2000.

Germany and Australia have good bilateral relations and warmth throughout the long-term and they are committed to promoting international trade liberalization and deepening economic links. Australia-Germany trade relations are highly developed. According to Australian Government. Department of foreign affairs and trade in 2016 Germany was ranked 10th at Australia's top two way trading partners, which services trade A20.2$ billion in 2016.Australia's main source of export to Germany are oilseeds, metals legal tender include automotive vehicles, mechanical equipment and medications.. Australian exports to Germany just below A$ 2.9 billion, while import value is nearly A$14 billion in 2014. As a result of this Germany is a Australia's 5th largest import partner. Australia's investment in Germany is worth about 65 billion US dollars, while Germany's investment in Australia is worth about 40 billion Australian dollars. As well as transportation services, which are the main source of imports.Germany is the cost of using intellectual property. For foreign investment ,Germany was ranked 13th in Australia. In terms of manufacturing, information technology, communications, finance, pharmaceutical and automotive, in 2016 was worth $ 38.8 billion.

Nowadays, India is the 3rd largest economy in the world (behind China and the United States) India has tremendous growth potential in the next few decades. The economy grows Approximately 7.4% in 2026 making it the fastest growing economy. Especially, when compared to China's fast-growing). Trade between Australia and India has grown tremendously over the last several decades, especially

The rapid rise since 2002. Australia has a sizeable trade surplus with India. In Asia Pacific they are an important economies,Both have British legal traditions and both are democracy. According to Australian Government Department of foreign affairs and trade in 2016  India was ranked 9th  at Australia's top two way trading partners, was worth $19.6 billion in 2015-16, due to this ranking reflects a very low level of imports, such as exports to India are ranked 5th. Australia operates a very large bilateral excess trade in goods and services. The major of Australia's goods export to india in 2015-2016 are coal, vegetables, gold and coal, while education and travel are an important part of trade. Moreover, education is Australia's important largest export to India, the reason for this is in 2016 more than 60,000 Indians studied in Australia which increase 12.4% form 2015.

It can be noted that a treaty is proposed to have been formed between Australia and Indonesia has been formed to ensure to strengthen the trade relations between the countries by opening new opportunities and markets. The treaty between Australia and Indonesia that will govern the terms of trade is Indonesia-Australia Comprehensive Economic Partnership (IACEPA) (Department of Foreign Affairs and Trade 2017). The treaty also aims to ensure that the trade relations between the countries are facilitated by bring in more primary produces, investors and service providers. It can be mentioned that several working groups have been formed to negotiate the terms of trade of goods, procedures of customs, technical barriers to trade, investment, telecommunication services, financial services and institutional framework provisions (Patunru and Rahardja 2015). It can be mentioned that both the countries are members of Australia-New Zealand free trade area. Both the countries are negotiating the IACEPA. It is assumed that if the treaty comes into being it would address the hindrances to trade, bilateral in nature. It would also address both tariff and non- tariff barriers to trade. It is also expected to improve the access to the service markets of each other. It aims to increase Australian investment in Indonesia and vice versa. It is to be mentioned that the treaty is expected to promote the facilitation of trade and create the pathway for liberalization of trade in the future.  

A free trade agreement exists between South Korea and Australia. It is to be stated that the agreement aims to promote bilateral free trade between the aforementioned countries (Siriwardana 2015).  The agreement came to force 2014. The department of foreign affairs and trade of Australia stated that the trade relations between South Korea and Australia are the strongest in the Asia Pacific region.  The aforementioned free trade agreement has notably reduced the barriers of Investment which has in turn made it easier Australia and Korea to do business (Fukunaga 2015).  The aforementioned department has also stated that the Korea has become the fourth largest partner trading with Australia. It is to be stated that the free trade agreement between Australia and Korea has ensure Australia to secure a position in the competitive market. In this competitive market the countries of the European Union, United States of America, and ASEAN countries have already enjoying preferential access. Benefits of the agreement include:

  • It is expected that due the agreement the Australian Exports to Korea would rise by twenty five percent by 2030.
  • By 2030 it is expected that the export of agricultural products to Australia would rise to seventy three percent. Export of minerals to Korea is also expected to rise by seventeen percent and manufacturing products by fifty three percent.

The terms of trade of countries are affected by several factors (Albinski 2015). Some of the key factors that affect the terms of trade between the aforementioned countries are:

  • Demand Elasticity- It can be mentioned that the elasticity of demand for the products to be imported and exported play a major role in influencing the terms of trade. It can be said that if Demand for exports of a country is less elastic than its imports, the terms of trade of such a country would be favourable.
  • Elasticity of Supply- The elasticity of supply of a country will also affect the terms of trade of such country. It is to be noted that if the exports of a country is more elastic than the imports of the country the terms of trade would be favourable
  • Nature of Goods- A country which only exports primary goods and imports only manufactured goods would have unfavourable terms of trade
  • Economic development- Economic development takes into consideration the demand effect and supply effect. The demand for imports is created when there is an increase in the per capita income of the country, which is also associated with economic development. The supply effect is created by the substantial increase of imported products      
  • Exchange Rate- It is to be said that the rise or fall of the value of a country’s currency also influences the terms of trade
  • Tariff Policy- If the Tariffs and Quotas of trade are not opposed by other countries, the terms of trade of a country are improved.
  • Population- The terms of Trade of an over populated country will be unfavourable as the country will have a high demand for imports. However, in case of an underpopulated country, the terms of trade will be more favourable.
  • Competition-It can be stated that if a country has monopoly of exports, it will have alternative sources of imports. Thus such a country is likely to enjoy favourable terms of trade.

Conclusion

Thus to conclude it can be said that to understand the strength of a country’s economy to have an idea of the Terms of trade of such country. To assess the terms of trade it is of utmost importance to understand the reason of rise and fall of a country’s exports in relation to the imports of a country.  The import and export prices of goods are closely interrelated.  Increase in the terms of trade of a country will be beneficial to such country.  On the other hand it can be stated that countries facing a significant decrease in the volume of goods exported will have deteriorating terms of trade. It can be said the trade relation between Australia and China is significantly strong. It can be said that Australia is the sixth largest trading partner of China. It can be mentioned that the trade relation between the countries of Japan and Australia have also evolved over the years with the creation of the Trade Diversion policy. . However, certain restrictions were imposed on importing goods in order to stimulate the domestic industries. The Australian Government Department of foreign affairs and trade had ranked the United Kingdom to be the fifth of the top Trading partner of Australia. UK was ranked sixth in the Australia’s top import markets. However after the trade relations between the aforementioned countries were affected. The Australia-United States Free Trade Agreement (AUSFTA) was signed in 2005. However imports from United States had declined from 22% to 16%. It can be noted that Germany and Australia have good bilateral relations. In 2016 Germany was ranked 10th at Australia's top two way trading partners. Trade between Australia and India has grown tremendously over the last several decades. The treaty between Australia and Indonesia that will govern the terms of trade is Indonesia-Australia Comprehensive Economic Partnership (IACEPA). A free trade agreement exists between South Korea and Australia. It is to be stated that the agreement aims to promote bilateral free trade between the aforementioned countries. It is als to mentioned that there are several factors that affect the trade relation between the aforementioned countries and the terms of such trade.

Reference List:

Economics Online, 2008. Terms of trade. [Online] Available at: https://www.economicsonline.co.uk/Global_economics/Terms_of_trade.html [Accessed 20 DECEMBER 2017].

Economics, 2014. Prebisch Singer Hypothesis. [Online] Available at: https://www.tutor2u.net/economics/reference/prebisch-singer-hypothesis [Accessed 20 DECEMBER 2017].

Holmes, D.A., 2013. Australia’s economic relationships with China. [Online] Available at: https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/BriefingBook44p/China [Accessed 19 DECEMBER 2017].

Australia and Japan—A trading tradition, 1999. A cautious beginning. [Online] Available at: https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Foreign_Affairs_Defence_and_Trade/Completed_inquiries/1999-02/japan/report/c05 [Accessed 18 DECEMBER 2017].

Ludema, R.D. and Mayda, A.M., 2013. Do terms-of-trade effects matter for trade agreements? Theory and evidence from WTO Countries. The Quarterly Journal of Economics, 128(4), pp.1837-1893.

Schmitt-Grohé, S. and Uribe, M., 2015. How Important Are Terms Of Trade Shocks? (No. w21253). National Bureau of Economic Research.

Patunru, A.A. and Rahardja, S., 2015. Trade protectionism in Indonesia: Bad times and bad policy.

Siriwardana, M., 2015. Australia's new Free Trade Agreements with Japan and South Korea: Potential Economic and Environmental Impacts. Journal of Economic Integration, pp.616-643.

Fukunaga, Y., 2015. ASEAN's leadership in the regional comprehensive economic partnership. Asia & the Pacific Policy Studies, 2(1), pp.103-115.

Department of Foreign Affairs and Trade. (2017). Indonesia-Australia Comprehensive Economic Partnership Agreement. [online] Available at: https://dfat.gov.au/trade/agreements/iacepa/pages/indonesia-australia-comprehensive-economic-partnership-agreement.aspx [Accessed 11 Dec. 2017].

Albinski, H.S., 2015. Australian policies and attitudes toward China. Princeton University Press.

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