Terms of Trade Effects: Theory and Measurement

Abstract

Foreign trade enables a nation to consume a different mix of goods and services than it produces, so to measure real gross domestic income (GDI) for an open economy, we must deflate by an index of the prices of the things that this income is used to buy, not the price index for GDP. The differences between these two indexes come from the export and import components of the GDP, and are measured by the trading gains index. Fisher indexes are a natural way to estimate the conceptual economic indexes of trading gains and real GDI because they are averages of the theoretical upper and lower bounds of the economic indexes. They can be decomposed in a way that permits analyses of the factors driving changes in trading gains, such as changes in the terms of trade and in the relative price of tradables, or changes in the prices of particular commodities. Applying these methods to the United States, we find that trading gains have a median absolute effect on US real GDI of 0.2 percentage points in annual data. The petroleum price shocks that occurred in late 1973 and in 1980 subtracted more than a full percentage point from the annual growth of real GDI, and in the first half of 2008 price increases in petroleum and other imported commodities subtracted 2 percentage points from the annual rate of growth of real GDI, making it negative despite the steady growth of real GDP. On the other hand, with petroleum prices excluded, US terms of trade begin to improve steadily starting in 1995 and the relative price of tradables falls. These effects increase the growth rate of US real GDI by 0.15 percent per year on average.

The Next Generation of the Penn World Table

“…The influence of both these terms on the gap between real GDP from the expenditure and output sides has also been shown by Kohli (2004Kohli ( , 2006 and Reinsdorf (2010), and we will illustrate this relation with some examples from PWT8.1 in Section VI.…”

The Impact of Foreign Direct Investment on GDP Growth in East Africa

“…Under multi-commodity and multi-country model, TOT is the difference between the real GDP and both domestic consumption and net exports (Reinsdorf, 2010). In the process of dynamic output production if export price over import price times 100 exceeds over 100 percent, then the economy is doing net capital accumulation since more money coming in than going out from the economy (Reinsdorf, 2009).…”

“…In the process of dynamic output production if export price over import price times 100 exceeds over 100 percent, then the economy is doing net capital accumulation since more money coming in than going out from the economy (Reinsdorf, 2009).…”

Real GDI, Productivity, and the Terms of Trade in Canada

“…Let a t XM 5a t X a t M , which defines the trading gains due to relative changes in the prices of exports, imports, and consumption. 3 The trading gains can be further decomposed into two effects on real income growth: the terms-of-trade effect and the relative-price effect, as shown in Diewert and Yu (2012a), Kohli (2004Kohli ( , 2006, and Reinsdorf (2010). The terms-of-trade effect reflects the contribution of changes in the export-import price ratio to real income growth; the relative-price effect captures the contribution resulting from trade imbalance, as well as from deviation of the price of tradables from the price of non-tradables.…”

“…While Diewert and Yu (2012a) use the consumption price to deflate nominal gross domestic income, Kohli (2004Kohli ( , 2006 measures the trading gains as the change of the GDP price relative to the price of domestic demand. Reinsdorf (2010) decomposes the trading gains into a terms-of-trade effect and a relative-price effect, but in the Fisher index framework. The advantage of the method reviewed above is that the translog form of production technology forces the decomposition of the real income growth to be exact, so that an approximation or an econometric estimation is not necessary.…”