The terms of trade debate and the policy implications for primary product producers

The terms of trade debate initiated by Raul Prebisch and Hans Singer over 60 years ago continues to this day and is unlikely to be resolved soon. However, even if Prebisch and Singer are right and the terms of trade of countries exporting primary products are falling, to suggest that these countries should diversify away from the production of mineral commodities and other primary products, as many have done, may be poor policy advice, encouraging countries to abandon a promising source of wealth with which to foster economic development.This is because the prices of most goods are correlated with their production costs. If the prices of primary products are falling but a country's production costs are declining more, the profits, producer surplus, and wealth that the country realizes are rising, increasing the benefits it reaps from its primary product production and trade. Alternatively, when prices are rising but a country's costs are rising faster, the benefits it enjoys are falling notwithstanding higher primary product prices.While it has long been recognized that falling costs can conceivably offset the adverse effects of lower prices and declining terms of trade for primary product producers, much of the available literature either ignores this likely possibility or contends in fact changes in relative product prices do not reflect changes in their production costs.

► According to the Prebisch Singer thesis developing countries should diversify away from primary products.
► Theory and empirical evidence indicate that product prices move with costs.
► Diversification as a result can be a bad policy.