By Willah J Mudolo
Discussing international trade often elicits a large yawn from the bored reader, who instantly clicks away from the web page or turns the page of the newspaper. But trade is a crucial subject that has vast implications for the quality of the lives of people on the African continent. Not only is it about the creation of wealth through increasing economic activity, but it is also an issue that raises questions of politics on a global scale. These include: who or what is driving trade within and outside Africa? With which countries is it best for Africa to trade? In what should Africa trade? So it is perhaps worth investing some time to understand all the implications.
The crucial element that links the answers to these questions is of course the terms under which a country trades with its partners. For economists, a country’s terms of trade are defined as the ratio between the index of export prices and the index of import prices in any given time period. If the prices of exports increase more than the prices imports, then a country has positive terms of trade. And consequently its people and industries can purchase more imports for the same amount of exports.
It follows then that the terms of trade are driven by not only the volume of trade but also by the prices paid and obtained on a county’s trade in both directions. And money matters… So the terms of a country’s trade influence the material lives of people at the micro level. When terms of trade improve, so the living standards of people improve and, simply put, they can buy more. If the terms of trade worsen, and the competitiveness of a country’s goods and services decrease, then the economy will produce less as a whole and people will experience higher unemployment. So, a country’s terms of trade certainly have real meaning for real people.
Just a final piece of economic theory, then. Changes in the terms of trade have an especially powerful influence on the macroeconomic performance of commodity-exporting countries, such as those in much of sub-Saharan Africa. About two-thirds of the region’s exports to the rest of the world remain dominated by raw materials. In parallel, roughly two-thirds of sub-Saharan Africa’s imports are made up of finished products, fuel and agricultural products. Not much then has changed since colonial times.
This structural relationship between the nature and volume of Africa’s exports and its imports is quite different to that enjoyed by the rest of the world. In Europe, America and Asia, over the last 50 or so years, the balance has shifted towards trade in manufactured goods and services as the reliance on the export of natural endowments has fallen. This may be as a result of the massive increase in trade in manufactured goods and services as a proportion of the exports of those countries – but the economic effect is the same. That is to say, their terms of trade have improved. In Africa, as we have seen, raw material often dominate exports – and in the whole period since the end of colonialism, they have not been augmented by relative increases in exports of manufacture goods or services.
This dependence on raw materials for export puts us firmly in the area covered by the Prebisch–Singer hypothesis which suggests that the price of primary commodities declines relative to the price of manufactured goods over the long term. This of course causes the terms of trade of primary product based economies, such as many of ours, to deteriorate. The reason for this is that as people earn more money, so they consume more. But in contrast, the consumption of raw materials remains broadly constant even in the face of significant changes in their price. Consequently, the higher demand for consumption goods and services leads to them increasing in price – according to the immutable law of supply and demand. But the constant demand for raw materials causes their prices to stagnate. Then subsequently, the price of the index of exports falls in relation to the index of import prices and so the country’s terms of trade can support fewer imports.
What then are the practical and pragmatic steps that can be taken to ensure that the terms of trade of African nations become, and remain, positive – so that our people can enjoy a better and more secure quality of life?
First of all, it needs to be recognised that Africa is the only continent that is often written about, examined and judged as a single entity. Such an approach fails to recognise the numerous differences between its countries in terms of their histories, cultures and present situations. More importantly, in the context of this particular discussion, it does not take into account the very different economic situations of the countries. These differences naturally lead to dissimilar terms of trade around the continent. So one must be careful of the common error of calculating aggregate sets of export and import indices for the continent as a whole as a basis for terms of trade calculations because they might lead to inaccurate conclusions that ultimately misdirect trade policy decisions in individual countries.
In terms of policy that might influence the terms of trade of a nation, there are a number of levers that governments might use or, at least, try to influence. Currency exchange rates, which impact the cost of imports in local currency as well as the value of exports expressed in the same units, are very much within the ambit of government choice. They are closely related to interest rates, which are used by the central bank to regulate money supply in the economy. Both exchange rates and interest rates influence the level of savings among the population – and what gets saved does not get spent. So disadvantageous exchange rates and high interests reduce consumer spending with consequent dissatisfaction in the population and likely worsening of the terms of trade.
Since the composition of imports and exports of most sub-Saharan African countries is, as we have seen, inflexible in the short term, governments cannot readily influence the earnings from and volume of exported raw materials. Export earnings are dependent on world commodity market prices and the volume of goods exported is determined by technical capacity. So governments have little leverage in countering changes in raw material price or consumption – and that worsens the terms of trade. Thus, the terms of trade for a country that is reliant on exporting raw materials for income, tend to remain poor.
In addition, there is the influence of shocks to the terms of trade. These shocks may be external to the economy and might be caused by changes in the world price of commodities such as oil or iron ore. Or they might be internal to the country and caused by a bad harvest that increases the price of domestically produced food with the result that consumers have less money to spend on imports. But both internal and external shocks can impact a country’s terms of trade negatively.
The way that African governments have handled trade shock has historically not been good. For example, many African governments responded to commodity price booms in the late 1970s by sharply expanding public expenditure on hastily executed, import-intensive public investment programmes. Once commodity prices declined and revenues from exports subsequently fell, these projects were either abandoned, with massive waste incurred, or were financed with new foreign borrowing.
The decision on whether to borrow from abroad in order to continue these public investment programmes or whether to adjust to the terms of trade shocks, was important for African countries during the 1960s, 1970s, and early 1980s. And uncertainty about how long shocks have an impact on the terms of trade contributed to overborrowing by African states during this period. It is this historical overborrowing which is at the root of the debt problems of many African countries today. These are basic policy errors that must be eliminated from governance on the continent because they result in unpredictable cycles of boom and bust.
For governments to eliminate boom and bust cycles driven by variances in the terms of trade, they must work to increase the value of exports, because in free economies such as we aspire to build, controlling imports, either by direct or indirect means, on the other side of the terms of trade equation is not desirable.
To encourage exports, African governments must do all that they can to reduce dependence on the exploitation of our natural endowments by encouraging the production of goods and services for export. Sub-Saharan Africa’s external trade needs to become more diversified both in terms of output and the destination of our trade. Conditions should be established for the seeking out of new markets all around the world so that overall export opportunities are maximised. Positive action will result in the creation of more added value that will in turn contribute to creating decent jobs for a continental population that continues to grow.
African governments themselves hold the key to advancing the continent’s development. Some conditions for improving the terms of trade (and with that the quality of life of our people) are being fulfilled. For example, we seem to be in a period of some political stability and many of our governments are getting better at managing their economies at the macroeconomic level. Structural transformation is also under way. All this helps to create the conditions for the organisation of healthy trade. But there is more to do.
Encouraging the continued development of agricultural productivity would be an excellent first step. It must be followed by backing of exports of agricultural products with added value. Regional integration, and the growing internal market, play an even more important role in the African development process. And Africa’s demographic trends and the emergence of a middle class make the continent an increasingly interesting market for regional trade. This is to be encouraged because there is an opportunity for Africa to finally resolve the paradox of producing what it doesn’t consume and consuming what it doesn’t produce. This weakness often frustrates our policy makers but, by managing the terms of trade through the careful use of macroeconomic levers at their disposal, our governments can begin to resolve this long lasting, and fundamentally African, problem.