Terms of Trade Reversal? The Challenge to Development

Strategy

IKD Seminar

18th January 2007

Terms of trade decline

• The prevailing post WW2 wisdom

• But, Singer/Prebisch:– Commodities are inputs into manufactures– Demand low for commodities as incomes rise– Demand for commodities falls as their price

increases– Synthetic substitute for natural materials– Low innovation barriers to entry

And then one other “Singer insight”…

• Labour markets– Cost-plus pricing in high income countries– Reserve army of labour in low income

economies

• So manufactures vs commodities really a surrogate for high income vs low income

Manufactures-commodities terms of trade

The drive to industrialisation

• Close association between incomes and industrialisation

• Manufactures are (relative to agriculture) income elastic and price inelastic

• Manufacturing embodies rents – agriculture does not

• Manufacturing can be labour intensive – primary commodities are very capital intensive

The Asian Drivers upset the applecart

Share of manufacturing value added

Share of the world

Share of developing countries

1985 1998 1985 1998

East Asia China South Asia Latin America and Caribbean Sub-Saharan Africa Middle East, North Africa,

Turkey

4.11.40.86.71.01.5

13.97.01.85.20.82.4

29.210.25.9

46.97.1

10.8

57.729.37.3

21.83.49.8

China’s growth is not unique..

Growth of exports

0123456

1 6 11 16 21 26 31 36 41Years from beginning of export surge

Lo

g o

f ex

po

rt g

row

th

China (1989-2003) Japan (1960-2003) Korea (1963-2003)

GDP (constant prices)

1.5

2

2.5

3

3.5

1 6 11 16 21 26 31 36 41

Years from beginning of growth surge

Lo

g o

f G

DP

gro

wth

China (1989-2003) Japan (1960-2003)

Korea (1963-2003)

Share of Global Population

0

5

10

15

20

25

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

China India J apan Korea, Rep.

But its not just the Asian Drivers

Market share of five largest retail chains (2000)

0 20 40 60 80 100

Netherlands

Sweden

Austria

Denmark

Norway

Switzerland

France

Finland

Germany

Belgium

UK

Portugal

Spain

Greece

Italy

Median

%

AC Nielson, cited in Bell 2003

With what consequences?

• Growing productive capacity means heightened competition

• Growing concentration in buying power

• Manufacturing caught between a rock and a hard place

World Manufacturing Export Price, 1986-2000

-10

-5

0

5

10

15

20

25

Ann

ual p

rice

chan

ge (%

)

IMF, World Economic Outlook Database

EU Imports from China

1st Q 2005/1st Q 2004 China Market Share in EU-25 Imports

Volumes % Price % 1 Q 2004 % 1 Q 2005 %

T-shirts 164 -26 7 17

Pullovers 534 -47 6 38

Men’s trousers 413 -16 6 35

Blouses 186 -24 6 22

Women’s coats 184 -18 6 10

Bras 139 -15 30 49

Socks and pantyhose

63 -22 30 54

Linen and ramie yarns

51 1 27 45

Linen fabrics 257 1 10 45Source: Euratex data as reported by Nathan Associates

Caught between a rock and a hard place

0

10

20

30

40

50

60

70L

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Resource basedmanufactures

Low technology Medium technology High technology

% o

f s

ec

tors

Percentage of sectors with negative price trends, 1988/9-2000/2001 by technological intensity and country-grouping

Employment in China’s formal sector manufacturing

Employment (‘000)Index of employment

(1995=100)

OECD 14* China India Brazil

OECD 14* China India Brazil

1995 85,623 98,030 6,500 9,438 100 100 100 100

1997 83,003 96,120 6,900 8,381 97 98 106 89

1999 81,266 81,090 6,700 7,420 95 83 103 79

2001 80,535 80,830 6,400 7,565 94 82 98 80

2002 78,761 83,080 6,500 7,556 92 85 100 80Source: Calculated from Carson, 2003

The picture is not so bleak for commodity producers

Actual and projected global share of China’s consumption of base metals

0%

5%

10%

15%

20%

25%

30%

1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

% o

f to

tal

Copper Alum inium Zinc Nickel Steel Iron Ore (Trade)

Source: Macquarie Mining

China's Share of Global Demand

8%

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

1995

1996

1997

1998

1999

2000

2001

2002

2003

% o

f to

tal W

orl

d

SteelNickelCopperAluminium

China's Share of Total World Growth

95%99% 100%

76%

68%73%

67%

51%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Steel Nickel Copper Aluminium

% s

har

e

2000-2003

1995-2003

Source: Macquarie Mining

Enormous demand potentialKgs/capita GDP per capita

($US1995)Aluminium Copper Steel

Japan19551975

0.610.5

1.27.4

80599

5,55921,869

Korea19751995

1.015.0

1.38.1

84827

2,89110,841

China1990199920022003

0.72.33.34.0

0.61.22.02.4

59108160200

342756933

1,103

All this has implications for the producers of manufactures

And for the producers of commodities?

• Commodities price boom:– Dutch disease

• Zambian copper, tobacco, maize and cotton

• Armed conflict• Corruption• Managing surpluses:

– LA and ownership• Chile and copper• Venezuela and oil

And for agriculture?

Appropriating rents in the coffee sector

• There are more varieties of coffee and with a greater variety of taste than they are of wine

• “Blue mountain coffee prices are not subject to the factors of supply and demand that affects other commodities. The price is fixed” (2001)

• Illy sells at $10/230gm compared to $1.50, and farmers get 30% more.

Escorial wool

• Maghreb sheep taken to New Zealand in 1828.

• Numbers are now severely limited by NZ farmers

• Resources put into marketing in 1990s

• “We have created ‘clean air’ between the generic ‘commoditised’ Merino wool”

• Escorial scarf retails at more than €600

And for income distribution

• Manufacturing is labour intensive

• Commodities are:– Capital intensive– Generally foreign owned– Kleptocracy– Armed conflict

Innovation is key to sustainable incomes

Avrge rate of profit

1st round innovation

2nd round innovation

3rd round innovation

Innovation rent

THE SCHUMPETERIAN INNOVATION SCHEMA

Rate of profit

Time

Endogenous rents

• Technology rents

• Human Resource rents

• Organisational rents

• Relational rents

• Design rents

• Marketing rents

Exogenous rents

• Resource rents

• Policy rents

• Infrastructural rents

• Financial intermediation rents

ProductionDesign

Value chains are increasingly global and dynamic

Competitive pressures

Marketing

Services Services

Competitive pressures

Our existing architecture is limited

• Competences and dynamic capabilities– But mostly within the firm

• Types of upgrading– Process upgrading

– Product upgrading

An upgraded architecture on innovation

• Competences and dynamic capabilities are now a value chain challenge

• Wider perspective on upgrading– Process upgrading– Product upgrading– Functional upgrading– Chain upgrading

Implications for Development Strategies

Sectoral choice

• Sectoral choice?– Agriculture– Commodities– Manufactures– Services

• Or positioning within sectors?– Back to Schumpeter and rents

Policies to facilitate innovation

– Macro policies

– Cross sectoral policies and market failure

– Sectoral and regional targeting

Income inequality and marginalisation

• Meeting the challenge in production

• Funding the challenge through production

• Don’t take politics out of this