terms of trade

When you swap cards, candy, or currencies, the deal lives or dies on the exchange rate between them: how many of mine for one of yours? A country faces the same question on a giant scale. It sells coffee, copper, or cars abroad and uses the proceeds to buy other goods. How much can a tonne of its exports buy in imports? That ratio is the country's terms of trade, and small shifts in it can make a whole nation noticeably richer or poorer.

Terms of trade is the rate at which a country's exports exchange for its imports — roughly, the price of what it sells divided by the price of what it buys. Economists usually track it as an index: take the average price of exports, divide by the average price of imports, and multiply by 100. If that number rises, the terms of trade have 'improved': each unit of exports now buys more imports, so the country can consume more for the same effort. If it falls, the terms of trade have 'worsened'. For example, if the world price of the oil a country exports doubles while the price of the machinery it imports holds steady, its terms of trade improve sharply and it grows richer without lifting a finger.

Terms of trade matter most for countries that depend heavily on a few exports, especially commodities. A coffee- or copper-exporting nation can see its national income swing wildly when world prices move, even if it produces exactly the same amount. There is a long-running debate, the Prebisch-Singer hypothesis, over whether the prices of raw-commodity exports tend to drift down over time relative to manufactured imports, which would slowly worsen the terms of trade of commodity exporters — the evidence is mixed and contested. Either way, the terms of trade decide how much real benefit a country actually draws from any given volume of trade.