Terms of Trade Reversal? The Challenge to Development Strategy IKD Seminar 18 th 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 East Asia China South Asia Latin America and Caribbean Sub-Saharan Africa Middle East, North Africa, Turkey

China’s growth is not unique..

But its not just the Asian Drivers

Market share of five largest retail chains (2000) 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, IMF, World Economic Outlook Database

EU Imports from China 1 st Q 2005/1 st Q 2004China Market Share in EU-25 Imports Volumes %Price %1 Q 2004 %1 Q 2005 % T-shirts Pullovers Men’s trousers Blouses Women’s coats Bras Socks and pantyhose Linen and ramie yarns Linen fabrics Source: Euratex data as reported by Nathan Associates

Caught between a rock and a hard place Percentage of sectors with negative price trends, 1988/ /2001 by technological intensity and country-grouping

Employment in China’s formal sector manufacturing Employment (‘000) Index of employment (1995=100) OECD 14*ChinaIndiaBrazil OECD 14*ChinaIndiaBrazil ,62398,0306,5009, ,00396,1206,9008, ,26681,0906,7007, ,53580,8306,4007, ,76183,0806,5007, Source: 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 Source: Macquarie Mining

Enormous demand potential Kgs/capitaGDP per capita ($US1995) AluminiumCopperSteel Japan ,559 21,869 Korea ,891 10,841 China ,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 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 1 st round innovation 2 nd 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

Production Design Value chains are increasingly global and dynamic Competitive pressures Marketing 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