The argument that export-biased growth may turn the terms of trade unfavourable to the country and hence may not be beneficial, is applicable in the case of a large country and not a small country." Explain.

Understanding the Terms of Trade

The terms of trade (TOT) represent the ratio of a country’s export prices to its import prices. A favorable TOT means a country can obtain more imports for a given quantity of exports, enhancing its welfare. Conversely, an unfavorable TOT requires exporting more to acquire the same amount of imports, reducing welfare. Export-biased growth, focusing on expanding exports, can influence these prices, especially for larger economies.

The Argument for Large Countries

The argument that export-biased growth can be detrimental to a large country’s terms of trade stems from the concept of demand and supply elasticity. A large country’s increased exports, representing a substantial portion of global supply, can lead to a decrease in the world price of that good. This is because the increased supply exceeds the increase in global demand.

• Downward Sloping Demand Curve: Large countries face a downward sloping demand curve for their exports. As they export more, the price falls.
• Prebisch-Singer Hypothesis (1949): This hypothesis, relevant here, suggests that the terms of trade for primary commodity exporters (often developing countries) tend to deteriorate over time relative to manufactured goods exporters. Increased specialization in primary commodities can exacerbate this effect.
• Example: Consider Saudi Arabia, a major oil exporter. If Saudi Arabia significantly increases its oil production, it can drive down the global oil price, potentially reducing its overall export revenue despite increased volume.

The fall in export prices, coupled with potentially stable or rising import prices, leads to a deterioration in the terms of trade. The gains from increased export volume may be offset, or even outweighed, by the lower price received for each unit exported. This is particularly true if the country’s import demand is relatively inelastic (i.e., demand doesn’t change much with price).

Why the Argument Doesn't Apply to Small Countries

Small countries, in contrast, have limited influence on global markets. Their exports represent a negligible portion of global supply. Therefore, increasing their exports has a minimal impact on world prices.

• Horizontal Demand Curve: Small countries face a horizontal demand curve for their exports. They can increase exports without significantly affecting the price.
• Price Takers: Small countries are ‘price takers’ – they must accept the prevailing world price.
• Example: Consider a small island nation specializing in banana exports. Increasing its banana exports will have a negligible impact on the global banana price. The country will benefit from increased export volume without experiencing a significant decline in price.

For a small country, export-biased growth generally leads to improved welfare because the benefits of increased export volume are not offset by a decline in export prices. They can enjoy the gains from specialization and economies of scale without facing the terms of trade deterioration experienced by larger economies.

Factors Influencing the Outcome

It’s important to note that the relationship isn’t always straightforward. Several factors can influence the outcome:

• Diversification: A country with a diversified export basket is less vulnerable to terms of trade shocks.
• Technological Advancements: Technological improvements can lower production costs, offsetting the impact of falling prices.
• Global Demand: Strong global demand can mitigate the price-reducing effects of increased exports.