An under-appreciated factor supporting the New Zealand economy in recent decades has been the terms of trade, which represents the ratio of export prices to import prices. Farmers are more concerned about the former, but it is the combination that matters.
New Zealand’s terms of trade rose almost 45% between 2001 and 2021. This allowed us to purchase more imported goods for every unit of export that we sold.
The terms of trade are now down almost 11% since 2021. This means New Zealand must export a greater number of units to purchase the same number of imports to keep our trade balance and current account in check.
The finger can be pointed at commodity prices (weak), and oil prices moving around, but the real issue is, has New Zealand’s terms of trade hit an inflection point? If it has, where should we turn for growth?
Many decades ago, the Prebisch-Singer hypothesis stated that the price of primary commodities should decline relative to the price of manufactured goods, which causes the terms of trade of primary-product-based economies to deteriorate. As incomes grow, we are assumed to spend more on manufacturing items, which have a higher income elasticity compared to food.
At face value this was bad for New Zealand, but the outcomes did not mirror the hypothesis. Our terms of trade rose.
A key reason was the rise in globalisation, which reduced the price of manufactured goods, particularly as outsourcing took hold and China became the epicentre for lots of manufacturing.
As the world became more and more connected, accessing cheap labour, and outsourcing to cheaper and low-cost producers took place, manufacturing goods become the new commodities.
New Zealand also benefited from lower prices for many capital goods, which incorporated falling prices for computer equipment. A computer built in 2001 is far less powerful than the ones we have today.
Other factors, such as relative inflation rates, trade policy and the currency, can play a role too, but the defining factor appears to have been globalisation and shifts in manufacturing pricing relative to commodities.
A debate is now raging over whether globalisation is over, or are we just moving into a different version of it? I side with the latter.
Globalisation has a tailwind in the form of technology. This reduces the tyranny of distance. The economics of trade is also clear – a more globally connected world boosts growth. The global economy will need interdependence and co-operation to crack climate change objectives and reduce poverty.
However, globalisation was always going to face challenges at some point. There was always going to be a stage where the integration of world views, products, ideas and culture into a universal set of values would face realities. Not everyone wants to be like the West who have modernised the most, and nor should we expect them to be.
Convergence is now divergence. Geopolitics is moving against globalisation and potentially a world dominated by two or three trading blocs. The economics of trade now has a security overlay, especially in technology.
Just-in-case is replacing just-in-time, our rules-based trading system is being challenged by the use of power, and protectionism is rife. As New Zealand’s chief trade negotiator Vangelis Vitalis puts it, “the golden era is over”.
How this impacts export and import prices over the medium term (looking beyond the current period) is open to debate. Supply-demand balances within various markets for commodities will remain influential.
However, we would be amiss not to acknowledge that if globalisation was one driving factor behind a rising terms of trade, even a partial reversal will not be good. The Prebisch-Singer hypothesis finds some favour in the literature but the 2000s commodities boom saw the terms of trade of most developing countries improved, while east Asia (which exports mostly manufactured goods) saw deteriorating terms of trade (though that was the booming China driving commodities, not the current China).
Where is the good news?
The primary sector is primarily concerned about absolute prices rather than relative ones, yet it is the relative prices that matter for the overall economy.
A lower terms of trade will need to be counteracted by a currency that supports exporting over importing. We are seeing that.
The terms of trade is one of many “old” drivers of the economy that have likely reached peak-influence. China’s growth prospects have weakened though India’s era is here. Interest rates will fall over coming years, but the trend will not be lower for the next 30 years like the previous 30. That will dampen capital gains.
A housing-centric growth model of 30 years just exacerbated unaffordability, inequality and division. Tourism is struggling to recover to pre-covid levels. Migration has been an easy lever not a substantive one. This model allowed us to get away with average (at best) policy and business practices. Sub-par practices and policies are now being exposed. Witness electricity.
Our “new” growth model likely has four essential components. Address poor productivity. Get the right settings for capital investment, which includes examining banking and the pricing of risk relative to the taking of it. Natural resource endowments need to be unlocked. Government policy and business execution needs to step up.
It’s a more substantive model than previous ones. We need the tough times to embed the shift to the new model and especially better policy.
