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Terms of Trade (ToT) - Agriculture

Terms of Trade (ToT) - Agriculture

GS3-Agriculture

Why in the news?

Over the past 15 years, there has been a substantial enhancement in the Terms of Trade (ToT) for Indian agriculture, involving a comparison of prices for farm commodities with those of non-farm goods and services.

More about the news

  • Agricultural Growth Impact
      • Annual Averages: The rise in agricultural growth rates, averaging 3.7% annually from 2005-06 to 2021-22, is a key factor contributing to the improved Terms of Trade (ToT).
      • Attribution: The enhanced ToT is directly linked to the robust performance of the agricultural sector.
  • Global Agri-Commodity Boom and Policy Interventions
      • Crucial Factors: The global boom in agri-commodity prices and strategic government interventions, particularly Minimum Support Price (MSP) hikes, have played pivotal roles.
      • Combined Impact: The synergy between international market trends and supportive government policies has contributed to the positive trajectory of ToT.
  • Historical ToT Trends
      • Pre-2000s Scenario: From 1973-74 to the mid-2000s, the ToT for agriculture remained subdued, indicating challenges in the sector.
      • Turning Point: A substantial recovery commenced in 2009-10, reaching its peak at 130.2 in 2020-21, marking a significant positive shift in ToT dynamics.
  • Disparities in Benefits
      • Agricultural Laborers vs. Farmers: Despite overall ToT improvement, benefits have been more pronounced for agricultural laborers than for farmers.
      • Stagnation for Farmers: The ToT ratio for farmers increased significantly by 17.3% between 2004-05 and 2010-11 but has since stagnated at 97-99 levels.
  • Shifts in Laborer ToT Ratio
      • Notable Increase: Agricultural laborers experienced a substantial increase in ToT ratio (109.2%) from 2004-05 to 2016-17.
      • Recent Decline: However, it declined to 119.5 in 2021-22, indicating fluctuations in laborer benefits.
  • Economic Growth Impact on Real Wages
    • Real Wage Increase: Economic growth and alternative employment opportunities outside agriculture have led to increased real wages for agricultural laborers.
    • Challenges for Farmers: This rise in real wages poses challenges for farmers who grapple with rising production costs without a proportional increase in crop prices.

What are Terms of Trade (ToT)?

  • Terms of Trade (ToT) refer to the ratio between the index of export prices and the index of import prices. 
  • When export prices experience a greater increase than import prices, a country achieves positive terms of trade. 
    • This signifies that, for the same volume of exports, the country can procure a greater quantity of imports.

Calculation of Terms of Trade (ToT)

  • The ratio is derived by dividing the price of the country's exports by the price of its imports.
  • The formula involves multiplying the result by 100 to express the ratio in percentage terms, providing a clearer representation of the relative values.
  • The calculation incorporates implicit price deflators, ensuring an accurate reflection of the real value of the commodities and goods in consideration.

Price Deflator

About

  • Also known as the implicit price deflator or simply the deflator.
  • It is a measure that adjusts the nominal value of an economic statistic, such as Gross Domestic Product (GDP) or personal income, to reflect changes in the general price level of goods and services. 
  • It serves as an indicator of inflation or deflation within an economy.
  • The price deflator essentially measures how much the purchasing power of a specific sum of money has changed over time due to inflation or deflation. 
  • A rising price deflator indicates inflation, while a falling price deflator suggests deflation.
  • Economists and policymakers use the price deflator to analyze trends in inflation or deflation and to make adjustments for the impact of changing price levels when comparing economic data across different time periods.

The formula for calculating the price deflator is as follows:

Price Deflator = (Nominal Value/Real Value) 100

Where:

  • Nominal Value represents the current value of a variable in current prices (not adjusted for inflation).
  • Real Value represents the value of the same variable in constant prices (adjusted for inflation).

For example, if the nominal GDP is $110 billion, and the real GDP (adjusted for inflation) is $100 billion, the price deflator would be (110/100)100 = 110.

Interpretation of Ratio Values

  • A higher ToT value is indicative of favorable conditions for the farm sector, implying that the prices received for agricultural exports are relatively higher compared to the prices paid for non-agricultural imports.
  • Conversely, a lower ToT ratio suggests unfavorable exchange conditions, signaling potential challenges for the sector in terms of relative pricing dynamics.

Significance of the Ratio

  • Favorable Exchange Indicator: An improvement in ToT signifies a favorable exchange condition for a particular sector, indicating that the prices received for exports are relatively higher compared to the prices paid for imports.
  • Decline as Unfavorable Condition: Conversely, a decline in ToT suggests unfavorable conditions, implying that the sector faces challenges in terms of selling prices versus buying prices.

Types of Terms of Trade (ToT)

  • Net Barter Terms of Trade: also known as commodity Terms of Trade, is a crucial economic metric representing the ratio of export prices to import prices. It provides insights into the exchange relationship between a country's exports and imports.
  • Gross Barter Terms of Trade: Introduces a physical dimension to the analysis by considering the ratio of the quantity of imports to the quantity of exports. This measurement adds a practical perspective to the trade dynamics.
  • Income Terms of Trade: It combines commodity TOT with the quantity of exports, providing a comprehensive view of the economic implications. It reflects the actual income generated from trade relationships.
  • Single Factor Terms of Trade: It extends the analysis by incorporating the productivity index of the domestic export sector. This factor emphasizes the efficiency and competitiveness of the export industry.
  • Double Factorial Terms of Trade: Introduces a dual-factor approach by considering the ratio of factor productivity in both the domestic and foreign export industries. This nuanced calculation provides a more nuanced understanding of trade dynamics.
  • Real Cost Terms of Trade: Evaluates the trade dynamics by factoring in the real cost, considering the disutility in producing export goods. This metric provides insights into the actual costs involved.
  • Utility Terms of Trade: It extends the analysis by incorporating an index of the relative average utility of imports and domestically forgone commodities. This measurement considers the utility aspect of trade relationships.

Factors Determining Terms of Trade of a Country

  • Reciprocal Demand: The strength and elasticity of each country's demand for the other country's products play a crucial role. If one country's demand for another's product is more intense (inelastic), the terms of trade may move against the former.
  • Tariffs: Imposing tariffs on imports can affect terms of trade. Countries imposing tariffs display a reduced willingness to absorb foreign products, potentially improving their terms of trade.
  • Tastes and Preferences: Shifts in the tastes or preferences of a country's population can impact terms of trade. If preferences shift towards domestically produced goods, it may favor the home country.
  • Changes in Factor Endowment: Changes in factors like labor supply can influence terms of trade. An increase in labor supply in a country specializing in labor-intensive products may lead to a decline in terms of trade.
  • Changes in Technology: Technological advancements can affect terms of trade. Improvements in productivity and cost reduction in exportable sectors may lead to changes, either favorable or unfavorable.
  • Growth: Economic growth, especially changes in labor or capital supply, can impact terms of trade. An increase in labor supply may lead to a decline, while growth in the supply of scarce factor capital may improve terms of trade.
  • Devaluation: Devaluation of a country's currency can lower export prices relative to import prices, potentially worsening the terms of trade.
  • Balance of Payments Position: A deficit in the balance of trade and payments, leading to measures like internal deflation or import controls, can worsen terms of trade.
  • International Capital Flows: Increased capital inflows may boost demand for a country's products, affecting prices of imported goods and potentially influencing terms of trade.
  • Import Substitutes: If a country produces sufficient substitutes for imported goods, its reciprocal demand for foreign products may weaken, leading to favorable terms of trade for the home country

TOT for Agriculture

What?

ToT refers to the ratio of prices received for a country's exports, specifically focusing on agricultural goods in this context, in relation to the prices paid for its imports, encompassing non-agricultural goods and services.

Relative Change in Terms of Trade

The "Relative Change in Terms of Trade" signifies shifts in the ratio between a country's export and import prices.

Pros of Relative Changes in Terms of Trade

  • Income Security for Farmers: Stable and favorable terms of trade ensure consistent and stable prices for agricultural produce, providing income security to farmers.
  • Incentives for Innovation: Relative changes in terms of trade, especially during bumper crops, can incentivize farmers to adopt new technologies and innovative farming practices.
  • Influence on Cropping Patterns: Changes in terms of trade have the potential to influence cropping patterns, encouraging shifts in technology and leading to a redistribution of resources and income in the agricultural sector.
  • Contribution to Food Security: Improving terms of trade in agriculture, often through interventions like price support, contributes to food security by maintaining a steady and reliable supply of agricultural products.
  • Rural Development: Well-managed terms of trade policies play a crucial role in rural development. They create cooperative markets, fostering a collaborative environment, and provide a level playing field for farmers against powerful market forces.
  • Enhanced Market Access: Favorable terms of trade can enhance market access for farmers, enabling them to sell their produce at competitive prices and expanding their economic opportunities.
  • Technology Adoption: A positive shift in terms of trade can encourage the adoption of advanced technologies in agriculture, leading to increased efficiency and productivity.
  • Diversification of Agriculture: Farmers may diversify their agricultural activities based on favorable terms of trade, exploring crops or practices that are more economically beneficial.
  • Sustainable Agriculture Practices: Relative changes in terms of trade can promote sustainability in agriculture, encouraging farmers to adopt practices that prioritize environmental conservation and resource efficiency.
  • Social and Economic Stability: Stable terms of trade contribute to overall social and economic stability in rural areas, supporting livelihoods and fostering a resilient agricultural sector.

Cons of Relative Changes in Terms of Trade

  • Income Destabilization for Farmers: Stabilizing agricultural prices may lead to income instability for farmers, particularly when they cannot capitalize on higher prices during partial crop failures.
  • Price-Price Inflation Challenges: Rising agricultural prices could trigger "price-price inflation," posing challenges for non-agriculturists and consumers.
  • Market Distortions from Fixed Prices: Fixed prices may result in market distortions, as not all agricultural surpluses are efficiently cleared, impacting the overall market equilibrium.
  • Harm to Small and Marginal Farmers: Higher agricultural prices may adversely affect small and marginal farmers who are "net buyers," purchasing goods at elevated prices after selling their produce at lower prices.
  • Neglect of Technical Support: The emphasis on price interventions may lead to a neglect of technical support in agriculture, potentially hindering long-term productivity and sustainability efforts in the sector.

Conclusion

The enhancement in the Terms of Trade (ToT) for Indian agriculture over the last 15 years is a testament to the sector's robust growth, global agri-commodity upswings, and strategic policy interventions like Minimum Support Price (MSP) hikes. While this positive shift brings economic advantages, it also underscores disparities, with agricultural laborers benefiting more than farmers. The evolving ToT landscape influences cropping patterns, technology adoption, and rural development, offering income security, innovation incentives, and market access for farmers. Yet, managing income stability, potential inflation, market distortions, and the need for balanced technical support present ongoing challenges. Achieving a harmonious blend of price interventions and holistic agricultural development is crucial for sustaining the positive impact of shifting Terms of Trade in the agricultural sector.

 
 
 

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