RDP 2005-01: Long-Term Patterns in Australia's Terms of Trade 4. Conclusion

Commodities have long constituted the majority of Australia's exports, averaging 73 per cent by value over the past century. While there has been a diversification away from commodity exports, they still account for over half of goods exports. Given that the majority of imports have been manufactures, the Prebisch-Singer hypothesis of falling relative commodity prices suggests that there should be a negative trend in Australia's terms of trade. But the trend is no more than −0.1 per cent per annum over the full sample. The trend appears to have changed at several times during the century, notably there was seemingly a stronger negative trend in the period 1955–1987, which has since largely been reversed. But statistical tests are not able to identify changes in the trend. The fact that Australia's terms of trade declined by less than the decline in the ratio of world commodity prices to world manufactures prices is due to two factors. First, the commodities that Australia has traditionally exported experienced faster price growth than a broader basket of commodities. Second, the export base diversified toward commodities that experienced relatively faster price growth. Perhaps surprisingly, the growth in manufactures exports had little role in ameliorating the negative trend. Manufactures export prices have risen more slowly than those of commodities, at least over the past 30 years. Overall, the negative trend is so slight that it is economically insignificant. Of more significance is the fact that shocks to the terms of trade have become shorter-lived.

Arguably, the more notable feature of Australia's terms of trade is their significant volatility, which is considered in the second part of the paper. We document that there have been two significant breaks in the volatility of the terms of trade, in 1923 and 1953. The volatility was over three times as high in the intervening years and remarkably similar in the adjoining periods. The episode of higher volatility is attributable to more volatile export prices for Australia's traditional commodity exports. The timing of the rapid diversification of exports coinciding with the second break would suggest this might have been a factor in the fall in volatility. We find that had Australia's exports been as diversified over the period 1923–1952 as they were in the latter half of the century, then volatility would not have increased as much over this period. However, even if Australia's export base had not become more diversified, volatility would also have fallen. In some ways this is not so surprising given volatility increased around 1923 even when the export base did not change. Undoubtedly diversification has made a return to the highly volatile terms of trade of the inter-war years less likely.