RDP 2014-01: Macroeconomic Consequences of Terms of Trade Episodes, Past and Present 2. Terms of Trade Episodes

This paper considers terms of trade episodes in Australia from the mid 19^th century onwards. These episodes are identified using the Bry-Boschan quarterly (BBQ) algorithm developed by Harding and Pagan (2002). The major episodes identified are illustrated in Figure 1 and generally align with accounts by economic historians (e.g. Bhattacharyya and Williamson 2011).^[1]

The key characteristics of each of the previous major upswings in the terms of trade are described below.

• 1894–1905: Increases in wool prices were the primary driver of Australia's terms of trade. Price increases were due to both demand and supply factors. Increased demand reflected the recovery from the global depression in the 1890s, together with the continued industrialisation of North America, Western Europe and Japan. Wool supply was stymied by the severe ‘Federation drought’ from 1895–1902 in Australia, which was the world's largest wool producer at the time (Pinkstone 1992; Meredith and Dyster 1999).
• 1922–1925: World prices for wool and grains rose strongly as the United Kingdom's wartime wool stockpiles were depleted and shortages in Europe emerged (Pinkstone 1992; Meredith and Dyster 1999). Despite rising world prices for raw materials, Australia's import prices declined significantly due to falls in prices of manufactured goods.
• 1944–1951: A surge in the demand for wool, particularly from the United States due to the Korean War, and a reduction in sheep numbers following a period of drought, caused a spike in wool prices. More generally, the prices for a range of rural goods and resource commodities were supported over this period by increased demand associated with post World War II reconstruction, higher population growth, and the resumption of world trade (Meredith and Dyster 1999). A large increase in import prices, due to rising global inflation, provided some offset to rising export prices.
• 1968–1974: Wool and other rural commodity prices, such as cereals and meat, drove export prices higher, although metals and minerals prices were also buoyant (Pinkstone 1992; Gruen 2006). Disruptions to food supplies, caused by adverse weather in major grain producing regions and US farm policies that discouraged a supply response to growth in protein demand from developed economies, contributed to this episode (Cooper and Lawrence 1975). High metals and minerals prices partly reflected resource-intensive growth in Japan (Smith 1987). As a net importer of crude oil, the surge in oil prices tempered the upswing in Australia's terms of trade.

Four common themes are evident in these episodes. First, major increases in the terms of trade have been driven by strong growth in export prices (Figure 2). The early 1920s was the only episode in which declining import prices was a major contributor.

Second, export price growth was typically driven by wool and other agricultural prices, reflecting the large share of exports they accounted for at the time (Figure 3). At their peak in the early 1950s, wool exports accounted for over half of the value of Australia's total goods exports; presently they account for less than 1 per cent (Figure 4).

Third, the prices of Australia's natural resources have been heavily influenced by global developments and adverse supply disruptions. This has included the emergence of large countries with rapid growth prospects as well as major conflict and severe drought. Fourth, these upswings are typically short-lived, ranging in duration between 2 and 5 years.

The recent episode is distinct in a number of ways. The rapid industrialisation of China has seen a sharp increase in iron ore and coal prices, rather than rural commodities (Figure 3).^[2] This reflects the steel-intensive growth that China has experienced so far and the fact that China's population is proportionally larger than previous industrialising countries. Consequently, resource exports' share of Australia's exports has risen markedly over the past decade (Figure 4).

The recent episode has also been more persistent, lasting at least three times as long as any previous boom.^[3] The length of the current upswing is the result of the interaction of the stronger-than-expected resource-intensive growth in China on the demand side, and long, complex planning and approvals procedures for resource projects. Uncertainty about how long the commodity price boom might last may also have delayed investment decisions by some companies for a time (Garnaut 2012; Plumb, Kent and Bishop 2013; Rees 2013).

Even though the terms of trade have been underpinned by export price movements in the current episode, declining import prices have been an additional factor contributing to the increase (Figure 2). These low prices partly reflect the availability of low-cost manufactured goods, due to high productivity growth and low wages in east Asia. The only previous episode in which import prices fell noticeably and contributed to the increase in the terms of trade boom was in the 1920s. At that time, falls in the prices of manufactured goods from the United States and the United Kingdom made a sizeable contribution to Australia's terms of trade upswing (United Nations Statistics Division 2009). Increases in import prices have, however, contributed sizeably to post-boom downswings in the terms of trade, most noticeably in the mid 1970s. In the very long term, Australia's import prices have generally moved in line with world inflation and have tended to increase alongside export prices.

Footnotes

The Excel version of BBQ, developed by Sam Ouliaris of the IMF Institute for Capacity Development, is applied to the log level of the terms of trade. As much of the data are annual, a restriction that the minimum length of a phase is two years is used, although this can be overridden if the terms of trade change by more than 20 per cent in a single year. See Appendix A for a list of terms of trade cycles identified using this algorithm. [1]

Other mining booms have occurred in Australia (see Battellino (2010)), although some were largely independent of the terms of trade. For example, the Gold Rush in the 1850s reflected the discovery of deposits, but the price of gold was set to according to the gold standard. [2]

The algorithm dates the upswing beginning in the mid 1990s, although this reflects declining import prices, and it is not until the mid 2000s that substantial increases in export prices occurred. [3]