SEM-6/Eco Dev/ Unit-1/ Dependency/Prebisch-Singer Hypothesis

One of the most celebrated academic debate about the terms of trade (TOT) and economic
development emanated from what is known as the Prebisch doctrine (similar ideas have also
been expressed by Hans Singer). In a short monograph written for the United Nations Economic
Commission for Latin America (UNECLA) (1950), Raul Prebisch argued that the less
developed countries (LDCs) exporting primary products almost invariably face a secular
decline in the TOT. His argument, however, was purely empirical one based on an analysis of
the TOT of Great Britain during 1876-1938. During that period the TOT of Great Britain
improved steadily. On the basis of this finding, Prebisch hypothesized that during that period
TOT of the LDCs worsened since the TOT of Britain was assumed to be an inverse of the TOT
of the LDCs.

Prebisch tried to generalize this finding into the assertion that a decline in the TOT of the LDCs
in the long-run is an essential consequence of the growth and trade between the ‘Centre’ (viz. the
developed countries) and the ‘periphery’ (viz. the LDCs). That the trade between the centre and
the periphery would lead to a long-run deterioration of the TOT of the LDCs, was based on the
following assumptions:

(1) As growth occurs, the relative demand composition in economies shifts away from primary
products to manufactures following Engel’s Law.
(2) Manufacturing industries are not typically competitive; so increase in productivity is not
passed on to consumers through lower prices, but is retained by the producing country as
higher profits.
(3) New synthetic substitutes for primary products are bound to appear periodically, thereby
diminishing the share of primary goods in the international market.

The Prebisch-Singer thesis basically indicated that the LDCs which generally export primary
products to the developed countries, would face a secular decline in their TOT. This theorem
shows that the advanced developed countries (or the centre) export manufactured goods. The
price elasticity of demand for manufactured goods (e m ) remains relatively elastic (e m >1).
However, the price elasticity of demand for primary goods (e p ) exported by the LDCs remains
relatively inelastic (e p <1).

It has been assumed that at the starting point, the growth rate of the national income in the
center (Gc) remains equal to that of the periphery (Gp).

Now, exports from periphery (Xp) = Gc. e p

And imports of the periphery (Mp) = Gp . e m

As e p < e m , and Gp = Gc (by assumption)

So, Xp < Mp

Dr. D.Mazumdar, Professor & HOD, Eco, THC 1

Similarly, exports from the Center (Xc) = Gp. e m

And imports of the Centre (Mc) = Gc . e p

Since e p < e m and Gp = Gc

So, Mc< Xc

Thus, in the periphery, the balance of payments account (BOP) would become unfavourable over
years.

Even if Mp = Xp

Or, Gp. e m = Xp [Since Mp = Gp . e m ]

Xp G c .e p
Or, G p = = [Since Xp = Gc. e p ]
em em

Gp ep
Or, = <1 [Since ep < e m ]
Gc em

So, Gp < Gc

Thus, the growth rate of NI of the periphery would be less than that of the Centre. This
result will hold as long as current account equilibrium in the BOP is a requirement and relative
price adjustment in international trade is either ruled out as an adjustment mechanism to rectify
BOP disequilibrium or it does not work. To avoid the consequences of this model, Prebisch
argued the case for protection which in effect, is a policy to reduce e m (i.e, the propensity to
import manufactured item.)

Explanation for falling trend in TOT of LDCs by Prebisch:

Prebisch has given the following explanations for the falling trend in the TOT of the LDCs:

(a) In developed countries, factor incomes tend to rise with the increase in factor productivity
but in LDCs factor incomes increase more slowly in comparison with the productivity
growth due to rising population pressure and surplus labour. Thus, prices of final
products in developed nations tend to rise faster than those in LDCs due to higher factor
prices prevailing in DCs.
(b) A ratchet effect operates with the prices of primary products because the prices of
primary goods fall relatively faster than the prices of manufactured items during the
downswing of the business cycle. However, during the upswing of the trade cycle, the
prices of primary goods rise at a slower pace compared to those of manufactured goods.
Such asymmetrical cycles would produce a secular falling trend in the average price of
the primary goods (Fig.-1).

Dr. D.Mazumdar, Professor & HOD, Eco, THC 2

 Price of primary goods (P)

Trend of P

t (time)
0
Fig.-1

(c) Different research workers such as Spraos(1980), Thirlwall & Bergevin (1985), Sarkar
(1986) etc. have confirmed such deterioration in TOT for LDCs exporting mainly
primary products. Grilli & Yang (1988) have shown that the TOT deterioration for all
primary products was to the tune of 0.5% p.a. during 1900-1983, and 0.6% p.a. for all
non-fuel commodities. Based on the World Development Report (1992), Thirlwall has
shown that the TOT of the low and middle income countries has deteriorated by about
6% during 1985-90.

Critical estimation:

This theorem has been criticized by several economists like Haberler (1961), Meier (1963),
Thirlwall (1972), Elkan (1973) etc.

(a) The TOT of Britain should not be treated as an inverse of that of the LDCs. A substantial
part of British imports came from other developed nations. Even the import of primary
products was substantial from Australia and New Zealand. Again, during that period
(1876-1938), the transport costs fell sharply causing an improvement in TOT of Great
Britain. So, there is no reason to treat an improvement in one country’s commodity TOT
as a reflection of the deteriorating TOT of its trading partners.
(b) The TOT does not always take into account the quality of a product; and it is reasonable
to assume that during 1876-1938, the quality of manufactured goods improved more than
the quality of primary goods. So an improvement in the TOT of Great Britain may be the
reflection of this quality improvement (i.e. more importable per unit of an exportable of
improved quality).
(c) This theory rests on the assumption of demand bias in favour of manufacturing items.
However, there are some objections to such demand-bias argument: (i) the term
‘exporters of primary goods’ and the ‘developing nations’ are not synonymous. For
instance countries like USA, Canada, Australia etc. are the major exporters of food, while
countries like South Korea and Taiwan export manufactured items. (ii) If the growing

Dr. D.Mazumdar, Professor & HOD, Eco, THC 3

supply of manufactured goods can satisfy its growing demand then its relative price in
terms of primary goods may not increase, i.e. the relative price of primary goods may not
fall, (iii) technological progress gives rise to new products and processes that require
lesser amount of raw materials in the production of those products.

Inspite some of those valid criticisms against this theorem, some economists like Kaushik
Basu believe that the purchasing power of primary goods has a tendency to decline in the
long-run and there may be some merit in Prebisch’s advocacy of import substitution and
industrialization in LDCs.

Dr. D.Mazumdar, Professor & HOD, Eco, THC 4