The Terms of Trade and Equilibrium Growth in the World Economy

Author(s): Ronald Findlay

Source: The American Economic Review , Jun., 1980, Vol. 70, No. 3 (Jun., 1980), pp. 291-
299
Published by: American Economic Association

Stable URL: https://www.jstor.org/stable/1805220

REFERENCES
Linked references are available on JSTOR for this article:
https://www.jstor.org/stable/1805220?seq=1&cid=pdf-
reference#references_tab_contents
You may need to log in to JSTOR to access the linked references.

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide
range of content in a trusted digital archive. We use information technology and tools to increase productivity and
facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at
https://about.jstor.org/terms

is collaborating with JSTOR to digitize, preserve and extend access to The American Economic
Review

This content downloaded from

115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
 The Terms of Trade and Equilibrium Growth
in the World Economy
By RONALD FINDLAY*
The extensive discussions that have been
going on in connection with proposals for a
New International Economic Order have
focused attention on the nature of the eco-
nomic relations between the advanced and
less developed regions of the world econ-
omy, or the "North" and "South" as it has
become customary to refer to them. Ever
since the work of Raul Prebisch and Hans
Singer almost three decades ago the move-
ment of the terms of trade between these
regions has been regarded as a key index of
the distribution of the benefits from the
international division of labor and the de-
velopment prospects of the South. Although
an extensive and controversial literature has
developed around these issues, there has
been a significant lack of rigorous formal
analysis to provide a framework within
which the diverse arguments and pieces of
empirical evidence can be sorted out and
assessed.
The objective of this paper is to present a
highly stylized dynamic model in which the
terms of trade emerge as the mechanism
linking the growth rates of output in the
North and South. The analysis attempts to
forge a synthesis of three famous papers,
using the neoclassical growth model of
Robert Solow for the North, the "labor
surplus" or "dual economy" model of W.
Arthur Lewis for the South, and the Harry
Johnson (Part 2) treatment of the terms of
trade to serve as the link between them.
I of manufactures, just as in the North. Labor
Imagine a world economy consisting of
two regions, the North and the South. The
North produces a single composite com-
modity, manufactures, which can be used
for either consumption or investment. The
*Columbia University.
291
This content downloaded from
115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
technology for manufactures is represented
by a neoclassical production function with
constant returns to scale and with capital
and labor as the inputs. Capital consists of a
stock of manufactures. The size of the labor
force is given at any instant and grows over
time at a constant rate. There is also labor-
augmenting technological progress at a fixed
rate assumed to be going on. Under these
assumptions, as is well known, the produc-
tion function can be expressed in terms of
capital and "effective" labor, which grows
over time at a fixed rate equal to the sum of
the rate of natural increase and the rate of
technological progress. A constant fraction
of output is saved and invested. Markets are
perfectly competitive and are cleared in-
stantaneously so that there is always full
employment of labor and full utilization of
capacity.
These assumptions, of course, correspond
exactly to the Solow neoclassical growth
model. The only change is that the portion
of output in the North which is not saved is
spent either on manufactures or on another
homogeneous commodity, representing pri-
mary products, with the proportions de-
pending upon the relative price of the two
goods. Income elasticities of demand for
both goods are unity.
Primary products constitute the sole out-
put of the South. There is again a neoclassi-
cal production function with capital and
labor as the inputs governing the output of
primary products. Capital consists of a stock
is in perfectly elastic supply from a "hinter-
land," which is otherwise outside the model,
at a fixed real wage in terms of primary
products. There is perfect competition so
labor is hired up to the point at which its
marginal productivity is equal to the fixed
real wage. Total employment at any instant
will depend upon the quantity of capital
292 THE AMERICAN ECONOMIC
available. The capital-labor ratio is uniquely
determined by the fixed real wage and in
turn determines the marginal product of
capital and hence the amount of profit per
unit of labor. The rate of profit, however,
cannot be determined unless the relative
price of manufactures and primary products
is known, since capital consists of a stock of
manufactures and profits of a flow of
primary products.
It is assumed that a constant fraction of
profits are saved and all wages are con-
sumed. Consumption expenditure, whether
out of wages or profits, is spent on manufac-
tures and primary products with the propor-
tions depending upon relative prices. In-
come elasticities of demand for both goods
are unity. Investment demand is thus purely
for manufactures while consumption de-
mand is divided between the two goods. The
fraction of profits which is saved determines
the increase in the stock of capital that
propels the system forward.
It is apparent that this depiction of the
South corresponds closely to the celebrated
Lewis model of economic development with
unlimited supplies of labor. The Solow
economy of the North and the Lewis econ-
omy of the South are linked through inter-
national trade. It is assumed that there is no
lending so that trade is always balanced.
The demand for imports in each region de-
pends upon the relative price of the two
goods and real income. Johnson obtained a
simple formula for the change in the terms
of trade resulting from exogenously given
growth rates of output in the two regions. In
the present model, however, there is a
feedback from the terms of trade to the
growth rate of output in the South. The next
section will demonstrate how the terms of
trade and the growth rate of the South have
to adjust to the growth rate of the "effec-
tive" labor force in the North that de-
termines the steady-state growth of the
whole interdependent dynamic system that
constitutes the specification of the world
economy.
II
The basic structure of the model will be
presented in this section. The following
This content downloaded from
115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
REVIEW JUNE 1980
notation will be used:
q = output per worker of manufac-
tures in the North
= output per worker of primary pro-
ducts in the South
LN, LS= employment in North and South
YN' YS =total incomes in North and South
kN, k5= capital-labor ratios in North and
South
w = fixed wage in the South
n = fixed growth rate of effective labor
in the North
9= the terms of trade (manufactures
per unit of primary products)
X=ratio of employment in the South
to employment in the North
p = rate of profit in the South
s = constant fraction of income saved
in the North
a= constant fraction of profit saved in
the South
IN' IS= total imports in North and South
m =per capita imports of the North
j=per capita consumption imports of
the South
71N,71=elasticities of m and I with respect
to 9 and 1/9, respectively.
Asterisks will denote long-run equilibrium
values of the corresponding variables.
The constant returns-to-scale production
function for primary products in the South
is
(1) = 7(kS)
and the profit-maximization condition is
(2) 7(ks) - 7'(ks)ks = w
Under the usual assumptions that i7'(k
> and i7"(ks) < 0, there is a unique k *
satisfies (2). Since capital consists of a stock
of manufactures and output of a flow of
primary products, the rate of profit in the
South is
(3) p= 07'(ks
while the common growth rate of total
capital, output, and employment in the
South is
(4) g= ap
 VOL. 70 NO. 3 FINDLA
which is the so-called "Anglo-Italian" equa-
tion.
A necessary condition for a steady-state
equilibrium in the world economy is that the
growth rates of North and South should be
equal. Since the natural growth rate of the
North is the constant n, it follows from (3)
and (4) that there is a unique value
(5) O* n
of the terms of trade that is consistent with
balanced growth of the world economy as a
whole. Notice that 9* depends only on
n,a,w, and the production function for the
South. It is completely independent of the
production function and propensity to save
of the North, and of the demand for imports
in the two regions.
The terms of trade must also, however,
equilibrate the balance of trade. I now turn
to the determination of the terms of trade in
the "short run" by reciprocal supply and
demand for exports and imports in the usual
manner, after which it will be shown how
the short- and long-run values of the terms
of trade become reconciled with each other.
The production function for the North is
(6) YN= q(kN)LN
where LN depends upon time by the relation
(7) LN =LOent
and kN at any instant is determined by past
history. The import demand function of the
North is
(8) IN= m[ 9, (1 s)q(kN) ] LN
where it is assumed that m'(0) <0 and that
the elasticity of m with respect to per capita
consumption (1 - s)q(kN) is equal to unity.
The import demand function for the South
is
(9) IS= [a7'(kS*)k*
I aW + (I - a)T'(ks)k)]LS
This content downloaded from
115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
Y: TERMS OF TRADE 293
where the expression in brackets is the sum
of per capita imports for investment and
consumption, respectively. At any price 1/9
the demand for capital goods will be
9ai7'(ks*)ks* per worker employed, so that
investment is always equal to the fraction a
of profits in terms of primary products, im-
plying that the price elasticity of demand for
capital goods imports is unity. Per capita
import demand for consumption purposes is
L, with t'(1/9)<0 and the elasticity with
respect to per capita consumption w +(1 -
a)r'(ks*)k.* is equal to unity. Southern em-
ployment Ls is determined by
(10) ks*Ls=Ks
where the total capital stock at any instant
Ks is given by past history. In the absence
of international capital movements the trade
balance must be zero so that
(11) SIN= IS
Substituting for IN and IS from (8) and
(9) and letting A = LS/LN denote the ratio
of employment in the two regions, (11) can
be solved to obtain
A (I ) W+(-'s*)ks*
(12) 0=-
m(O, kN) -f X7(k *)ks*
In the short run X and kN are given by
past history so that (12) determines the
value of 9 that equilibrates the trade bal-
ance. On the other hand, if 9 is at its long-
run value 9* as determined by (5) then for
each kN there is a value of X such that (12) is
satisfied. In particular, if kN is at the
steady-state value kN given by the condition
(13) k* sq(kN)
N n
then (12) determines the corresponding
unique steady-state value of X as
(14)
9*m*(9*, kZ)
w ,* ,, Iw (- a) 7'(k *) ks* + nks*
294 THE AMERICAN ECONOMIC REVIEW JUNE 1980

after using (5). It is apparent that X* is equal DkN 0

to the ratio of steady-state per capita im-
ports for the two regions.
The ratio of total incomes in the two DA=O
regions is

(15) Ys 9*r(k*)X*
YN q(kN)

In interpreting (15) it should be noted

that q(kN) is output per unit of "effective
labor." If n includes labor-augmenting tech-
nical progress then the ratio of effective to
actual labor will be continually increasing in
the North. The per capita income of the
actual labor force will be continually rising
in the North while it will be constant in the
South since n is there the rate of growth of * k* N
the actual labor force.
FIGURE 1
III

Having obtained the steady-state solution
of the model, this section examines the
question of convergence towards the steady
state from arbitrary initial conditions. At
any instant LN, KN, and Ks are all given by
past history, and Ls is determined by
the fixed wage w and the corresponding
capital-labor ratio ks*. Dividing KN and Ls
by LN, one obtains the normalized variables
kN and X which are the state variables of the DX=0 locus is therefore one which shows
dynamic system to be studied explicitly in
this section. Capital in the South Ks is not kN
separate state variable since it is always
strictly proportional to Ls by virtue of the
fixed-wage assumption. Under the assump-
tions about saving out of profits and wages,
the common growth rate of Ks and Ls is
07r'(ks*)(X, kN). The relative rate of change
of X is therefore the difference between this
rate and the fixed growth rate n of labor
force in the North. The rate of change of(19)
kN
is equal to the difference between per
capita saving and the requirements for
maintaining the capital per head of the
growing labor force.
The basic dynamic system can therefore
be formulated as
where D denotes the derivative with respect
to time.
The properties of this system can be con-
veniently seen by means of the phase dia-
gram constructed in Figure 1. The DkN=O
locus is a vertical line at the value kN ob-
tained in (13). It is independent of N. The
condition for DX = 0 is that 9 should be at
the value 9* obtained earlier in (5). The
the value of X corresponding to any value of
a such that = 9*. The positive slope of
the DX = 0 locus is derived from the relation
d__ ao a9
(18) dkN * akN ax
which is obtained by total differentiation of
(12) evaluated at 9*, with
as ~~~~(I - s) q'(kN) th
a = _
(20)

(16) Dk = q G7'(ks*)-(, kN)k-n]/X __ -XaT'(k 1(-s ["ai(k*)kN*

[m - aT'(ks*)ks I -71s -A _,N)

( 17) DkN = sq(kN) -nkN

This content downloaded from

115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
 VOL. 70 NO. 3 FINDLA Y: TERMS OF TRADE 295

The common denominator of (19) and The "determinant condition" for stability
(20) is the product of two terms, the first of is also fulfilled since
which is the denominator of (12) and is

(24) a2~
ak,V (DX) _ ao
positive. The second is negative if
X a7T'(ks*) ak >0

(21) Om >1
(25) a(DkN)
ax
where s and fN are the elasticities of con-
sumer import demand with respect to the The conditions imply that X falls at any
terms of trade in the two regions. This is point above the D A = 0 locus and rises at
what corresponds to the familiar Marshall- any point below it, while kN increases at any
Lerner stability condition in the present point to the left of the DkN= 0 locus and
model, since the elasticity of demand for decreases at any point to the right. The
investment imports in the South is unity. It motion of X and kN is indicated by the
is apparent that (21) and the Marshall- arrows in each of the quadrants. A possible
Lerner condition are equivalent since (21) trajectory from an arbitrary initial condition
implies that qN plus a weighted average of
is indicated by the dashed curve in Figure 1.
qs and the unit elasticity of investment At im-
the initial point 9 is below 9* so that the
ports with k,u/Om as the weight of qs ex- rate of the South is below n which
growth
ceeds unity. The symbol mh in the numerator means that X falls and 9 increases. When the
of (19) is the partial derivative of m with DX = 0 locus is reached 9 = 9*. The increase
respect to per capita consumption expendi- in kN raises the terms of trade above 9*
ture (1 - s)q(kN) in (8). It follows that which means that A must now start to in-
crease together with kN towards the steady-
ao > 0, ao <> state values A* and kN while 9 approaches
*akN 'ax 9* from above. The terms of trade therefore
overshoot the long-run value 9* but then are
if (21) holds, which establishes the positive pulled towards it. The intersection of the
slope of the D X = 0 locus from (18). The trajectory with the DX=O locus divides the
reason for this slope is clear since an in- approach towards the steady state into two
crease in kN improves the terms of phases,
trade of the first in which the South grows
the South above 9* so that an increase in X more slowly than the North and the terms
is required to restore this value. The inter- of trade continually improve, and the sec-
section of the D X = 0 and DkN= 0 loci de- ond in which the South grows faster than
termines the steady-state value X* of X, the North and the terms of trade converge
already obtained in (14). toward 9* from above.
Examining the dynamic system (16) and
(17) the "trace condition" for stability is IV
seen to be satisfied since
This section investigates the impact and
long-run effects of variations in the parame-

(22) (DX) =* '(ks*) ao <O ters. The initial position will in all cases be
taken as the steady-state point (X*, kN).
First, suppose that there is a shift of de-
mand in the North towards primary prod-
(23)(2)(DNa)
akN = sq'(kN*)-n(<O ucts, so that m is larger for any given 9. The
impact effect on 9 is given by partial dif-
ferentiation of (12) with respect to a shift
at the steady-state point (X*, kN). The condi- parameter which reveals that 9 would in-
tion (23) is the same as the familiar stability crease if the stability condition (21) holds.
condition for the Solow model of a closed This raises the rate of profit in the South
economy. which causes X to increase and 9 to fall. It is

This content downloaded from

115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
296 THE AMERICAN ECONOMIC REVIEW JUNE 1980

clear from (5) that the long-run value of 9*

is independent of the import demand func-
tion of the North, so that 9 converges back
towards the original 9*, while (14) indicates
\ B
that X* increases in the same proportion as
the increase in m. In terms of Figure 1 the
B~~~~~~~~
effect is to shift the D X = O schedule up-
wards, while leaving the DkN= 0 schedule
unchanged, so that A* rises and kN remains B~~~~~~~~~
constant.
The impact and long-run effects of the
shift in import demand can be conveniently * A*
0-
seen in terms of Figure 2. The BB curve lI B -
shows the combinations of 9 and X that
maintain equilibrium in the trade balance
when the capital-labor ratio of the North is
at its steady-state value kN. The negative
slope follows from the assumption that
the Marshall-Lerner stability condition (21) FIGURE 2
holds. An increase in the propensity to im-
port of the North shifts BB to the right to
B'B', since X has to increase at constant 9 that X must fall if there is to be equilibrium
for (12) to still hold. In the short run X in the balance of trade with everything else
cannot change so it remains at the original held constant. The fact that the D = O
value of A* while 9 increases to the corre- locus shifts down while the DkN= 0 locus
sponding point on B'B'. This raises the rate shifts to the right might appear to render the
of growth of the South so X increases gradu- effect of a rise in s on A* ambiguous. If the
ally while 9 falls and the economy of the North is to the left of the Golden Rule point
South moves down B'B', approaching the where q'(kN) =n, however, a rise in s must
point on it corresponding to the original raise total consumption per capita (1-
terms of trade 9*. The same line of reason- s)q(kN*). It follows from (14) that A* must
ing indicates that a shift in the South's con- increase in the same proportion as steady-
sumption demand towards manufactures state per capita consumption in the North,
eventually leaves 9* unchanged but reduces since the elasticity of demand for primary
X* by a proportion equal to the product of products with respect to consumption ex-
the increase in consumption demand and penditure is unity. It is interesting to note,
the share of imports for consumption to therefore, that A* is maximized, for given
total imports in the South. The effects on values of all other parameters, when the
relative income shares of these shifts in propensity to save in the North is at the
import demands are proportional to the level required by the Golden Rule. The dis-
changes in X*, as (15) indicates. parity in per capita consumption and in-
An increase in the propensity to save of come levels between North and South is of
course widened by the increase in s since
the North raises kN by virtue of (13) so that
the DkN=O schedule is shifted to the right, the levels of these variables in the South are
while (5) shows that 9* is not affected by not affected by s. The ratio of total incomes
this change. An increase in s, for given shown in (15) worsens for the South in spite
values of 9 and kN, must lead by (12) to of a the increase in A*, since the proportion-
reduction in X, so that the DA= 0 schedule ate increase of this variable is equal to
is shifted downwards as a result. This is (1-s)q(kN) which is less than that of
because a rise in s means a shift towards q(kN*) because of the rise in s. An increase in
manufactures and away from primary prod- the North's propensity to save therefore
ucts in the demand pattern of the North, so raises relative employment in the South but

This content downloaded from

115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
 VOL. 70 NO.3 FINDLA Y: TERMS OF TRADE 297

it lowers its relative per capita income. The
favorable effect on relative total income of
the South of the improvement in relative
employment is not sufficient to offset the
decline in relative per capita incomes.
Technological change in the North can be
introduced in the form of a once and for all
Hicks-neutral shift in the production func-
tion q(kN), or in the form of an increase in
the rate of labor-augmenting Harrod-neutral
progress that results in an increase in n, the
growth rate of the effective labor force.
Taking the case of the Hicks-neutral shift
first, it is evident that the DkN= 0 locus is
shifted to the right and that kN increases.
For given values of 9 and kN (12) implies
that X must increase if q(kN) rises. Theof the fact that a/a/ <O. The rise in ks*
D X
=0 locus is therefore shifted upward and so
X* increases. The immediate impact of the
Hicks-neutral shift in the production func-
tion of the North is for 9 to increase with X*
and kN at their original steady-state values.
The initial rise of 0 raises the growth rate of
the South above n, which causes A to in-
crease towards its new steady-state value,
while kN also increases because savings in
the North now exceed the steady-state re-
quirement. The fact that the South grows
faster than the North means that 9 falls
after the initial jump in its level, and it
eventually approaches its original level 9*
which, as may be seen from (5), is not
affected by the shift in q(kN). It can out
from (14) and (15) that the shift in q(kN)
no effect on the relative total incomes of the on X* is obtained by logarithmic differentia-
North and South since X* increases in the
that the elasticitiy of 9* with respect to a is
same proportion as q(kN) while 9* remains
unchanged. Relative per capita incomes of
course move in favor of the North.
An increase in n shifts the DkN = 0 locus
to the left and reduces kN. From (5) it is
clear that 9* must rise in the same propor-
tion as n, so that there is a permanent im-
provement in terms of trade of the South.
For any given kN it follows from (12) that a
higher 9* requires a lower X to equilibrate
the trade balance, so that the DX= 0 sched-
ule is shifted downward and A* falls.
A change in any of the South's parame-
ters does not affect the DkN = 0 locus and so
leaves kN unchanged. The welfare of the
North, however, can be altered by these
parameter shifts through their effects on
the terms of trade. An increase in the fixed
real wage iw raises the capital-labor ratio ks*
in the South and so reduces 7'(ks*), the
marginal productivity of capital. This results
by (5) in a rise in 9* proportionately equal
to the fall in ff'(ks*). The South is therefore
able to improve its terms of trade in the
long run by an exogenous increase in the
fixed real wage. The price for this, however,
will be a reduction in the relative employ-
ment ratio X*. This can be proved by show-
ing that an increase in w must reduce X* if
the terms of trade are held constant, so that
the improvement in the South's terms of
trade must reduce it even further by virtue
induced by the rise in w, combined with
the fact that the South is to the left of
the Golden Rule since a < 1 means that
total consumption expenditure w +(1 - a)
7r'(ks*)ks* and investment nks* both rise on
a per capita basis. At constant terms of
trade this means an increase in the demand
for imports for both consumption and in-
vestment purposes. Exports will however be
constant, since the North's income is not
affected, so that X* must fall as a result of
the rise in W with 9* held constant. But 9* in
fact rises, so that X* must fall even further
since ax/ao O.
An increase in a, the propensity to save
be of profits in the South, leads by (5) to a
seen
fallhas
in 9* in the same proportion. The effect
tion of (14) with respect to a, using the fact
minus unity. This establishes that
(26) a dA 0
depending upon whether
(27) N+r qs Z_ I +
where f is the additional import of manu-
factures for consumption resulting from an
increase in total consumption expenditure
in terms of primary products w- + (1-a) -
I'(ks*)ks*. The condition (27) on the sum

This content downloaded from

115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
298 THE A MERICAN ECONOMIC RE VIEW JUNE 1980
of the elasticities of import demands is more
stringent than the stability condition (21),
since the marginal propensity to import
when income in the South is measured in
terms of manufactures is A/IO*,
which is
between zero and unity, making (a*-A)
positive.
The effect of a rise in a on A* at constant
terms of trade is for it to be reduced, since
all of the increase in saving out of profits is
spent on imports while only part of what
was formerly being consumed was spent on
imports, requiring X* to fall to equilibrate
the trade balance. The terms of trade wor-
sen, however, which, if (21) holds, leads to a
rise in X*. The necessary and sufficient con-
dition for the induced increase in X* to
more than offset the fall at constant terms
of trade is provided by (27).
In terms of Figure 2 the increase in a
shifts the BB curve to the left to B "B ". In
the short run X* remains fixed so 0 falls to
the corresponding point on B"B". This de-
cline, however, may be smaller or greater
than the long-run decline in 9* which must
be in the same proportion as the increase in
a. The new steady-state value of X* will be
at the point on B "B" corresponding to this
long-run decline in 0* and the economy of
the South moves along B"B" in whichever
direction is required to get to this point
since DX will be positive or negative de-
pending upon whether the impact effect on
0 is less or more than the long-run effect.
The effect of the increase in a is to worsen
the relative per capita income of the South
since 9* falls while 7(ks*) and q(kN) are
unchanged. The effect on relative total in-
comes depends in addition upon what
happens to X*. So long as the total elasticity
of X* with respect to a, obtained earlier in
connection with (27), does not exceed unity
the relative total income of the South must
also decline.
A simple way in which a once and for all
technological change in the South can be
introduced is by an increase in the marginal
productivity of capital with the capital-labor
ratio and the marginal productivity of labor
unchanged. This will lower 9* in the same
proportion as the rise in the marginal pro-
ductivity of capital, as implied by (5). De-
noting 7r'(k*) by r, the effect of this type of
This content downloaded from
115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
technical progress on X* is obtained by loga-
rithmic differentiation of (14) with respect
to r, using the fact that the elasticity of 9*
with respect to r is minus unity. This yields
the result
that
r d/X*
(28) A* dr 0
depending on whether
9*m + , [O* -(1- )fj] rks*
(29) A qN
The interpretation of (29) is analogous to
that of (27). The impact and long-run effects
on 9 and X can also be shown in terms of
Figure 2 in a manner corresponding exactly
to the preceding analysis of the increase in
the propensity to save, since the increase in
the South's income at constant terms of
trade requires X to be reduced, thus shifting
BB to the left.
The effect of this type of technological
change is to reduce the relative per capita
income of the South. The reason is that 9*
deteriorates in the same proportion as r
increases while r(ks*) increases only by the
share of profit times this amount. Thus the
relative total income of the South would
also decline unless the total elasticity of X*
with respect to r, obtained in connection
with (29), were to exceed the share of wages
times the proportionate increase in r result-
ing from the technological change.
V
"An engine of growth" was the famous
phrase that Dennis Robertson used to de-
scribe the role of international trade in the
expansion of the world economy from the
mid-nineteenth century to World War I, a
process that has continued in the last three
decades after the disruptions of the interwar
years. In the model that has been presented
here, trade is indeed an engine of growth for
the economy of the South, but the power
that drives that engine is generated by the
exogenously determined natural growth rate
of the North. The South does not have a
given natural growth rate but an endoge-
nous one, depending upon the value of the
 VOL. 70 NO. 3 FINDLA
terms of trade since this is what determines
the rate of profit in the Anglo-Italian equa-
tion. The steady-state level of the terms of
trade must be whatever is necessary to make
the endogenous growth rate of the South
equal to the fixed natural growth rate of the
North.
The structural differences in the de-
termination of the growth rate of the
two regions produces asymmetrical con-
sequences on the terms of trade of changes
in technology and the propensity to save. As
demonstrated in the previous section, once
and for all improvements in the production
function of the North and increases in its
propensity to save leave the terms of trade
unchanged in the long run and increase its
real per capita income. In the South, on the
other hand, these shifts lead to a pro-
portionate fall in the long-run terms of trade
and a decline in real per capita income
measured in terms of manufactures. These
unfavorable effects, however, are compen-
sated by an increase in the relative employ-
ment ratio if the elasticities of import de-
mand are sufficiently high. This asymmetry
is a prominent feature in the writings of
Raul Prebisch and Hans Singer. The argu-
ments put forward for this asymmetry by
these writers, however, usually involve the
role of monopolies and trade unions in the
North and generally have not been very
convincing. The present analysis obtains
similar conclusions in spite of assuming per-
fectly competitive markets everywhere.
In conclusion some of the major limita-
tions of the model may be noted. One of
these is the absence of international capital
mobility in response to differences in the
rate of profit between North and South.
This can readily be handled but an ade-
quate treatment requires a separate paper.
Another is the assumption of complete spe-
cialization in both regions. Two-sector open
dual economics have been studied, for ex-
ample in my book, Part 2, though only in
This content downloaded from
115.187.45.112 on Fri, 08 Dec 2023 06:00:10 +00:00
All use subject to https://about.jstor.org/terms
Y: TERMS OF TRADE 299
the context of either constant terms of trade
or an exogenously shifting demand curve
for the exportable primary product. Once
again, an extension of the analysis to ac-
commodate this feature is quite feasible but
would require too much space to attempt
here.
The most basic assumption of all, of
course, has been that the South enjoys un-
limited supplies of labor at a fixed real
wage. This is not intended as a permanent
state of affairs, since if the growth rate of
employment in the "modern" or com-
mercialized sector exceeds the rate of popu-
lation growth, the unlimited supplies of
labor must become exhausted and growth
will eventually produce a rise in the real
wage. Structural differences between North
and South would then no longer exist and
the neoclassical model would come into its
own the world over. Hopefully that day will
come, but it has not as yet.
REFERENCES
Ronald Findlay, International Trade and De-
velopment Theory, New York 1973.
Harry G. Johnson, International Trade and Eco-
nomic Growth, Cambridge, Mass. 1967.
W. A. Lewis, "Economic Development with
Unlimited Supplies of Labour," Man-
chester Sch. Econ. Soc. Stud., May 1954,
22, 139-91.
Raul Prebisch, The Economic Development of
Latin America and its Principal Problems,
New York 1950.
D. H. Robertson, "The Future of Interna-
tional Trade," Econ. J., Mar. 1938, 48,
1-14.
H. W. Singer, "The Distribution of Gains
between Borrowing and Investing Coun-
tries," Amer. Econ. Rev. Proc., May 1950,
40, 473-85.
R. M. Solow, "A Contribution to the Theory
of Economic Growth," Quart. J. Econ.,
Feb. 1956, 70, 65-94.