By Xavier Cirera
Today’s newspapers are full of reports of commodities prices falling (see Reuters and Guardian for a couple of references). And just last week, BBC News questioned whether this is just a small blip or a turning point. Whilst this might not yet be clear, one thing is certain: commodity prices have risen steadily since the early 2000s.
In addition, the main view is that commodity prices are expected to remain high in the long run, due to increasing energy and resource pressures arising from higher demand in emerging markets. All this begs the question of whether we are seeing the beginning of the reversion of the Singer-Prebisch (S-P) hypothesis.
What is the Singer-Prebisch hypothesis?
There are countless theories that surround development economics, but without doubt one of the most influential and solid hypotheses is the S-P theory. It describes the trend of primary commodity prices to deteriorate in the long-term, therefore reducing the terms of trade for countries that specialise in commodities.
As many developing countries tend to export commodities and import manufactured and capital goods, this implies the need to increase the volume of exports in order to keep importing the same level of manufactured and capital goods, or otherwise experience a deterioration of the trade balance.
Declining terms of trade was one of the arguments used to justify Import Substitution Industrialization (or ISI) policies, aimed at distorting the economy to facilitate the development of manufacturing sectors, very popular in the 1960s and 1970s. It has also influenced discussions about whether natural resources are a curse for development.
Is the hypothesis being reversed?
Although it is still very early to tell, a sustained increase in commodity prices, including agricultural products, could potentially enhance developing countries’ terms of trade. If this does happen, the policy question will be how to use the rents from commodities and natural resources for sustained productivity changes, economic growth and human development.
The evidence from resource-rich countries tells us that this can be very challenging and difficult to achieve. However, I’m certain that a scenario of improving terms of trade for developing countries presents more opportunities for structural transformation than ISI strategies have had in the past, especially when the S-P hypothesis may still stand for low-skilled manufacturing products.