The terms of trade and the direction of trade in the maltese economy

World Development, Vol. 21, No. 2, pp. 269-276,1993. Printed in Great Britain.

0305-750X/93 $6.00 + 0.00 0 1993 Pergamon Press Ltd

The Terms of Trade and the Direction the Maltese Economy

of Trade in

LINO BRIGUGLIO Foundation for International Studies, University of Malta Summary. - This paper attempts to show that changes in the Maltese terms of trade are influenced by Malta’s direction of trade, and not by the agricultural/manufacturing composition of exports and imports. It is shown that the deterioration (or improvement) of Malta’s commodity terms of trade may be linked to the fact that Malta has to compete with developing countries in its export trade and to purchase most of its imports from industrialized countries. The paper also describes Malta’s incomes terms of trade and shows that these have tended to change in a different manner from the commodity terms of trade. It will be suggested that the improvement in Maltese export competitiveness may in some years, have given rise to an increase in export demand which more than offset the negative effect of a fall in the relative prices of exports. The conclusions reached in this paper may have implications for very small and very open economies, where knowledge of what determines the terms of trade is of extreme importance, due to the fact that changes in the ratio of export to import prices have a relatively very high impact on the capacity to import of such countries.

1. INTRODUCTION This paper attempts to explain the factors affecting the pattern of change of Malta’s commodity terms of trade since 1970. The novelty of this paper is that it does not explain changes in the terms of tiade with respect to primary commodity/manufactured products composition of trade, but in terms of the direction of trade. It will be argued that the deterioration (or improvement) of Malta’s commodity terms of trade may be linked to the fact that Malta has to compete with developing countries in its export trade and to purchase most of its imports from industrialized countries. The paper also describes Malta’s incomes terms of trade and shows that these have tended to change in a different manner from the commodity terms of trade. It is suggested that the improvement in Maltese export competitiveness may in some years have given rise to an increase in export demand which more than offset the negative effect of a decline in the relative prices of exports. The conclusions reached in this paper may have implications for very small and very open economies, where knowledge of what determines the terms of trade is of extreme importance, because changes in the ratio of export to import prices have a relatively very high impact on the capacity of such countries to import. 269

Issues related to the terms of trade have long attracted the interest of economic researchers. Some early works include Prebisch (1950). Singer (1950). Viner (1952) and Ellsworth (1956). A recent survey paper on this topic is given in Sapsford (1990). Such work, however, did not generally deal with very small economies, and hardly any work has focused on the Maltese terms of trade. At least two authors, Briguglio (1989) and Scicluna (1984). have published studies on the effects of import and export prices on Maltese international trade. but the factors influencing the Maltese terms of trade themselves have not been the subject of investigation. The paper is divided into six sections. Section 2 is a brief description of the Maltese economy. Section 3 defines terms of trade and present time series data on the Maltese commodity and incomes terms of trade. The most important changes in these data are described and analyzed. Section 4 presents a very simple test of the hypothesis that Malta’s commodity terms of trade have been influenced by the direction of trade. Section 5 presents data on Malta’s income terms of trade and discuss the argument that these terms of trade have improved in line with Malta’s export competitiveness. suggesting that a deterioration in the commodity terms of trade need not result in an overall disadvantage for the

270

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economy. Section of the paper.

6 summarizes

DEVELOPMENT

the conclusions

Table

2. The trade balance and the resource balance (five-yearly annual averages: LM million)

Merchandise 2. MALTESE ECONOMY AND ITS FOREIGN SECTOR

Period

The Maltese economy is one of the smallest in the world. In 1990, the Maltese GNP was approximately US$21,000 million and the Maltese population was approximate_ly 350,000, occupying a land area of about 320 square kilometers. In terms of GNP per capita, however, Malta is not on the low side by international comparisons. Although usually classified as a developing country, its average 1990 per capita GNP, amounting to approximately US$6.000, is higher than most Third World countries, and the World Bank classifies the Maltese economy as an upper middle-income one. The Maltese economy, like many other small economies, has a relatively large foreign sector. Table 1 shows the percentage of the Maltese total final expenditure that is exported and the import content of final sales, since 1970. The table shows that the Maltese economy is very much dependent on international trade. During the 198Os, Malta exported around 40% of its total final sales and the import content of these same sales was around 47%. The Maltese balance of trade is characterized by consistent deficits, as shown in Table 2, which presents data on merchandise only and on the resource balance (merchandise and services taken together) at current and constant (1970) prices. Table 2 shows that in most subperiods since 1970, the resource balance would have been in surplus and the trade balance would have had very much smaller deficits, had prices of exports and imports remained constant (or had the prices of imports not increased faster than the prices of imports since 1970).

Table

Period 197&74 1975-79 19X!-84 19X5-89

Current prices

197&74 1975-79 1980-84

1985-89

67.80 56.43 s9.73 59.21

-44.68 -34.11 -33.42 -47.28

-25.96 -23.54 -54.26 -62.46

balance Constant prices

- 17.01 17.96 23.62 26.87

Sources: Merchandise balance: Malta, Annual Abstracr

issues). Resource balance: Malta, Nafional Accoums Maltese Islands (various issues).

3. COMMODITY

TERMS

of /he

OF TRADE

The simplest definition of terms of trade is the ratio at which imports and exports can be exchanged. This is known as the commodity terms of trade, the changes in which can be expressed as: Tc, = (P&/P&

,)/( PmjPm,_

,)

where Tc stands for commodity terms of trade, Px stands for export prices and Pm stands for import prices. The subscripts t and t-l stand for the current and the previous period respectively. For the purpose of this paper, we will measure these terms of trade for merchandise only and for merchandise and services taken together.

(a) Malta’s commodity

terms of trade

Malta’s commodity terms of trade, calculated on the basis of the formula just presented, are given in the appendix and in Table 3. The appendix gives annual changes whereas Table 3

Expenditure (‘%) Exports 32.20 43.57 40.27 40.79

Resource Current prices

of Slatislics (various

1. Percentage shares of final expenditures

C+I+G*

-60.70 - 109.38 - 173.68 -205.43

balance Constant prices

(five-yearly averages)

Total

Sources (‘X) Imports GDP

100.00 100.00 100.00 100.00

S4.08 51.14 53.26 53.23

Source: Malta, National Accounts of the Maltese Islands (various *Consumption plus government plus investment expenditures.

45.92 4X.86 46.74 46.77 years).

271

MALTA Table 3. Five-yearly chunges in the commodity icrms of trade (74) Commodity Merchandise

terms of trade Resource balance

1970-74 lY7S-79 198w34 1Y85-89

95 99 99 105

96 98 YY 102

197(HY

09

YX

Sources: Merchandise balance: Malta. AI~IILI~Abstrucf oJ Stutisrics (various issues). Resource balance: Malta. Nurionul Accounrs of [he Mahese Islands (various issues).

annual changes averaged over five years. In Table 3, a figure lower than 100 shows a deterioration in the terms of trade on a fiveyearly basis, whereas a figure of more than 100 shows an improvement. It can be seen that the commodity terms of trade applicable to merchandise have tended to deteriorate only up to 1984, according to the fiveyearly averages given in Table 3. The single year changes, given in the appendix, indicate that there were odd years when an improvement was registered. After 1984 the commodity terms of trade have tended to improve. The same pattern can be detected with respect to the commodity terms of trade applicable to the resource balance, but the improvement after 1983 has been very modest and there was a decline during 1988-89 (see appendix). Overall, during the 20-year period (197(X39), there was a tendency for the commodity terms of trade to decline, as shown in the last line of Table 3. This conforms with the trend shown in Table 2. The growth of the trade and resource deficits can be partially attributed to a deterioration in the terms of trade, taking 1970 as base year. given

(b) The Maltese composition of exports Development economics textbooks often argue that less-developed countries tend to face deteriorating terms of trade. The leading exponents of this view, Raul Prebisch and Hans Singer, have argued that countries exporting primary products will face a sluggish increase in demand (relative to supply) for these products while countries exporting manufactured goods

face a more rapidly growing demand (relative to its supply). Prices of imports of developing countries tend to increase at a slower rate than the prices of exports. This argument hinges on the heavy dependence of less-developed countries on exports of primary products, and on the low income and price elasticities associated with demand for primary products, when compared to demand for other merchandise and services. These arguments do not, however, apply to the Maltese economy. The exports of primary products from Malta are minimal, since Malta depends rather heavily on the exports of manufactured goods. Table 4 shows the pattern of Maltese exports since 1970. It can be seen that around 90% of Malta’s exports consisted of manufactured products during the 1YXOs. The share of primary products exports accounted for under 1.5%. Table 4 shows that Malta’s pattern of exports is very dissimilar to that associated with developing Malta’s deteriorating commodity countries. terms of trade cannot therefore be attributed to a high degree of dependence on exports of primary commodities. Malta’s pattern of imports is also dissimilar from that of many developing countries, since in Malta the imports of finished manufactured goods account for a relatively small proportion of imports. Table 5 shows that during the period under consideration, industrial supplies and capital goods accounted for about 70% of total imports.

(c) The direction of Multese trade One possible reason for the deterioration in Malta’s terms of trade is that Malta imports goods from countries where prices, measured in a common currency, the US dollar, for example, have increased faster when compared to the prices in countries with which Malta competes to sell its exports.’ Tables 6 and 7 show the direction of trade of Malta’s exports and imports. It can be seen that Malta depends to a very large extent on industrialized market economies, primarily the European Community, for its exports and imports. It is tempting to conclude that given the information presented in Tables 4, 5, 6 and 7, Malta’s exports and imports prices are determined by the prices prevailing in industrialized market economies. This, however, is not the case, because Malta exports goods and services to industrialized market economies in competi-

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272

4. Percentage

Table Period

Primary

1970-74 1975-79 1980-84 19X5-89 Source:

Manufactures

Period

77.1 x2.9 88.2 90.6

5. Percentage Industrial supplies

197@74 1975-79 198&X4 1985-89

51.0 54.8 56.0 59.1

Source:

United

72.7 73.1 75.5 73.9 Malta,

Period

Source:

72.7 74.8 74.0 70.6 Malta,

17.7 15.0 10.4 8.1

United

100.0 100.0 100.0 100.0

issues).

distribution of imports

Capital goods

Consumer goods

13.0 14.1 15.4 17.4

Total

36.0 31.1 28.6 23.5

10.0 100.0 100.0 100.0

Oceania 2.x 2.3 1.0 0.4

Annual Abstract of Statistics (various

Europe

197@74 1975-79 198&84 1985-89

States

6.3 8.4 7.7 7.2

Table

Total

6. Destination of e.uports

Table

197&74 1975-79 1980-84 1985-89

Reexports

Trade Statistics of Multa (various

Malta.

Europe

of Maltese exports

distribution

5.1 2.1 1.4 1.3

Table

Period

DEVELOPMENT

Japan

Other

2.6 3.1 2.9 2.2

15.5 13.1 13.0 16.2

Total 100.0 100.0 100.0 100.0

issues)

7. Main sources of imports States 4.7 1.7 3.8 8.2

Oceania

Japan

Other

Total

0.4 0.2 0.2 0.1

0.1 0.3 0.1 0.1

22.1 23.0 21.9 21.0

100.0 100.0 100.0 100.0

Annual Abstract of Statistics (various

issues)

213

MALTA

tion with developing countries, mostly Mediterranean region, and prices in the countries may be more relevant for pricing in Malta. This hypothesis is tested next section.

4. MALTA’S COMMODITY TRADE AND FOREIGN

TERMS PRICES

in the latter export in the

price elasticities Symbol

Elasticity 1.12* 0.83 1.44 1.05*

OF

It is hypothesized that keeping exchange rates constant (a) export prices in Malta are influenced mainly by export prices of export-competitor countries which are primarily Mediterranean less-developed countries and (b) import prices in Malta are determined mainly by export prices of import-supplier countries which are primarily industrialized market economies. We have attempted to test this hypothesis by using a very simple regression approach, in order to test the relationship between the Maltese terms of trade and prices in Malta’s client and competitor countries. The following specifications were utilized: MXP=al+a2CXP+ul

(1)

MXP=b1+b,SXP+u2

(2)

MMP=c,+c2CXP+u3

(3)

MMP=d,

(4)

fdZSXP-ku4

Table 8. Estimates of domestic to foreign

where: MXP stands for Maltese export unit values in US dollars; MMP stands for Maltese import unit values in US dollars; CXP stands for export unit values of exportcompetitor countries in US dollars; SXP stands for export unit values of importsupplier countries in US dollars. All variables are measured in logs, so that the coefficients a2, b2, c2 and d, are elasticities. If any of these have a coefficient which is not statistically different from one, than it can be concluded that export and import prices in Malta change proportionately with export unit values in competitor or supplier countries. The equations can be interpreted as representing the relationship between Maltese exports (or import) prices and export prices in foreign countries, keeping exchange rates constant.* The ordinary least squares (OLSQ) regression results are shown in Table 8.

T-statistic 1.93 -7.89 9.18 1.75

*Indicates that the estimate is not different from unity at the 95% level of statistical significance. The f-statistic tests the difference of the coefficient from unity.

The results suggest that: (i) Export prices in Malta changed: - in approximately direct proportion with respect to export prices in competitor countries - less than proportionately with respect to export prices in supplier countries. (ii) Import prices in Malta changed: - in approximately direct proportion with respect to export prices in supplier countries - more than proportionately with respect to export prices in competitor countries. Although one cannot conclude, on the basis of these results that Malta’s import prices are exclusively influenced by export prices in supplier countries, which, as already stated, are industrialized market economies, yet there is a strong indication that they are closely linked, since they changed roughly in proportion with each other. Similarly, the results should not be interpreted as proof that Malta’s export prices are exclusively determined by export prices in competitor countries, which as stated are less-developed countries. The findings, however, that these prices change roughly in proportion with each other suggests that there may be a connection between them. The finding that Malta’s import prices tended to rise more than proportionately with respect to prices of competitor countries and less than proportionately with respect to prices of supplier countries suggests that prices of the former rose faster than those of the latter. A simple regression analysis indicates that, on average, for every 1% increase in the prices of supplier countries, there was a 0.75% increase in the prices of competitor countries.3 These findings suggest that Malta’s commodity terms of trade depend on Malta’s direction of trade and not on the dependence of primary products, as is usually thought to be the case for less-developed countries.

27-I

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5. MALTA’S

INCOMES

TERMS

DEVELOPMENT

OF TRADE

The incomes terms of trade are here defined as the commodity terms of trade multiplied by the volume of exports. Changes in these terms of trade may be expressed as: Ti, = Tc, (J&IX,_,) where Ti stands for the incomes terms of trade and X stands for export volume. The term Tc has already been defined above. This formula allows for improvements in the capacity to import due to increases in exports (which may be partly due to the relatively low export prices and the resulting improvements in export competitiveness). The Maltese incomes terms of trade, computed on the basis of the formula just presented, are shown in the appendix and Table 9. As was the case in Table 3, the five-yearly changes shown in Table 9 represent annual average changes. The results indicate that the Maltese incomes terms of trade have tended to improve throughout 197049, with the exception of the first half of the 1980s. In Table 9, a figure lower than 100 shows a deterioration in the terms of trade on a five yearly basis, whereas a figure of more than 100 shows an improvement.

(a) Comparing the incomes and commodity terms of trade Yearly given in 1970s the while the

Table

data for the Maltese the appendix, shows incomes terms of trade commodity terms of

terms of trade, that during the were improving trade were de-

9. Five-yearly changes in the incomes terms of trade (%) Incomes Merchandise

terms

of trade Total trade

197CJ4 1975-79 198C84 1985-89

117 115 101 111

107 109 95 110

197&89

10X

105

Sources: Trade Balance: Malta, Annual Abstract of Statistics (various issues). Resource Balance: Malta, National Accounts of the Maltese Islands (various issues).

teriorating. During 1981-83 both types of terms of trade deteriorated, with more pronounced deterioration in the incomes terms of trade. During the second half of the 1980s both types of terms of trade tended to improve, with faster improvements in the incomes terms of trade. A question of interest in this respect is whether there is a tradeoff between the commodity and the incomes terms of trade. In other words, does the attempt to increase export demand through the lowering (in relative terms) of export prices, give rise to a deterioration in the commodity terms of trade and an improvement in the incomes terms of trade? If this were so, one would find a negative correlation between the two types of terms of trade. Such a correlation is not immediately apparent in the case of the Maltese terms of trade. In fact, an OLSQ test using the data presented in the appendix did not yield statistically significant correlation between the commodity and the incomes terms of trade. This is possibly due to the fact that there are variables, other than domestic prices, which determine export demand including prices of exports of competitor countries, the exchange rate of the Maltese lira, and demand conditions in client countries. It has been estimated elsewhere’ that the export demand/export price elasticity is around -3. This means that a decrease of 10% in export prices is estimated to increase export demand by around 30%, keeping everything else constant. It is therefore probable that an improvement in export competitiveness via reduction in the domestic prices of exports, keeping everything else constant, would result in a deterioration in the commodity terms of trade and an improvement in the incomes terms of trade. In the real world, however, where the terms of trade are not determined under ceteris paribus conditions, there is the possibility that both terms of trade deteriorate or improve simultaneously, as is the case in the Maltese data shown in the appendix. This discussion can help us explain why the commodity terms of trade as well as the incomes terms of trade have both tended to deteriorate during 1981-83 and both tended to improve during 1984-89. During 1981-83 the Maltese lira tended to appreciate against the currencies of competitor countries’ and to avoid heavy loss in competitiveness, Maltese exporters may have had to keep their domestic prices as low as possible. At the same time, import prices, being (as suggested above) to a large extent determined by prices in industrialized market economies, rose faster than the prices of exports. This led to

MALTA a deterioration in the commodity terms of trade. At the same time, however, the adverse effects of a high-valued exchange rate of the Maltese lira coupled with recessionary tendencies in Malta’s client countries, resulted in a rapid decrease in export demand, giving rise to a deterioration in the incomes terms of trade.b In the second half of the lYSOs, domestic prices of exports rose rapidly, even faster than the prices of imports, giving rise to improvements in the commodity terms of trade, as shown in the appendix. At the same time, however, export demand picked up rapidly, possibly because of the recovery in Malta’s client countries and a more reasonably valued exchange rate of the Maltese lira in terms of the currencies of competitor countries. This may have given rise to improvements in the incomes terms of trade. As stated above, during the 1970s the two types of terms of trade tended to move against each other. One explanation for this could be that export prices were kept relatively low, giving rise to deteriorations or very small improvements in the commodity terms of trade. The relatively high demand for Maltese exports, however, possibly as a result of competitive prices,’ gave rise to consistent improvements in the incomes terms of trade.’

6. CONCLUSION In this paper we have shown that during the 197Os, the Maltese commodity terms of trade tended to deteriorate but the incomes terms of trade tended to improve. We have also shown that during 1981-83 both the incomes terms of

275

trade and the commodity terms of trade tended to deteriorate. We have argued that 1981-83 was not a good period as far as export performance was concerned, not only because export prices tended to rise at a slower rate than import prices, but also because export volume rose very slowly and even decreased, giving rise to a decline in Malta’s capacity to import. During the second half of the 198Os, both the incomes terms of trade and the commodity terms of trade tended to improve. We have also tested the hypothesis that Maltese commodity terms of trade may have been influenced by Malta’s direction of trade, and not be dependence on primary production. as is thought to be the case for many less-developed countries. We have found that there is some evidence to support this hypothesis. Finally, we have argued that under certain circumstances, there may be a negative relationship between the commodity terms of trade and the incomes terms of trade. In particular, a deterioration in the commodity terms of trade may be accompanied by an improvement in the incomes terms of trade if such deterioration is due to an improvement in export competitiveness, which gives rise to an increase in exports sufficiently high to offset the decrease in the commodity terms of trade. This might have been the case in Malta during the 1970s. The arguments presented in this paper are rather tentative, but they may shed light on Malta’s capacity to import. The conclusions just described have important implications for a small country such as Malta, which, like many other small countries. depends to a very large degree on imports and exports.

NOTES 1. The unit values of exports in US dollars of exportcompetitor countries and import-supplier countries have been computed as weighted averages as follows: (a) The five competitor countries are Greece, Spain, Cyprus, South Korea and the Philippines. These were chosen principally because data on export unit values in US dollars were available for the period of the study. The weights were assigned somewhat arbitrarily, since there is no way of knowing the extent to which these countries compete with Malta. The Mediterranean countries, being closer competitors, were assigned 25% weight each. The Asian countries were assigned 12.5% weight each. (b) The three supplier countries, were the United Kingdom, Germany and Italy. These together supply around 60% of Malta’s imports. The weights were assigned according to the average percentage of imports originating from these countries. The source of the data is the IMF (various years).

2. It should be noted here that equations (1) and (2) would be misspecified if domestic export prices were influenced by conditions of demand in Malta. When indices of demand conditions in Malta were introduced in these two equations, the results did not change significantly, since the demand conditions variable did not have a statistically significant effect. This suggests that Maltese producers adjusted their prices in line with even if the domestic cost of foreign competitors, production changed in accordance with market forces. Given that Malta is a price-taker, this assumption may not be implausible. 3. It should be recalled well as export prices countries are measured between Maltese export prices therefore allows rates.

that Maltese export prices, as of competitor and supplier in US dollars. The relation prices and foreign export for variations in exchange

276

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4. See Briguglio these estimates.

(1989) and Scicluna

DEVELOPMENT

(lY84) regarding

5. The Maltese lira is pegged to a number of currencies. according to prespecified weights. The currencies which had the largest weights in the Maltese lira formula tended to strengthen during the first half of the 1YXOs. This was in line with the policy of the government of the time, who tried to contain imported inflation by strengthening the Maltese lira. 6. Between the end of 1980 and the end of lY83., the volume of exports decreased by about 9%.

7. During the 1970s. the real exchange rate of the Maltese lira tended to decrease. On this question see Scicluna (1984) and Briguglio ( lY80). 8. Unfortunately it was not possible to confirm the tendencies just described on the basis of a quantitative test. Regression analysis of the relation between the incomes terms of trade and the commodity terms of trade, keeping constant (a) prices of exports of competitor countries (b) the exchange rate of the Maltese lira and (c) demand conditions in client countries constant did not yield plausible results.

REFERENCES Briguglio, L., “The impact of a devaluation on the Maltese trade balance with special reference to price and income reversal effects,” Applied Economics, Vol. 21 (198Y), pp. 325-328. Ellsworth, P. T., “The terms of trade between primary producing and industrial countries,” Infer-American Affairs, Vol. X (Summer 1956). International Monetary Fund, Inlernational Financial Sratislicul Yearbook (Washington, DC: IMF, various years). Malta, Annuul Abstract of Sfatistics (Malta: Central Office of Statistics, various issues). Malta, Nutionul Accounts of the Maltese lslunds (Malta: Central Office of Statistics, various issues). Malta. Trude Slafisrics (Malta: Central Office of Statistics, various issues).

APPENDIX:

ANNUAL

Commodity Merchandise 1970-7 I 1971-72 1972-73 1Y73-74 lY74-75 lY75-76 lY76-77 lY77-78 lY78-79 lY7Y-80 IYHt~Xl IYXl-82 1‘982-83 I YX3-84 19X4-85 19X5-86 19X6-87 19X7-8X 19Xx-89

95.4 101.9 XX.8 Y3.2 YY.4 102.8 95.3 102.4 95.7 96.6 Y7.3 103.9 Yl.8 103.7 101.7 106.5 104.1 109.5 101.4

Prebisch, R., The Economic Development of Latin America and its Principal Problems (New York: United Nations, 1950). Sapsford, D., “Primary Commodity Prices and the Terms of Trade,” The Economic Record, Vol. 66 (IYYO), pp. 342-356. Scicluna, E. S., “Export competitiveness and Ihe Mallese liru” (Malta: Federation of Industry, 1984). Singer, H. W.. “The distribution of trade between investing and borrowing countries,” American Economic Review, Vol. 40 (lY50). pp. 473-485. Viner, J. (lY52), International Trade and Economic Deve[opmenl (Glencoe, IL: The Free Press. 1952).

CHANGES IN THE COMMODITY TRADE (“/o)

terms

of trade Total trade Y7.5 YY.7 XY.8 97.5 92.6 YY.4 96.2 Y8.6 96.4 99.7 100.1 101.7 YS.4 100.4 101.6 100.0 101.5 103.‘) 99.6

Incomes Merchandise 122.4 130.7 11x,.7 Y8.0 110.7 146.7 119.5 106.0 103.4 100.X 94.4 Y7.3 92.4 118.5 104.1 Ill.2 105.1 112.6 122.0

TERMS OF

terms

of trade Total trade 102.4 Y6.7 116.1 114.0 Ill.0 115.3 I 10.0 103.2 112.6 111.6 X8.7 X7.6 03.6 104.5 109.1 107.0 114.3 110.3 110.3