Country terms of trade: Trends, unit roots, over-differencing, endogeneity, time dummies, and heterogeneity

Abstract. The debate about the Prebisch-Singer thesis has focused on primary commodities with some extensions to manufactures. As we think that the link between the terms of trade and long-run development, growth and convergence is the ability of exports to enhance investment through importing capital goods we analyse trends in country terms-of-trade for goods and services rather than those for commodities. Open economy growth models may be observationally equivalent to closed economy growth models under special conditions where they generate constant though endogenous terms of trade. We therefore consider trends in terms of trade for country groups according to the World Bank income classification. We find that all groups but the poorest have common unit roots, but none has individual unit roots. As low-income countries have no unit roots, over-differencing is inefficient and biases significance levels in first differences against the fall in the terms of trade. For the low-income countries the terms of trade of goods and services are falling at a rate that is significantly negative without and with endogeneity treatment by system GMM. A comprehensive analysis of the effects of time dummies supports the result of falling terms of trade for low-income countries. When all coefficients are country-specific 50% of all low-income countries have falling terms of trade in a simultaneous equation estimation using the SUR method.

Key words: country terms of trade; Prebisch-Singer thesis; long-run development; World Bank income classification.

JEL-code: F43, O19