How can growth lead to a deterioration in the terms of trade

How can growth lead to a deterioration in the terms of trade for the large country? Can growth ever improve a country\'s terms of trade? If so, when?

Solution

When a country is large enough to influence world prices, then its growth which is export biased i.e. growth which is the result of large increase in exports results in large decline in the relative price of the export good and leaves the country worse off. This theoretical situation where the fall in terms of trade outweighs the gains from growth is known as immiserizing growth. So in this way as a result of fall in the price of export commodity in the world market, the terms of trade of a large country deteriorates as growth occurs.

Growth can improve a country’s terms of trade when:

1. The country is small enough for not being able to influence world prices. This will not reduce the price of its exports when it supplies more of them.

2. When as a result of growth, the country switches from the production of more labour intensive to more capital intensive commodities for which there is lesser demand elasticity.

3. When growth raises income but people wish to spend that income domestically rather than on imports.

4. If growth focuses on export promotion and import substitution.