Step 5: Trade, Export-Led Growth and the Terms of Trade
MatchesA-level trade and development · IB Economics trade strategies and Fairtrade · undergraduate trade and development
In 30 seconds
- Comparative advantage: countries gain by specialising in goods they make at lower opportunity cost. Heckscher-Ohlin says this follows factor endowments, so labour-rich countries export labour-intensive goods.
- Export-led growth uses world demand to grow beyond the limits of a small home market.
- The terms of trade = (index of export prices ÷ index of import prices) × 100.
- The Prebisch-Singer hypothesis: primary commodity prices tend to fall relative to manufactures over time, so commodity exporters lose out.
- Global value chains let countries join one stage of production, but most of the value often stays with brands and retailers.
Comparative advantage and endowments
A country with plenty of low-cost labour and little capital has a comparative advantage in labour-intensive goods such as garments, footwear and assembly. Exporting them creates jobs, earns foreign exchange to buy machinery and lets firms learn. Over time, rising skills and wages shift the advantage to more complex goods.
Key termsTerms of trade: the ratio of a country’s export prices to its import prices. Primary product dependency: reliance on a few raw commodities for most export earnings. Value added: the value a stage of production adds above the cost of its inputs.
Terms of trade and Prebisch-Singer
Worked example
Between 2020 and 2025, a coffee exporter’s export price index falls from 100 to 85 while its import price index rises from 100 to 110. What happens to the terms of trade?
12020: \( (100/100) \times 100 = 100 \).
22025: \( (85/110) \times 100 \approx 77.3 \).
3The terms of trade worsened by about 23%.
ResultEach tonne of coffee now buys about 23% fewer imports. The country must export more just to keep the same imports: the Prebisch-Singer problem in action.
Why do commodity prices fall in relative terms? Demand for food and raw materials grows more slowly than income (low income elasticity), many producers compete, and synthetic substitutes emerge, while manufactures benefit from branding and market power. Prices are also very volatile, which makes planning hard.
Case studies for this step (in the 100 Case Studies pack)
- Case 89: Bangladesh Garment Industry. How a country with no natural resources built a $45 billion export industry, and what it cost: comparative advantage, export-led growth and labour standards after Rana Plaza (2013).
- Case 33: Ethiopia’s Coffee Sector. Why the world pays $60 for coffee that the Ethiopian farmer received $1.50 to grow: value chains, Prebisch-Singer and Fairtrade.
Get the Bangladesh and Ethiopia cases with data and exam guidance: 100 Economics Case Studies for $9 (was $15).Get the 100 cases · $9
Common mistakeSaying a fall in the terms of trade is always bad. If export prices fall because productivity rose, export volumes and incomes can still grow. Check the income terms of trade (terms of trade × export volume).
Exam tipStrong trade answers name a strategy (diversification, moving up the value chain, regional trade, Fairtrade) and weigh it against a real constraint, such as rich-country tariffs on processed goods (tariff escalation).
Practise: 6 questions
Try each one on paper first, then check the worked answer.
EasyQ1. Write the formula for the terms of trade. Show worked answer
(Index of average export prices ÷ index of average import prices) × 100.
EasyQ2. State the Prebisch-Singer hypothesis. Show worked answer
Over the long run, the prices of primary commodities tend to fall relative to the prices of manufactured goods, so the terms of trade of commodity exporters tend to worsen.
MediumQ3. Export prices rise 5% and import prices rise 12%. Find the new terms of trade from a base of 100. Show worked answer
\( 105/112 \times 100 \approx 93.75 \): a deterioration of about 6%.
MediumQ4. Use Heckscher-Ohlin to explain Bangladesh’s garment exports. Show worked answer
Bangladesh is abundant in low-cost labour and scarce in capital. Garments are labour-intensive, so its cost advantage is greatest there, and it specialises and exports them.
MediumQ5. Give two reasons Ethiopian coffee farmers receive a small share of the retail price. Show worked answer
Most value is added later (roasting, branding, retail) in rich countries; farmers are many and small, with little bargaining power against a few large buyers; tariff escalation discourages processing at home.
ExamQ6. Evaluate export-led growth as a development strategy. [10] Show worked answer
For: scale beyond home markets, jobs, foreign exchange, technology learning; Bangladesh garments, South Korea [4]. Against: exposure to world demand shocks; race to the bottom on labour standards (Rana Plaza); commodity exporters face Prebisch-Singer and volatility (Ethiopia coffee) [4]. Judgement: works best for manufactures and services with upgrading and diversification, less well for raw commodity exports [2].
Check yourself
1. A country’s terms of trade improve when
The ratio of export to import prices rises.
2. Tariff escalation means
It discourages developing countries from processing their own commodities.
3. Commodity prices tend to fall relative to manufactures partly because
As world incomes grow, demand for food and raw materials grows more slowly.
Your score: 0 out of 3
The short version
- Factor endowments shape comparative advantage.
- Terms of trade = export prices ÷ import prices × 100.
- Commodity exporters face falling, volatile relative prices.
- Use Bangladesh (case 89) and Ethiopia’s coffee (case 33).
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