Barter Terms Of Trade Limitations

Measuring the direction of movement of the gains from trade, this concept has important limitations.

1. Problems of Index Numbers: 

Usual problems associated with index number in terms of coverage, base year and method of calculation arise.

2. Change in Quality of Product:

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The Swap Products terms of trade are based on the index numbers of export and import prices. But they do not take into account changes taking place in the quality and composition of goods entering into trade between two countries. At best, commodity terms of trade index shows changes in the relative prices of goods exported and imported in the base year. Thus the net barter terms of trade fail to account for large change in the quality of goods that are taking place in the world, as also new goods that are constantly entering in international trade.

3. Problem of Selection of Period:

Problem arises in selecting the period over which the terms of trade are studied and compared. If the period is too short, no meaningful change may be found between the base date and the present. On the other hand, if the period is too long, the structure of the country’s trade might have changed and the export and import commodity content may not be comparable between the two dates.

4. Causes of Changes in Prices:

Another serious difficulty in the commodity terms of trade is that it simply shows changes in export and import prices and not how such prices change. As a matter of fact, there is much qualitative difference when a change in the commodity terms of trade index is caused by a change in export prices relative to import prices as a result of changes in demand for exports abroad, and ways or productivity at home. For instance, the commodity terms of trade index may change by a rise in export prices relative to import prices due to strong demand for exports abroad and wage inflation at home. The commodity terms of trade index does not take into account the effects of such factors.

5. Neglect of Import Capacity:

The concept of the commodity terms of trade throws no light on the “capacity to import” of a country. Suppose there is a fall in the commodity terms of trade in India. It means that a given quantity of Indian exports will buy a smaller quantity of imports than before.

Along with this trend, the volume of Indian exports also rises, may be as a consequence of the fall in the prices of exports. Operating simultaneously, these two trends may keep India’s capacity to import unchanged or even improve it. Thus the commodity terms of trade fails to take into account a country’s capacity to import.

6. Ignores Productive Capacity:

The commodity terms of trade also ignores a change in the productive efficiency of a country. Suppose the productive efficiency of a country increases. It will lead to a fall in the cost of production and in the prices of its export goods.

The fall in the prices of export goods will be reflected in the worsening of its commodity terms of trade. But, in reality, the country will not be worse off than before. Even though a given value of exports will exchange for less imports, the country will be better off. This is because a given volume of exports can now be produced with lesser resources, and the real cost of imports, in terms of resources used in exports, remains unchanged.

7. Not Helpful in Balance of Payment Disequilibrium:

The concept of commodity terms of trade is valid if the balance of payments of a country includes only the export and imports of goods and services, and the balance of payments balances in the base and the given years. If the balance of payments also includes unilateral payments or unrequired exports and or/imports, such as gifts, remittances from and to the other country, etc., leading to disequilibrium in the balance of payments, the commodity terms of trade is not helpful in measuring the gains from trade.

8. Ignores Gains from Trade:

The concept of commodity terms of trade fails to explain the distribution of gains from trade between a developed and under-developed country. If the export price index of an underdeveloped country rises more than its import price index, it means an improvement in its terms of trade. But if there is an equivalent rise in profits of foreign investments, there may not be any gain from trade.

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To overcome this last difficulty, Taussig introduced the concept of the gross barter terms of trade.

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