The aim of this essay is to provide an explanation about two models: the Beckerman model and the Prebisch-Singer hypothesis. In both models, changes in the terms of trade between countries influence economic growth; however, these changes in the terms of trade seem to affect growth differently. The main reason for this fact is that there are different assumptions in both models and then the models deal with the problem from different approaches. It is also aimed at analysing the differences in these assumptions and the effect that they have on the differences in the models. Through the essay, an economic growth perspective is always taken into account as both models are concerned with explaining growth.
This paper starts with a brief description of both models, without going into further details. Afterwards a small section aims at explaining how these models predict economic growth to happen. Finally, a further discussion of the assumptions underlying both models are analysed and compared when it is possible to do so.
1. A brief description of the models
1.1 The Beckerman Model
The Beckerman Model is an export-led model of economic growth in an open economy. This means that the main feature of the model is that it explains a countrys growth by the exports (in terms of international trade). The fundamental theory in the model is that: A high (low) growth rate of exports induces a high (low) growth rate of output and through the operation of increasing returns of productivity (Boggio, 2003: 9-10).
The hypothesis of increasing returns to scale is fundamental in this model. The increasing returns to scale imply that production is more effective for higher quantities of product, thus becoming less costly as production increases. This has implications in terms of productivity since it becomes higher for higher levels of production. In the case of greater external demand, increasing returns to scale permit lowering costs of production, and thus the following growth circle, as explained by Beko (2002). An acceleration in foreign demand increases domestic production, where increasing returns to scale are verified. With production being more effective there is an increase of exports and thus an increase of the domestic output. So the main conclusion of the model is that an increase in external demand concludes in a rising output growth rate. This mechanism is known to be of cumulative causation, which means that a cycle of productivity develops with increased advantages for the economy.
1.2 The Prebisch-singer Hypothesis
Prebisch (1950) and Singer (1950) put international trade effects on economic growth in a different perspective from those described in the Beckerman model. For these authors, export from less developed countries rely more on primary goods, while imports are mainly manufactured goods (Bloch and Sapsford, 2000). From a different point of view (as in Bunzel and Vogelsang, 2003) over time the net barter terms of trade between countries specialised in the export of commodities and those specialised in the exports of manufactured goods are expected to decrease. Moreover, the trend of the terms of trade (or of the ratio of prices) is know to be, and acknowledged by Prebisch (1950) as, stable declining, i.e. on a stable downward trend (e.g. Powell, 1991 and Sapsford, 1985). In this respect, the Prebisch-Singer hypothesis relies mostly on the ratio of prices between classes of commodities traded worldwide (Spraos, 1980). The importance of the Prebisch-Singer hypothesis is proved by the amount of literature devoted to support or criticise it, over the last decades as recognised by several authors (e.g. Bloch and Sapsford, 2000 and Bunzel and Vogelsand, 2003).
This biased distribution against developing countries postulated by Prebisch and Singer is based on two complementary hypotheses (as in Peon, 2004):
1. A negative effect brought by the income elasticity of demand for primary goods and raw materials on developing countries where the goods market is responsible for the deterioration of the real prices for primary goods; and
2. The asymmetries of the labour markets in those markets also seem to have a negative effect and thus the deterioration of the (real) commodities prices coming from the market of factors.
2. How do these models explain growth?
In the Beckerman Model, as before referred to as an export-led model of growth, economic growth is enhanced by the virtuous cycle described. External demand seems to have an effect in the domestic output due to the existence of increasing returns to scale. The opposite is also expected to be verified. In this case a vicious cycle of growth is expected. On the other hand, Palley (2003) addresses a criticism to all the export-led models. The core fallacy of these models is that it is assumed that growth can be induced by external demand growth and thus leading to a situation where all countries make the exports the focus of their growth creating a situation of global excess supply and deflation.
According to the Beckerman Model as referred to in Boggios quotation in section 1.1 of this paper) a low growth rate of imports will also induce a low growth of output and the increasing returns play against the country. On the other hand, an exogenous improvement in terms of trade can also have a perverse effect on economic growth. An increase in the price of exports in relation to the price of imports enhances a loss of competitiveness in international markets and thus a reduction in exports (and again a reduction in output, via the effect of increasing returns). The following loss of productivity induces a growth in the inflation rate and further loss of competitiveness. Regarding this question, some remarks should be made. The higher price of exports may provide extra profits for firms allowing them to re-invest them and re-gain competitiveness, offsetting the negative effect from the terms of trade improvement. On the other hand, the decrease in the import prices can also act in favour of the country and offset the increase trend of inflation rates.
The Prebisch-Singer hypothesis seems to support the Ricardian thesis that each country should specialise in the production of goods that it produces better and thus gains from international trade arise. Growth is expected from the technology spread from the manufacturer-specialised countries to the primary activities in the peripheral commodities-producer country. This is clearly shown by the final paragraph of the Singer (1950, p.485) paper:
Finally, the argument put forward in this paper would point the lesson that a flow of international investment into the underdeveloped countries will contribute to their economic development only if is absorbed into their economic system; i.e., if a good deal of complementary domestic investment is generated and the requisite domestic resources are found.
Although growth seems to be a contagious process, it is necessary that the advantages of technological advance are to be embedded into underdeveloped peripheral countries and thus an increase on the productivity of primary goods is to be found. The main argument in the Prebisch-Singer hypothesis can be seen in a different perspective. The manufacture countries specialise in the production of technology that not only affects their own productivity but can also be transferred to underdeveloped countries and then affect the productivity of the primary sector in these countries, enhancing growth in both countries.
Discussion of the assumptions
The main assumption in the Beckerman model is that industries verify increasing returns to scale. As it is widely known, some industries verify constant or even decreasing returns to scale. This assumption is important in determining whether the increase of external demand will conclude in an increase of the domestic output. In fact, in case of decreasing returns to scale, an increase in the external demand will have a negative effect on productivity. In this case, production becomes less profitable and thus salaries warrant a higher increase than productivity leading to a process of negative economic growth.
A basic difference between the two considered models is that while Prebisch and Singer consider the existence of different sectors and that countries tend to specialise in either commodity or manufactured goods, Beckerman does not takes that into account. This partly explains Beckermans assumption that all industries verify the same type of returns to scale (increasing).
From a different point of view, Beckerman does not explicitly include a technological dimension argument. Although it can be claimed that the increased returns to scale embody part of the technological progress as industries seem to be characterised and experiment advantages from mass production.
In terms of markets, Beckerman does not seem to include a competition dimension in his model. According to Bloch and Sapsford (2000), the Prebisch-Singer hypothesis predicts that markets for manufactured products are known to experiment with higher levels of imperfect competition than the markets for primary goods. The consequence is a higher gap between the price and the costs of production for the manufacture goods markets, leading to higher levels of profit that will have an impact on the levels of investment and thus technology, income, and so the argument runs.
Another key point in the Prebisch-Singer hypothesis is that the workforce is easily transferred between sectors. The authors include in their models the assumption that, when a certain sector creates a surplus of workforce, this workforce is to be transferred to the other sector, having effects on the wages and productivity of both sectors and so runs the argument. In fact, workforce transference does not occur in a linear way between sectors either, it occurs between different regions or countries. However, the Beckerman model does not include such workforce transferences as well but salaries and productivity play a more important role in his model.
As linked to the point before, the linear transference of workforce it is not expected to develop a situation of unemployment. If this assumption is not to be taken into account, the unemployment is a phenomenon that is likely to appear when one of the sectors produces a surplus of workforce. Furthermore, when revealing the existence of unemployment the reaction of wages may react in a different way rather than just when movements on productivity are considered.
In line with the factors market, raw materials seem to have an effect on economic growth and more specifically in the terms of trade in the Prebisch-Singer hypothesis. The decrease in the prices for primary goods has an effect on the income elasticity of demand for commodities, and thus the price of commodities decreases as income rises (Kearns, 2005). In the Beckerman model there is no place for effects in demand and prices arising from the differences in wages and thus the income elasticity of demand is not taken into consideration.
Although both the Beckerman model and the Prebisch-Singer hypothesis are concerned with how terms of trade affect economic growth, through a process of exports achievement (or decrease), both models also rely on different assumptions and deal with different variables in explaining the same phenomenon. In a way they become different faces of the same coin.
While the Beckerman model relies on a global perspective of the economy and global external demand has an effect on the whole economy, The Prebisch-Singer hypothesis relies on a compartmented and sectorised economy where there is space for different sectors, experimenting with different conditions in terms of prices, market, elasticities, productivity and wages.
In both cases, a deterioration in terms of trade between countries is at the heart of the explanation of economic growth, and again in both cases, exports seem to be the core variable in inducing economic growth. The reason for the explanation of how these models predict differently those changes in terms of trade impact on economic growth, relies on the differences in the assumptions used by both models.
Finally, while in Beckerman the element responsible for the deterioration of terms of trade is the external demand (with the associate returns to scale) that affect the domestic output and thus affecting that countrys economic growth, for Prebisch-Singer at the heart of the deterioration of terms of trade lies the differences in the sectors that each country specialises in depending on whether this sector is a primary or a manufacture sector.
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