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1  Introduction

New Zealand is a small economy dependent on its external sector as a major source of economic growth and development. Although its trade to GDP ratio is not high by OECD standards, at 60%, it does leave it prone to movements in the relative prices of internationally traded goods. The terms of trade, or the ratio of export prices to import prices, is a measure of these relative prices and can have substantial welfare effects on the economy.

Figure 1 – New Zealand’s Merchandise Terms of Trade
Sources: NZIER, Statistics New Zealand

Figure 1 above shows New Zealand’s merchandise terms of trade since 1900.[1] It is clear that there have been periods over this time when the terms of trade has changed considerably from both a trend and volatility perspective. This paper attempts to answer three questions: how the trend and volatility in the terms of trade impact on New Zealand’s economic growth; whether or not the trends and volatility of the terms of trade have changed over time; and what factors are likely to influence the trends and volatility of the terms of trade in the future.

This paper adds to the ever growing literature on the drivers of New Zealand’s economic growth by examining how the terms of trade affects the economy as well as what factors will influence the terms of trade in the future. As New Zealand is a small country, the terms of trade can be thought of as predominantly exogenous. Therefore rather than policy makers targeting the terms of trade as a policy instrument, it is more appropriate for them to have an understanding of how the terms of trade affects the economy and hence have an understanding of the policy implications of terms of trade movements. Policy makers, not only in New Zealand, but other countries are increasingly thinking of the terms of trade in this way.[2]

The debate in the literature on the macroeconomic effects of trends in the terms of trade is mixed. Views vary from the terms of trade having a positive effect to a negative effect on economic growth, with the former being the most common. This is because a rise in the terms of trade implies a rise in a country’s real domestic income. An increase in export prices relative to import prices allows a larger volume of imports to be purchased for a given volume of exports, resulting in an increase in purchasing power.

The terms of trade can also be thought of as a return on investment and it is through this investment channel and the real domestic income channel mentioned above that the macroeconomic effects of the terms of trade are commonly studied. However, there is one area of the literature that concludes that increases in the terms of trade have a negative effect on a country’s growth performance. One of the reasons proposed for this is known as the ‘resource curse’. This is discussed further below.

The literature is much more united in its belief about the economic effects of volatility in the terms of trade. Increased volatility is found to have a negative impact on economic growth. Section two examines this literature as well as the literature looking at the macroeconomic impacts of trends in the terms of trade. In order to put it into a New Zealand context, an empirical analysis based on work by Grimes (2006) is tested in this section to see how economic growth in New Zealand is affected by trends and volatility in the terms of trade.

Section three looks at the historical trends and volatility of New Zealand’s terms of trade. For the majority of New Zealand’s economic history, primary commodities have dominated its goods exports while it has largely imported manufactured goods. According to the Prebisch-Singer hypothesis, which states that over time primary commodity prices decline relative to manufactures prices, New Zealand should have experienced a secular trend decline in its terms of trade. This section examines this hypothesis to assess whether it holds for New Zealand using the methodology of Gillitzer and Kearns (2005). They performed a similar study for Australia and found that its terms of trade have declined over time, albeit very gradually. The volatility of the terms of trade is also examined in this section to assess if it has changed over time.

Section four examines some developments in New Zealand export and import prices and how they have affected the trend and volatility of the terms of trade. Section five uses the analysis of the trends and volatility of the previous sections and considers other issues such as the emergence of China in the global market and potential trade reforms to assess possible future movements in New Zealand’s terms of trade. The final section concludes as well as looks at policy implications and areas of future research.


  • [1]This paper uses the goods terms of trade rather than the goods and services terms of trade due to better data availability. Statistics New Zealand has data on the SNA services terms of trade back to 1988. It is very highly correlated with the New Zealand TWI exchange rate (correlation = 0.95).
  • [2]For example, Henry (2006)
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