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Past, Present and Future Developments in New Zealand's Terms of Trade - WP 06/09

5  Factors likely to influence the terms of trade in the future

This section of the paper pulls together the findings of the previous sections as well as other recent developments in order to apply them to the outlook for New Zealand’s terms of trade. Although the future of the terms of trade is uncertain, this discussion aims to increase the knowledge about what factors in the future will affect the terms of trade movements.

5.1  Changes in the trend and volatility

Section 3 examined some statistical properties of New Zealand’s terms of trade over time. It was found that there was no statistical evidence that the terms of trade has declined since 1900. However, as suggested by Kellard and Wohar (2006), this analysis may be over-simplistic. Looking at the post 1973 period, there is evidence that the terms of trade has been on an upward trend over this period. Much of this increase in New Zealand’s terms of trade (especially relative to world commodity prices) is a result of higher prices received for New Zealand’s exported products. The question is whether this trend will continue into the future.

It was also found that this upward trend in the terms of trade exceeded that suggested by relative world commodity prices (Figure 5). Much of this increase in New Zealand’s terms of trade relative to world commodity prices is a result of higher prices received for New Zealand’s exported products. Specifically, New Zealand appeared to be experiencing higher prices for its exports than other primary commodity exporters. The compositional change that New Zealand’s exports have gone through over the past 40 years is arguably the major reason for this strong growth in relative export prices. This therefore suggests that New Zealand needs to continue in this vein in order to extend this trend in prices into the future. The recent “de-commodification” of some of New Zealand’s primary export commodities is also a pattern that may need to continue. Kaplinsky (2005) suggested that this de-commodification gives producers greater price setting power and by developing new “value-added” products such as that demonstrated in Figure 11 would allow New Zealand to continue to develop and open new markets overseas.

The discussion to this point has ignored the cyclical properties of the terms of trade and these are important. Even though there may be an upward trend in the terms of trade, there will still be cyclical movements as a result of international developments. This paper has found, however, that the volatility in the terms of trade has decreased and that the New Zealand economy is in a better position to handle shocks to commodity prices as it is no longer focused on exporting a small number of commodities to a small number of countries but has diversified the types of goods it exports and where it exports to. It also found that the largest contributor to this decrease in volatility was falling volatility in aggregate export prices. If New Zealand continues to move away from the exportation of unprocessed primary commodities and into less homogeneous products, this pattern is likely to continue.

5.2  China

5.2.1  Implications for New Zealand’s export prices

Kaplinsky (2005) reported that for the first half of 2004, China had a trade deficit on foodstuffs of US$3.7 billion. This is predicted to widen considerably as more of the population enjoys higher income levels as a result of the recent economic boom. For example, according to the US Dairy Association, per capita dairy consumption averaged 6.9 kilograms in 2000 – well below the world average of 46.4 kilograms per capita. It is expected that as income levels rise, the consumption of dairy products in China will increase. This has already started to occur with Chinese imports of whole milk powder increasing by 120% between 2000 and 2004.

Figure 13 below displays how the contribution of agriculture to China’s GDP has been trending downwards since 1970. This is a result of both the considerable growth in other areas of the economy as well as a shift in resources from agriculture to other sectors. Kaplinsky (2005) suggests that this is likely to be a result of land conversions from farming to industrial uses, as well as low agricultural productivity growth and this pattern is one that is expected to continue into the future. This therefore leaves New Zealand with a huge opportunity to take advantage of the growing demand in China (due to increases in disposable incomes) to increase its agricultural exports. However, it is likely to face strong competition from other countries in meeting this extra demand from China. Some of this is discussed in Section 5.3.2. If New Zealand was able to gain a larger presence in the Chinese market, this extra demand would likely flow into higher prices for New Zealand’s exported commodities.

Figure 13 – Proportion of GDP by Economic Activity for China
Source: United Nations Statistical Division

Although there are likely to be increases in the prices of some of New Zealand’s exported commodities due to increased demand from China, there may also be some offsetting movements in the price of other exported goods. This could be the case for New Zealand manufactured goods exports. As discussed above (and below in Section 5.2.2), China has an extremely large labour force which has enabled it to produce many manufactured products relatively cheaply in comparison to other countries. In a sense they have been exporting deflation over recent times. If China continues to play a greater role in the world market and exports manufactured goods at prices lower than other countries, then the downward pressure on world manufacturing prices is likely to continue. However, New Zealand may be able to avoid this price pressure to some extent by differentiating its products from those produced in China and competing on quality rather than price. This is very similar to the “de-commodification” idea of Kaplinsky (2005). If New Zealand is able to export manufactured products that are unique it will give producers greater price setting power and the opportunity to develop niche markets overseas.

5.2.2  Implications for New Zealand’s import prices

As discussed above, China has also arguably had a significant impact on the price of manufactured goods traded on the international market. Kaplinsky (2005), using Harmonised System trade data, performed an analysis of EU import categories to study the source and extent to which import prices had fallen. It was found that one third of the imports sourced from China had experienced price falls between 1988 and 2001. This compares with only 9% of products sourced from high income countries over the same period.

As a general rule, the higher the per-capita income group of the exporter, the less likely the unit-prices were to fall. Thus, within a large number of product groups, the prices of products exported into the EU by China and low income economies was more likely to decline than the prices of the same product-groupings sourced from other high income economies. Kaplinsky, 2005:17

It was concluded that as China’s participation in global markets increases, the likelihood of price decreases (particularly for manufactures) also increases (as long as China is still catching up with the rest of the world in labour and manufacturing costs).

This has implications for New Zealand. As discussed previously, New Zealand is primarily an importer of manufactured goods and, as illustrated by Figure 12, China is a growing source of these imported goods. If New Zealand continues this recent trend of sourcing more of its imports from China (and other “low-cost” nations such as the ASEAN countries) then it should continue to experience falling prices for some of its manufactured imports.

However, as with export prices, there are some factors that could partially offset any gains made through lower manufactured import prices (and higher export commodity prices). One of these is the fact that Chinese demand has driven up the price of many hard commodities and these are often used as inputs into production of their manufactured exports. If the prices of these hard commodities continue to increase, then the gains that China has in terms of low labour costs may be offset by the increasing costs of other factors of production which in turn could be passed on through higher manufactured goods prices. Another issue is the fact that New Zealand is a net importer of oil and petroleum products. For the year ended December 2005, New Zealand imported just over $4.2 billion of mineral fuels, approximately 24% more than the previous year. Undoubtedly, this significant increase was due to higher prices for crude oil and part of this price increase is a result of extra demand from China.[20] If that demand from China were to continue, the price of oil may stay high for some time.


  • [20]Not all the recent increases in the oil price can be attributed to increased demand from China. There have also been significant capacity constraints recently both from a production and refining perspective and this has also contributed to the price increases, as well as geopolitical uncertainty.
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