A fundamental change in the global economy bodes well for New Zealand.

Listener: 20 March, 2010

Keywords: Globalisation & Trade;

Throughout most of the 20th century, the prices we got for our farm exports fell relative to what we paid for our imports. This drop in our terms of trade meant we had to export more to import the same amount. And since imports are an important part of the production process, productivity growth slowed.

The protection and support the rich nations gave to their farmers – at our expense – contributed to the terms of trade decline of the last half century, as did the rise of substitutes: synthetics for cross-bred wool, margarine for butter and white meats for red meats.

This long-term decline may have ended in the early 1990s. At first I thought the better prices for our foodstuffs were a consequence of food-trade liberalisation. But I now think the change is more fundamental – although a successful Doha trade liberalisation round would also help.

The process of industrialisation, which concentrated the world’s manufacturing in a few centres in Europe and North America, also depressed agricultural prices. This concentration occurred because manufacturing processes experience strong economies of scale, which can easily offset the falling costs of distance. The rest of the world, crammed onto the farming land, produced low-priced farm products.

This might seem to be a recipe for permanent North Atlantic dominance, but the sophisticated model I am using – described in my book Globalisation and the Wealth of Nations – says occasionally a low-productivity country will split off and join the rich ones – as happened to Japan.

The model also predicts that as the costs of distance keep falling, the rich industrialised economies will lose their dominance. Manufacturing relocates to places with large, dense but low-waged populations, as is happening in China and its East Asian neighbours.

This relocation of manufacturing to the periphery affects the farm sector. First, workers leave farms and head for the factories, so the country produces less food. (The standard analysis says such countries need to increase the productivity of their farming, but that’s harder to do than the theory advises.) Second, not only do new factory workers keep eating, but they eat more as their standard of living rises, and this increases the demand for food.

As the price of food rises, the price of manufactured goods falls (because the new factory workers are much cheaper than their counterparts in the old industrial economies). This benefits third-party suppliers, such as New Zealand. So, in contrast to the 20th century, when industry was concentrated in a few rich countries, our terms of trade may be starting to rise.

This is a plausible explanation of what is currently happening (after allowing for the global financial crisis). Of course, the world is more complex than this simplified (but oh so complicated) model. It does not allow for the replacement of oil by biofuels, for the effects of responses to global warming, or for what happens as resources –  including water and ocean fish – run low. All these things may also boost farm product prices. So we might expect a tendency for food (and other resource) prices to rise for some decades relative to prices for manufactured goods.

We need to think carefully about the implications. The easy answer is that since we have a free-trade agreement with China and other new industrialising countries, dairy farmers will do well, so why worry? But the changes are likely to have a major impact on our social and geographical structures. And I’m not entirely happy about putting all our eggs in the dairy basket (to confuse the metaphor); Fonterra should not be either.

Much of our development debate is stuck within the framework of the past 50 years with its falling terms of trade. Some or our so-called innovative thinkers are only repeating what was the conventional wisdom back then. How to have a serious discussion about economic structure over the next 50 years?