Relationship between countries at different levels of development — practice questions

(a) Calculation of Terms of Trade (ToT) Index

Step 1: State the formula. The formula for the Terms of Trade Index is: ToT Index = (Index of Export Prices / Index of Import Prices) × 100

Step 2: Substitute the given values. Index of Export Prices (Px) = 95 Index of Import Prices (Pm) = 110

ToT Index = (95 / 110) × 100

Step 3: Calculate the final value. ToT Index = 0.8636... × 100 ToT Index = 86.36 (to 2 decimal places)

(b) Explanation of the Impact

1. Interpretation of the result: A fall in the ToT index from 100 in 2020 to 86.36 in 2024 represents a deterioration or worsening of the terms of trade.

2. Impact on purchasing power: This means that for every unit of exports sold, Zambezi can now buy fewer imports. Specifically, the purchasing power of its exports has fallen by approximately 13.64% (100 - 86.36).

3. Impact on the Balance of Payments: Assuming the volume of imports and exports remains unchanged (ceteris paribus), the fall in export prices relative to import prices will lead to a worsening of the current account balance. The value of exports will fall while the value of imports rises, increasing the current account deficit or reducing any surplus.

4. Impact on Standard of Living: To afford the same quantity of imports as before, Zambezi must now export a greater volume of copper. This requires more resources and effort for the same return, potentially leading to a fall in the country's real income and standard of living.

Context — constraints on development:

• Falling terms of trade (15%) → export revenue buys fewer imports → Prebisch–Singer confirmed — primary dependency harmful.
• Debt 80% GDP, service 25% revenue → fiscal space crushed — limits spending on health, education, infrastructure.

Option 1 — Tied aid ($500m infrastructure):

Benefits:

• Infrastructure (roads, ports) → lowers costs, may boost export capacity.
• Immediate capital inflow without increasing private debt.

Costs:

• Tied to HIC firms — money returns to donor economy; recipient gets less value.
• Maintenance costs may burden government after project completion.
• Does not address terms of trade or debt service directly.
• Risk of white elephant projects if not aligned with local needs.

Option 2 — FDI in mining:

Benefits:

• Capital, technology, jobs — may raise export earnings from copper.
• Tax revenue if tax agreements fair.
• Private sector risk — not added to public debt.

Costs:

• Reinforces primary export dependency — deepens terms of trade vulnerability.
• Profit repatriation — much value leaves LIC.
• Environmental damage — external costs borne locally.
• Enclave economy — limited linkages to wider economy.

Better development path:

• Untied aid or debt relief to free the 25% revenue trapped in debt service.
• Diversification away from primary exports — manufacturing/services.
• If FDI, require local content rules, technology transfer, environmental standards.

Judgement: Neither option alone promotes sustainable development. Tied aid is particularly weak (Prebisch–Singer + tied spending). Mining FDI may worsen dependency. Best approach combines debt relief, untied aid for human capital, and FDI in diversified sectors — not primary enclaves.