The terms of our trade

How ever-changing relative prices affect us all

Whether we realize it or not, we are all subject to fluctuations in our ‘terms of trade’. By this I mean simply the relationship between the prices we benefit from and those which are a cost to us.

For example, consider the apple farmer. He benefits when the price of apples rises, or when the costs of apple farming, such as for water and insecticide, decrease. And he loses when these prices move in the opposite directions.

Another example is the public service worker. She gains when her new union contract gives higher wages and benefits and loses when the prices she must pay for groceries, rent and her other costs of living increase.

It is possible to calculate one’s own terms of trade for any given period, such as a year, although it may be rather complicated in some cases. It’s just a matter of computing a weighted average of the price changes for beneficial prices and dividing by a weighted average of the costly ones. For some people the beneficial prices are the wage rates they receive for their labour and possibly the interest and dividend rates that apply to their financial holdings. Their costs could also be fairly straightforward and might be approximated by the change in the consumer price index, or a reweighted average of CPI components.¹

From a broader perspective, Canada as a whole also has terms of trade, associated with our international commerce. We both buy and sell goods and services from/to other countries and we can benefit or lose out over time as the prices of these traded products change. If the prices we are able to charge for the products we export go up, Canada gains, while if those for the products we import go up, we suffer the consequences.

Chart 1 shows Canada’s international terms of trade, measured annually over the past century by Statistics Canada. The measurement is simply a price index - much like the consumer price index - for all the products Canada exports to other countries divided by a price index for all the products we import. The important thing is not whether these price indexes go up or down, but rather how one of them is changing relative to the other. From the perspective of Canada as a whole, it is okay if import prices are rising provided export prices are rising even faster.²

The broad story in Chart 1 is that over the long haul of the last century, global prices have evolved in a way that has been of significant benefit to Canada. This is because Canada is rich in natural resources, exporting a lot of them, and the demand for those resources has risen as the global economy has grown bigger.

World prices fluctuate considerably, reflecting a wide range of factors in international markets that affect demand for and supply of traded products. The ratio of export to import prices - Canada’s international terms of trade - had little trend between 1926 and 1972, but the situation clearly changed in the mid 1970s. That change was closely related to the sharp energy price increases engineered by the Organization of Petroleum Exporting Countries (OPEC) at the time. Canada, though not a member of OPEC, was and is an energy-product-exporting country and benefitted greatly from the higher prices.

Canada’s terms of trade shifted upward again in the 21st century. They reached a new high in 2022 when the world prices of energy products, metals and minerals, forestry products and some agricultural products such as grain all rose sharply. This surge in world prices reflected a strong recovery in demand following the COVID-19 pandemic, especially in the United States, accompanied by a number of supply problems as the world economy struggled to reverse gears quickly.

Chart 2 shows the product composition of Canada’s merchandise trade³ in 2022. Energy products dominate exports while consumer goods are the largest component of imports. Canada’s exports exceed its imports for metal ores and non-metallic minerals and products derived from them, forestry products and building and packaging materials, farm, fishing and intermediate food products and, as noted energy products. Our imports are greater than our exports for motor vehicles and parts, industrial machinery, equipment and parts, electronic and electrical equipment and parts, basic and industrial chemical, plastic and rubber products and, again, consumer goods.

Canada’s terms of trade picture, as seen in Chart 1, was rather extraordinary in 2022. Table 1 below shows the percentage changes for exported and imported goods prices in that year. The 55.8% increase in the price index for energy products was the big factor in Canada’s terms of trade gain in the year. In contrast the price index for imported energy products rose only about half that percentage rate and in any case Canada imports relatively few energy products. The products Canada imports most - consumer goods and motor vehicles and parts - saw substantial price increases but they were far lower than the price jumps for several of the raw material products Canada exports.

The increase in Canada’s nominal gross domestic product was extraordinary in the first half of 2022 due to the big improvement in the terms of trade. GDP rose 3.7% in the first quarter and a further 4.0% in the second. These are exceptional numbers. Many Canadians felt richer and government tax revenues surged. But the thing about world trade prices is that they can be volatile in both directions. In the third and fourth quarters the terms of trade started to come down again, bringing GDP declines of 0.6% and 0.7% respectively. The first quarter of 2023 gave us a further drop in the terms of trade (Chart 3).

So what to conclude from all this? The ‘terms of trade’ concept is important at many levels, from the person or household, to the town or city, to the province or territory, right up to the nation as a whole. In our mostly free market economy, relative prices keep fluctuating to equilibrate markets under changing demand and supply circumstances and as they do, there are always winners and losers. The terms of trade reveal who falls into which category.

At the level of the nation as a whole, the national accounts provide indexes of Canada’s exports and imports that together reveal changes in our country’s ‘winner or loser’ status within the global community. In the first half of 2022 Canada was a big winner as the world prices for the goods we export soared on global markets relative to the goods we import. It was great while it lasted, but the most recent three quarters have brought our status back down to a more normal level.

1. Statistics Canada offers a personal inflation calculator here. It asks for your expenditure information and calculates a reweighted CPI.

2. Of course, while the benefits or losses to Canada as a whole are calculated this way, those benefits and losses are not distributed equally across the population. Some of Canada’s

40 million people will inevitably experience a deterioration/improvement in their personal terms of trade even if Canada’s overall terms of trade improve/deteriorate.

3. While chart 1 focusses on trade in both goods and services, charts 2 and 3 and table 1 are about goods (merchandise) only. Goods trade accounts for over 80% of Canada’s total trade.