Research Proposal on "What Is the Prebisch-Singer Hypothesis What Are Its Major Defects?"

Research Proposal 6 pages (1938 words) Sources: 3 Style: Harvard

[EXCERPT] . . . .

Prebisch-Singer hypothesis? What are its major defects?

The Prebisch-Singer hypothesis was a theory of international trade popular in the 1960s and 1970s that attempted to explain why trade between developing and developed nations often resulted in an inequitable relationship. Its name derives from its founders, even though the two never formally collaborated. Raul Prebisch was an economist from Latin America, Hans Singer was an Englishman, however their views of trade and economic inequities around the world were viewed to be so complementary, their thinking eventually become merged into a single hypothesis.

Prebisch's theory combined both supply side and neo-Keynesian ideas. He stated that although wages tend to be 'sticky' or immobile during economic downturns in industrialized nations, the power of labor unions meant that wages rise during times of economic expansion. However, in developing nations with weaker labor unions, wages seldom rise during business cycle upswings, but wages are still sticky during downswings. In fact, wages in developing countries were more likely to be cut because of ineffective unionization and the desperation of the populace to work for any wage at all. Prebisch first formulated his thesis, it should be noted, during the 1950s and the height of the influence of American labor unions and European trade unionism. The effect of poor efforts at unionization in developing nations meant that the cost of primary commodities rose less precipitously than the cost of manufactured goods during upswings and fell more swiftly more during downswings, creating a continuous decline in the relative cost of primary commodities for developed nations and real wages (Cuddington, Ludema, & Jayasuriya 2002, p.5).

Singer "focused more on the demand side, considering mainly price and income elasticities" (Cuddington, Ludema, & Jayasuriya 2002, p.6). Singer argued that no matter how much technological progress a manufacturing industry might experience in industrialized nations, monopoly power due to high barriers of entry enabled manufactures to forestall lowering prices in a significant fashion (the rapid decline in the price of computers and cell phones immediately comes to mind as a 'problem' with this statement). "Singer also argued that the demand for primary commodities showed relatively low income elasticity, so income growth tended to lower the relative demand for, and hence relative price of, primary commodities. Moreover, he argued that technical progress in manufacturing tended to be raw-material saving (e.g., synthetics), thereby causing the demand for primary products to grow slower than for manufactures (Cuddington, Ludema, & Jayasuriya 2002, p.6). In short, wages go up in the West, enabling Westerners to buy more commodities with a lower percentage of their income, freeing more money for savings and manufactured goods. The commodity-producing poor stay poor in the developing world and their wages buy fewer goods.

For example, as incomes get higher, incrementally yet noticeably in the West, demand for bananas remains stable -- yet banana-producing regions see their workers have relatively no growth in wages, thus the industrialized world's buying a .10 banana vs. A .9 banana fails to give a developing world's processing plants little additional profit over time. The demand for bananas abroad will not noticeably increase if the price falls to .5, while domestic workers wages remain low to price the goods as low as possible to gain at least some competitive advantage for the produce. The commodity goods are less profitable for the producing nation, as demand is relatively stable regardless of price or the cost of manufacturing, so the producer attempts to save on wages. Also, there is only so much that can be saved by improving the manufacturing process. For the workers, their cost of the food is a much higher percentage of their income than in the developed world. Prebisch and Singer suggest that protectionism may be necessary to keep the price of primary goods artificially high along with domestic worker's wages and to ensure that the goods are profitable, given the inelasticity of commodity demand.

Prebisch and Singer attempted to explain what had been observed anecdotally in many nations but had not been described theoretically, namely that former colonies often had difficulties in advancing their economies even after the colonizing nation had left. "It became the basis of much of what was later called dependency theory. The idea was that the world was split into two parts, the core and the periphery. The core was characterized by a high level of industrial development, well-organized labor and a high rate of technical progress. Meanwhile, the periphery was mostly engaged in producing primary products (agriculture and raw materials) and had poor labor organization," often because of oppressive political systems that were hostile to labor ("Prebisch-Singer theory," everything2.com, 2005).

In theory, of course, peripheral nations could leverage their wealth of primary goods against core regions to gain political power and a comparative advantage in trade through specialization. Why this did not occur, even after industrialization caused prices to drop through technical improvements, was explained by the Prebisch-Singer thesis. Prebisch and Singer suggested that the core could not leverage its power because even with technological improvements, the prices of manufactured goods were falling at a lesser rate than primary goods, and developing nations would continue to be able to buy fewer primary goods from the developed world as a result. "Manpower was plentiful in the developing world, so there was little pressure on wages to increase. Rather, there was competition between exporters of primary products to find buyers for their commodities. Higher incomes don't tend to much increase people's demand for food or raw materials, meaning it was hard to find buyers even in periods when the world economy was doing well. Hence, there was a race to the bottom - food producers passed all of their technical gains onto buyers by lowering prices. Hence, the core was benefitting from technical progress in the developing world through decreased prices, whereas the workers themselves received nothing," creating an international system of haves and have-nots Marxists called exploitation (Prebisch-Singer theory, everything2.com, 2005.)

Prebisch and Singer assumed that developing countries were specialized in primary commodities and industrialized countries specialized in manufactured goods that were more responsive to increases in income. But one challenge to this hypothesis is that fewer nations than their hypothesis might immediately suggest derive 50% or more of their export earnings from a single commodity, and these tend to be the oil-rich nations of the Middle East, Africa, and Venezuela (Cuddington, Ludema, & Jayasuriya 2002, p.7). Oil prices are kept artificially high because of the behavior of OPEC and oil prices are not uniformly, stably low, according to market forces and thus the behavior of oil on the world market does not neatly fit into the Prebisch-Singer hypothesis.

Another criticism of the hypothesis was that it did not differentiate between different types of primary commodity resources, which might vary from nation to nation. A nation producing oil for export and nation producing bananas might experience very different income and wealth effects, given the stable demand and the cartel-influenced prices of the latter. Also, demand for primary goods as a whole might be more variable than the hypothesis suggests -- demand for corn has increased exponentially, for example, given the demand for ethanol. And the United States, despite being a manufacturing powerhouse, is also often called the breadbasket of the world, given its ability to produce massive amounts of agricultural products. These agricultural products, for better or for worse, have also been enhanced by technology, such as genetically modified disease and insect resistant plants and chemical fertilizers, another flaw in a theory which proposes that agriculture is impervious to technological improvements and changes over time.

Other criticisms of the hypothesis pertain to the data used in the authors' original work. For example, Prebisch and Singer mainly used Latin American British data and "Britain's terms of trade were not representative of the terms of trade of industrialized countries on the whole" given its small size, early industrialization, and colonial relationship with much of the developing world (Cuddington, Ludema, & Jayasuriya 2002, p.16). On its balance sheets: "British exports were valued f.o.b. (i.e., without transport costs), while its imports were valued c.i.f. (i.e., inclusive of transport costs). Thus, declining transport costs alone could improve the British terms of trade, thereby overstating the drop in commodity prices" (Cuddington, Ludema, & Jayasuriya 2002, p.16). Many industrialized countries export primary commodities, such as sugar and corn in the U.S. On a scale that Britain cannot. There is also the influence of higher-quality and new manufactured products: "introducing new manufactured goods and improving the quality of existing ones may push up the price index of manufactures, giving the impression of a decline in the relative price of commodities which means that the "inverse of their terms of trade is bad measure of relative commodity prices" (Cuddington, Ludema, & Jayasuriya 2002, p.16).

Defenders of the hypothesis have noted that it was often misinterpreted, particularly by Latin American governments "to justify exaggerated protectionism and inflationary financing of government" and Prebisch always advocated central-bank independence, and fiscal stability as… READ MORE

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