The aim in this note is to reintroduce the single factoral terms of trade into the policy arena. This economic concept has scarcely been used by analysts or policy makers over the past three decades. It is defined and compared favourably with other terms of trade concepts in terms of their usefulness to agricultural policy makers in Australia. A distinction is made between the single factoral terms of trade from the viewpoint of the farm business and from the viewpoint of the farm household, but only slightly different indices are specified in each case because of the very high positive correlation between farm prices paid and consumer prices. Developing industry-level indices appears to be a more attractive way to proceed given the substantially different rates of growth in total factor productivity (TFP) between agricultural industries. Despite its usefulness, challenges lie ahead in accurately estimating each of the two components of the single factoral terms of trade, the net barter terms of trade and TFP, and the relations between these two components.net barter terms of trade, single factoral terms of trade, total factor productivity, Farm Management, International Relations/Trade,

Fleming, Euan M.

English

Research Papers in Economics

 
The Australian Journal of Agricultural and Resource Economics
 
, 51, pp. 113–119
 
© 2007 The Author 
Journal compilation © 2007 Australian Agricultural and Resource Economics Society Inc. and Blackwell Publishing Ltd
doi: 10.1111/j.1467-8489.2007.00366.x
 
Blackwell Publishing Ltd Oxford, UK AJAR Australian Journal of Agricultural and Resource Economics 1364-985X © 2007 The Author Journal Compilation © 2007 Australian Agricultural and Resource Economics Society Inc. and Blackwell Publishers Ltd XXX  
 
NOTES
 
Single factoral terms of trade E. Fleming
 
NOTES
 
Use of the single factoral terms of trade to 
analyse agricultural production*
 
Euan Fleming
 
†
 
The aim in this note is to reintroduce the single factoral terms of trade into the policy
arena. This economic concept has scarcely been used by analysts or policy makers
over the past three decades. It is deﬁned and compared favourably with other terms of
trade concepts in terms of their usefulness to agricultural policy makers in Australia.
A distinction is made between the single factoral terms of trade from the viewpoint of
the farm business and from the viewpoint of the farm household, but only slightly dif-
ferent indices are speciﬁed in each case because of the very high positive correlation
between farm prices paid and consumer prices. Developing industry-level indices
appears to be a more attractive way to proceed given the substantially different rates
of growth in total factor productivity (TFP) between agricultural industries. Despite
its usefulness, challenges lie ahead in accurately estimating each of the two components
of the single factoral terms of trade, the net barter terms of trade and TFP, and the
relations between these two components.
 
Key words:
 
net barter terms of trade, single factoral terms of trade, total factor productivity.
 
1. The search for a shorthand measure of the returns to farm resources
 
The aim in this note is to reintroduce into the policy arena an economic
concept that has lain dormant for the past three decades, the single factoral
terms of trade. A case is put for its usefulness as a shorthand measure of the
returns to factors engaged in agricultural production in Australia. Four terms
of trade concepts are typically discussed in international trade text books that
could be applied at the sector level as measures for this purpose.
The two most commonly used concepts are too crude to provide any
meaningful comparison and one, while theoretically superior, is impractical
because of its stringent data requirements. The crudest and simplest concept,
the net barter or commodity terms of trade, is the most commonly used
measure. For example, the farmers’ terms of trade are regularly reported by
the Australian Bureau of Agricultural and Resource Economics (ABARE
2004a) and featured strongly in a recent survey of trends in Australian agri-
culture conducted by the Productivity Commission (2005, pp. 116–117) using
 
* I am grateful for the comments of the anonymous referees on an earlier draft.
 
† 
 
Dr Euan Fleming (email: eﬂeming@une.edu.au), School of Economics, University of New
England, Armidale, New South Wales, Australia.  
114 E. Fleming
 
© 2007 The Author 
Journal compilation © 2007 Australian Agricultural and Resource Economics Society Inc. and Blackwell Publishing Ltd
 
estimates of productivity change summarised by ABARE (2004b). While it
has some limited use, it takes no account of changes in input and output rela-
tions and, in itself, is unsuitable as a measure of sectoral returns to resources.
The income terms of trade are an improvement on the net barter terms of
trade in that they take into account changes in farm output quantities, but
they ignore changes in farm input quantities.
The third concept, the utility terms of trade, is ideal for quantifying wel-
fare changes in that it measures the utility gained by agricultural producers
in trading the goods they produce (Viner 1937, p. 560). Measuring farmers’
utility gains each year is out of the question, but it is possible to use revealed
preferences so long as annual consumption data for producers are available.
Sadly, this is not the case.
The fourth concept, and the one best suited as a shorthand measure of the
returns to factors engaged in agricultural production in Australia, is the single
factoral terms of trade. The concept of single factoral terms of trade has a
long history, dating back to its ﬁrst use by Viner (1937, p. 559), building on
the early work of Mill (1844) and Edgeworth (1894). It incorporates changes
in inputs and outputs, through changes in total factor productivity (TFP), and
changes in prices paid and received by farmers, through the net barter terms
of trade. The estimates of changes in TFP and farmers’ prices paid and prices
received that are needed to calculate the single factoral terms of trade in the
Australian agricultural sector are all widely available and can be decomposed
to the agricultural industry level.
 
2. Calculating the single factoral terms of trade
 
Meier (1968) deﬁned and discussed the merits of the four terms of trade con-
cepts. The single factoral terms of trade index is deﬁned here using a more
recent deﬁnition and notation by Appleyard and Field (1998, pp. 120–122).
Appleyard and Field (1998, p. 120) begin by deﬁning the net barter terms of
trade (
 
TOT
 
N
 
) in the usual manner as the ratio of an index of export prices
(
 
P
 
X
 
) and an index of import prices (
 
P
 
M
 
). They then use these net barter terms
of trade to deﬁne the single factoral terms of trade as:
 
TOT
 
SF
 
  
 
=
 
  (
 
P
 
X
 
/
 
P
 
M
 
)
 
O
 
X
 
, (1)
where 
 
O
 
X
 
 is the TFP index. This equation simpliﬁes to:
 
TOT
 
SF
 
  
 
=
 
 
 
TOT
 
N
 
O
 
X
 
. (2)
As originally deﬁned, the single factoral terms of trade index covers all activ-
ities involved in producing a product or group of products to the point of
export. As the purpose of this note lies in examining welfare implications for
agricultural producers as a speciﬁc group in the economy, we deﬁne the single
factoral terms of trade in terms of farm output prices (
 
P
 
Y
 
) (ABARE 2004a), 
Single factoral terms of trade 115
 
© 2007 The Author
Journal compilation © 2007 Australian Agricultural and Resource Economics Society Inc. and Blackwell Publishing Ltd
 
rather than export prices, and TFP in terms of farm production (
 
O
 
F
 
), rather
than production to the point of export. The appropriate index to use as
the denominator is the index of prices paid by agricultural producers (
 
P
 
I
 
)
(ABARE 2004a), which is the ‘import price index’ for farm businesses in
the agricultural economy that is equivalent to the import price index for
participants in the national economy. The single factoral terms of trade index
for Australian farm businesses is therefore deﬁned as:
 
TOT
 
SF
 
  
 
=
 
  (
 
P
 
Y
 
/
 
P
 
I
 
)
 
O
 
F
 
. (3)
This index enables us to determine whether a decline in the farm-gate prices
producers receive for their output relative to farm input prices (as has histor-
ically been the case in Australian agriculture) is less than the percentage rise
in productivity in their production, in which case ‘more [goods and services]
can be purchased for a given amount of employment time of the factors of
production’ (Appleyard and Field 1998, p. 120). If the price decline is greater,
returns to the factors engaged in their production would fall. Because the index
measures factor income relative to factor inputs and input prices, an increase
implies an improvement in farmers’ welfare. A decrease means farmers are
sharing the gains of any productivity increase with participants in the rest of
the domestic economy or overseas.
The single factoral terms of trade index has been left on the shelf chieﬂy
because of a lack of time-series data on productivity. This lack of data remains
a problem at the export level because it has proven especially difﬁcult to
obtain reliable TFP estimates at all levels of economic activity from primary
production to the point of export. It has now been largely overcome at the
agricultural production sector level in Australia, yet the concept has not
regained currency as a consequence here or elsewhere.
 
3. The single factoral terms of trade and its implications for welfare change
 
In its original use, the concept of single factoral terms of trade had as its
denominator the import price index. It is argued above that the equivalent
measure for the farm business is the prices paid by farmers, notated as 
 
P
 
I
 
 in
Equation (3). However, this index does not capture fully the welfare effects of
change on the farm household. Given the predominance of family farms in
Australian agricultural production, we need also to take account of the pur-
chasing power of the farm household from the net farm income earned and
for which the consumer price index is a suitable proxy. The relevant single
factoral terms of trade for the farm household then becomes:
 
TOT
 
SH
 
 
 
=
 
 
 
w
 
F
 
(
 
P
 
Y
 
/
 
P
 
I
 
)
 
O
 
f
 
 
 
+
 
 
 
w
 
H
 
(
 
P
 
Y
 
/
 
P
 
C
 
)
 
O
 
F
 
, (4)
where 
 
w
 
F
 
 is the weight applied to the expenditure by the farm household on
farming operations, measured as the proportion of farm costs to the gross 
116 E. Fleming
 
© 2007 The Author 
Journal compilation © 2007 Australian Agricultural and Resource Economics Society Inc. and Blackwell Publishing Ltd
 
value of farm production, 
 
w
 
H
 
 is the weight applied to the expenditure by the
farm household on consumer goods and services, measured as the proportion
of the net value of farm production to the gross value of farm production,
and 
 
P
 
C
 
 is the consumer price index.
The single factoral terms of trade concept has an advantage over proﬁt
concepts in that it is a comprehensive measure of returns to all factors of pro-
duction whereas other measures of proﬁt are expressed in terms of a particular
factor, such as returns to capital, or farm business. Also, it has the useful
attribute that changes in it are readily decomposable into changes in output
prices, input prices, technical efﬁciency, allocative efﬁciency and scale efﬁciency.
In the following section, some estimates are provided of both the farm business
single factoral terms of trade and the farm household single factoral terms
of trade in Australia.
 
4. Empirical evidence in Australian agriculture
 
Although the Productivity Commission (2005, chap. 6) did not refer to the
single factoral terms of trade index, it reported and commented on trends in
the data needed to calculate it. To illustrate the use of the concept, data from
ABARE (2004a,b) are now reorganised to provide some empirical evidence
of trends in Australian agriculture at both the sectoral and individual industry
levels. Figure 1 shows the trend in the single factoral terms of trade index for
the whole agricultural production sector over three decades from 1974/1975
Figure 1 Single factoral terms of trade for the agricultural production sector, 1974/1975 to
2003/2004.
Sources:A B ARE (2004a, b), Productivity Commission (2005). 
Single factoral terms of trade 117
 
© 2007 The Author
Journal compilation © 2007 Australian Agricultural and Resource Economics Society Inc. and Blackwell Publishing Ltd
 
to 2003/2004. The index is from the perspective of the farm business (there is
negligible difference between this index and the index from the viewpoint of
the household). A linear trend line is included that clearly shows an upward trend.
Despite the fact that the prices paid index increased by an average 1.62 per cent
more per annum than the prices received index, the single factoral terms of trade
index increased on average by 0.65 per cent per annum, signiﬁcant at the 3 per cent
level. Farm businesses and households have been able gradually to purchase
more goods and services for given levels of use of their factors of production.
While there was a general increase in the index, fortunes varied substantially
over the period between farmers in different agricultural industries. Mean
annual changes in the farm business single factoral terms of trade index for
selected agricultural industries from 1977/1978 to 2001/2002 (1978/1979 to
2001/2002 for the dairy industry) are presented in Figure 2 using ABARE
(2004a,b) estimates summarised by the Productivity Commission (2005, p. 129).
Sheep specialists and sheep–beef producers suffered deterioration in the single
factoral terms of trade index, sheep-crops and beef-crops producers experienced
a static index, and beef specialists, crop specialists and dairy producers enjoyed
improvements in the index. The annual rate of decline for sheep specialists
was greater than 1 per cent.
 
5. Challenges ahead
 
A number of challenges lie ahead in accurately measuring change in the
single factoral terms of trade in the Australian agricultural sector. Not least
among them is a need to incorporate changes in the stocks of environmental
Figure 2 Mean annual change in the single factoral terms of trade for selected agricultural
industries, 1977/1978 to 2001/2002.
Sources:A B ARE (2004a, b), Productivity Commission (2005). 
118 E. Fleming
 
© 2007 The Author 
Journal compilation © 2007 Australian Agricultural and Resource Economics Society Inc. and Blackwell Publishing Ltd
 
resources on the farm into estimates of the TFP component of the index.
Randall (2006) observed that increased TFP in Australian agriculture may have
been at an environmental cost. He called for analysts of TFP change to account
more fully for changes in stocks of land (soil erosion and degradation/enhance-
ment; loss/gain of habitats and species; degradation/improvement of land-
scape amenities), other environmental assets (water abstraction; exhaustible
resource abstraction; air pollution; water pollution) and ﬂows of environmental
services (landscape amenities; land-based biodiversity services; nuisance; waste
generation).
Concerns have also been expressed about the accuracy of estimates of
change in the net barter terms of trade component of the single factoral terms
of trade index. In particular, quality changes have been difﬁcult to take into
account when measuring the index, as differentials in quality change are likely
between manufactured goods and most primary products (Findlay 1981, p. 438).
For example, Lipsey (1994) reported that the annual growth rate in the price
index of exports of manufactured products from developed countries could
be over-estimated by up to 1 per cent because of a failure to account for
quality improvements in manufactures.
Finally, it is demonstrated above that TFP growth has helped to counter
the impact of adverse relative price movements on agricultural industries.
Note, however, that prices are not independent of TFP growth because higher
output resulting from TFP growth can lead to a fall in prices. If foreign
demand is very inelastic, this price fall may negate the gains from TFP growth
and even produce ‘immiserising growth’. Analyses of this relationship have
become more sophisticated over time, to the point where general equilibrium
modelling can now be used to estimate the impact of TFP growth on farmers’
welfare.
 
6. Conclusion
 
The concept of single factoral terms of trade is shown to be a useful addition
to the arsenal of agricultural policy makers in Australia in that it can be used as
an index to track changes in the welfare of farm households in the agricultural
sector in general and farmers within an agricultural industry in particular.
Evidence is presented to show that TFP growth has helped to counter the
impact of adverse relative price movements on some agricultural industries.
But the usefulness of the concept depends on an ability to measure accurately
changes in its components, the 
 
TOT
 
N
 
 and TFP, and the potentially negative
relation between these two components.
While it is possible to distinguish between the single factoral terms of trade
from the viewpoints of the farm business and the farm household, only
slightly different indices are reported because of the very high positive corre-
lation between farm prices paid and consumer prices. Rather than distinguish-
ing indices according to the farm business or household, a more rewarding
course of action would be to develop indices for groups of farm businesses 
Single factoral terms of trade 119
 
© 2007 The Author
Journal compilation © 2007 Australian Agricultural and Resource Economics Society Inc. and Blackwell Publishing Ltd
 
according to the agricultural industry in which they operate. The main reason
for following this line of analysis is that substantial differences exist in the
rates of growth in TFP between agricultural industries. A related argument
for speciﬁc industry analysis is that differences in market structure for agri-
cultural and other primary industries, such as export market concentration
and other idiosyncratic factors, inﬂuence any analysis of gains from trade.
 
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Australian Commodity Statistics 2004
 
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The World Economic Order: Past and Prospects
 
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Sustainability: searching for grand principles, or just looking for clues at the scene of the crime?,

The fundamental determinants of the terms of trade,

The theory of international values,

Use of the single factoral terms of trade to analyse agricultural production

Use of the single factoral terms of trade to analyse agricultural production

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