Impact of terms of trade on economic growth: empirical evidence from Sri Lanka

Abstract

Introduction

The terms of trade is used as an indicator of a country‘s economic condition. It is measured by domestic export price divided by the price of imports (Sherbourne, 2009). In the presence of world global integrations or disintegrations, where export prices converge or diverge worldwide, terms of trade have even more influence on economic growth (Wong, 2009; Blattman, Hwang & Williamson, 2003). An improvement of an economy‘s terms of trade is a result of a rise in the price of exports relative to the price of imports and a deterioration is induced by a rise of the price of imports relative to the price of exports over a given time period. Declining of terms of trade is one of the main reasons for an income gap between developed and developing countries. Increase in terms of trade would lead to increase in investment and thus economic growth will increase (Jawaid and Raza, 2012).

A number of studies have been extensively arguing the impact of terms of trade on economic growth. Most of them identified a positive effect (e.g. Jawaid and Raza 2012; Mputu 2016) while some of the studies reported an adverse effect (e.g., Kalumbu and Sheefeni 2014; Jebran et al 2018). This indicates that there is no consensus among the researchers regarding the relationship between terms of trade and economic growth. In sum, according to the existing literature, terms of trade plays a significant role in determining the growth. In this regard, although the government of Sri Lanka (SL) has made a tremendous effort to increase the terms of trade through the implementation of favorable export and import policies since 1977, the amount of terms of trade in SL is still very low and has high fluctuations. Moreover, the impact of terms of trade on economic growth in Sri Lanka remains scantly researched in recent time and it is a widely debated issue. Thus, this study attempts to examine the influence of terms of trade on economic growth.