Thursday, 31 January 2013

Unfair Contract Terms Act (UCTA) 1977

Unfair Contract Terms Act (UCTA) 1977

The UCTA will be looked in respect to what extended, parties, can limit and exempt themselves from liabilities.

This post will be looking at how freedom of contract is regulated through UCTA. 

It is important to note that UCTA does not replace the common law ways of dealing with limited liability and exemption clauses, as the contract still has to establish whether the actual exemption clause is incorporated and then the UCTA is applied.

It is for this reason the doctrine of contra proferentem (that in the event of ambiguity the term will be interpreted against the party that imposed them) is now of less significance and UCTA focuses more on defining reasonability in order to assess if and to what extent the exemption clause should be upheld.   

The UCTA has two approaches to the exemption clause, the first is to prohibit certain clauses indefinitely and the second is to apply the reasonability test and on the basis of this result deduce whether it is to be upheld or not. 


The UCTA can be divided into two sections:


S.2 - How to deal with negligence liability
S.3 - How to deal with liability caused by breach 
S.6 - Sale of Goods Act 1979 (SOGA)
S.7 - Dealing with Goods not covered by SOGA


S.11 - Sets out reasonability test
S.12 - Defines what is a consumer as throughout the act rules set out may only apply to consumer

POINT 1: So what contracts can UCTA apply to?

  1. Business related s.1(3)
  2. Not specific ones like employment which is covered by other statute Sch 1
  3. Only domestic contracts s.26 (3)

Section 1

Section (1) lays out the crucial requirements, without which this act is useless.  

S1 (3) : In the case of both contract and tort, sections 2 to 7 apply (except where the contrary is stated in section 6(4)) only to business liability, that is liability for breach of obligations or duties arising—

(a)from things done or to be done by a person in the course of a business (whether his own business or another’s); or

(b)from the occupation of premises used for business purposes of the occupier;
and references to liability are to be read accordingly [F1but liability of an occupier of premises for breach of an obligation or duty towards a person obtaining access to the premises for recreational or educational purposes, being liability for loss or damage suffered by reason of the dangerous state of the premises, is not a business liability of the occupier unless granting that person such access for the purposes concerned falls within the business purposes of the occupier]

What does this mean:

  • That essentially the UCTA cannot be applied to private contracts, it is limited to business contracts - where there is a ‘business liability’ to be found.

There is further restriction on the types of contracts that are covered by the act. These are to be found in Schedule 1.

Schedule 1

Sections 2 to 4 of this Act do not extend to—

(a)any contract of insurance (including a contract to pay an annuity on human life);

(b)any contract so far as it relates to the creation or transfer of an interest in land, or to the termination of such an interest, whether by extinction, merger, surrender, forfeiture or otherwise;

(c)any contract so far as it relates to the creation or transfer of a right or interest in any patent, trade mark, copyright [F28or design right], registered design, technical or commercial information or other intellectual property, or relates to the termination of any such right or interest;

(d)any contract so far as it relates—
(i)to the formation or dissolution of a company (which means any body corporate or unincorporated association and includes a partnership), or
(ii)to its constitution or the rights or obligations of its corporators or members;

(e)any contract so far as it relates to the creation or transfer of securities or of any right or interest in securities.

Within this schedule you will find a list of contracts that are not covered by this act e.g. employment contracts or the sale of intellectual property. The reason why they are excluded is because there is already a vast amount of law regulating these types of contracts. 

Furthermore international contracts are not subject to this act as you will see in S.26 (3)

26 International supply contracts.
  1. The limits imposed by this Act on the extent to which a person may exclude or restrict liability by reference to a contract term do not apply to liability arising under such a contract as is described in subsection (3) below.

(2)The terms of such a contract are not subject to any requirement of reasonableness under section 3 or 4: and nothing in Part 11 of this Act shall require the incorporation of the terms of such a contract to be fair and reasonable for them to have effect.

(3)Subject to subsection (4), that description of contract is one whose characteristics are the following—
(a)either it is a contract of sale of goods or it is one under or in pursuance of which the possession or ownership of goods passes; and
(b)it is made by parties whose places of business (or, if they have none, habitual residences) are in the territories of different States (the Channel Islands and the Isle of Man being treated for this purpose as different States from the United Kingdom).

Once these requirements are fulfilled we can move to the utilisation of  this act

POINT 2: When dealing with liability arising from negligence

Section 2 sets out how to deal with liabilities that have arisen from negligence and whether a party can exclude themselves from this. I translate the act into simple words underneath.

Negligence in defined in s1 (1) - basically where a party has fallen short of their obligation and this has resulted in a liability.

(1)For the purposes of this Part of this Act, “negligence” means the breach—
(a)of any obligation, arising from the express or implied terms of a contract, to take reasonable care or exercise reasonable skill in the performance of the contract;
(b)of any common law duty to take reasonable care or exercise reasonable skill (but not any stricter duty);
(c)of the common duty of care imposed by the M1 Occupiers’ Liability Act 1957 or the M2 Occupiers’ Liability Act (Northern Ireland) 1957.

2 Negligence liability.

(1)A person cannot by reference to any contract term or to a notice given to persons generally or to particular persons exclude or restrict his liability for death or personal injury resulting from negligence.

(2)In the case of other loss or damage, a person cannot so exclude or restrict his liability for negligence except in so far as the term or notice satisfies the requirement of reasonableness.

(3)Where a contract term or notice purports to exclude or restrict liability for negligence a person’s agreement to or awareness of it is not of itself to be taken as indicating his voluntary acceptance of any risk.

S 2(1) - This section prohibits parties from excluding any form of liability for negligence which results in death or personal injury. 

S 2(2) - This section says it is possible to limit or exclude liability to negligence that causes other types of damage e.g. damage to property, on the condition that it satisfies the reasonability test that is laid out in s11. 

S 2(3) - This talks about a specific defence in the area of tort law 

POINT 3: When dealing with liability arising from breach 

Section 3 sets out how to deal with this liability. Explanations found underneath.

Liability arising in contract.

(1)This section applies as between contracting parties where one of them deals as consumer or on the other’s written standard terms of business.

(2)As against that party, the other cannot by reference to any contract term—
(a)when himself in breach of contract, exclude or restrict any liability of his in respect of the breach; or
(b)claim to be entitled—
(i)to render a contractual performance substantially different from that which was reasonably expected of him, or
(ii)in respect of the whole or any part of his contractual obligation, to render no performance at all,except in so far as (in any of the cases mentioned above in this subsection) the contract term satisfies the requirement of reasonableness. 

S 3 (1) This section on applies to consumer-business relationships or in relationships where standard form was accepted by one party. 

S 3(2)(a)  The non-consumer party can only limit their liability of breach only insofar as they pass the test of reasonability in s11. 

S 3(2)(a) (i) - The non-consumer party cannot limit their liability where they write their clause in disguise and so the consumer would have no idea about it. 

S 3(2)(a) (ii) - They cannot limit their liability where only part or none of the whole duty is fulfilled. 

Case Point***

Timeload Ltd v British Telecommunications plc 1995

Timeload purchased a number from BT, BT held the clause that they could remove the contract in 1 months advance. Timeload argued that this terms was in disguise and under S3 (2) (a) (ii) the courts ruled that it was unfair and therefore unenforceable.

Paragone Finance v Staunton 2001

Under the variable mortgage scheme, the defendant who fell back in their payments argued that the claimant did not pass on the lower interest costs and this was unfair under S3(2) of the UCTA. It was held that it was not because the contractual performance was up to the discretion of the parties. 

POINT 4: How do objective test for reasonability? 

Section 11, sets out how we apply the reasonability test. 

The “reasonableness” test.

(1)In relation to a contract term, the requirement of reasonableness for the purposes of this Part of this Act, section 3 of the M6 Misrepresentation Act 1967 and section 3 of the M7 Misrepresentation Act (Northern Ireland) 1967 is that the term shall have been a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made.

(2)ln determining for the purposes of section 6 or 7 above whether a contract term satisfies the requirement of reasonableness, regard shall be had in particular to the matters specified in Schedule 2 to this Act; but this subsection does not prevent the court or arbitrator from holding, in accordance with any rule of law, that a term which purports to exclude or restrict any relevant liability is not a term of the contract.

(3)In relation to a notice (not being a notice having contractual effect), the requirement of reasonableness under this Act is that it should be fair and reasonable to allow reliance on it, having regard to all the circumstances obtaining when the liability arose or (but for the notice) would have arisen.

(4)Where by reference to a contract term or notice a person seeks to restrict liability to a specified sum of money, and the question arises (under this or any other Act) whether the term or notice satisfies the requirement of reasonableness, regard shall be had in particular (but without prejudice to subsection (2) above in the case of contract terms) to—
(a)the resources which he could expect to be available to him for the purpose of meeting the liability should it arise; and
(b)how far it was open to him to cover himself by insurance.

(5)lt is for those claiming that a contract term or notice satisfies the requirement of reasonableness to show that it does.

S11 (1) - States that this test applies to the Misrepresentation Act and is an objective test based on what parties should have know not what they did. [Do note that especially in common law systems nothing can be completely objective]. 

S11 (2) - Gives courts the right to remove clauses from contracts especially were exemption clauses are concerned and so if a clause is said to be unreasonable, courts have the authority to dismiss the clause. 

S 11(4) - That limited liability clauses should be tested for reasonability based on (i) its proportion against the parties’ resources and (ii) the possibility of the party being able to protect itself with insurance. 

S11 (5) - The burden of proof lies with the party that imposed the clause to proof it is reasonable. 

Schedule 2 also provides guidelines for to use the reasonability test.

The matters to which regard is to be had in particular for the purposes of sections 6(3), 7(3) and (4), 20 and 21 are any of the following which appear to be relevant—

(a)the strength of the bargaining positions of the parties relative to each other, taking into account (among other things) alternative means by which the customer’s requirements could have been met;

(b)whether the customer received an inducement to agree to the term, or in accepting it had an opportunity of entering into a similar contract with other persons, but without having a similar term;

(c)whether the customer knew or ought reasonably to have known of the existence and the extent of the term (having regard, among other things, to any custom of the trade and any previous course of dealing between the parties);

(d)where the term excludes or restricts any relevant liability if some conditionwas not complied with, whether it was reasonable at the time of the contract to expect that compliance with that condition would be practicable;

(e)whether the goods were manufactured, processed or adapted to the special order of the customer.

a - What are the relative strengths of the bargaining power?
b - how competitive is the market?
c - Was there any incentive pushing the consumer/business to enter the contract?
d- How aware was customer of the clauses?
e- Are there reasonable condition e.g. saying you only have two hours to register or we exempt ourselves - is that reasonable?
f- bespoke products, are they different?

Case Point***

George Mitchell v Finney Lock Seeds 1983

The claimant purchased seeds for circa £200 from the defendant. The seeds grew cabbages that were not fit for consumption and cause £61,000 in loss. The defendant used the defence of the limits liability clause of £200 but was unsuccessful as the courts ruled this was unfair as only defendant would have (a) known about the defect and (b) be able to insure themselves at a small cost. 

Smith v Eric Bush 1989

The claimant paid for the valuation of his house in order to get a mortgage. The defendant, the surveyor was negligent as he failed to give the right advise and looked to rely on a limited liability clause. The courts ruled that it was not reasonable as the valuable of the property was low and that the advise was for mortgages purposes not business or commercial investment. 

The House of Lords asks 4 questions when looking at reasonability:

  1. Do the parties have equal bargaining power?
  2. Is it reasonable for the party to take advice from alternative sources?
  3. How difficult is the task being undertaken? e.g. surveying is not particularly difficult
  4. What are practical consequences of conducting the reasonability test. 

Courts look at at the time how the parties were acting, not retrospectively saying x or y should be done or intended. 

POINT 5: Dealing with goods covered by SOGA

Goods dealt with in the Sale of Goods Act 1979, are dealt with in section 6. 

Sale and hire purchase.

(1)Liability for breach of the obligations arising from—
(a)[F2section 12 of the Sale of Goods Act 1979](seller’s implied undertakings as to title, etc.);
(b)section 8 of the M3 Supply of Goods (Implied Terms) Act 1973 (the corresponding thing in relation to hire-purchase),
cannot be excluded or restricted by reference to any contract term.

(2)As against a person dealing as consumer, liability for breach of the obligations arising from—
(a)[F3section 13, 14, or 15 of the 1979 Act](sellers’s implied undertakings as to conformity of goods with description or sample, or as to their quality or fitness for a particular purpose);
(b)section 9, 10 or 11 of the 1973 Act (the corresponding things in relation to hire-purchase),
cannot be excluded or restricted by reference to any contract term.

(3)As against a person dealing otherwise than as consumer, the liability specified in subsection (2) above can be excluded or restricted by reference to a contract term, but only in so far as the term satisfies the requirement of reasonableness.

(4)The liabilities referred to in this section are not only the business liabilities defined by section 1(3), but include those arising under any contract of sale of goods or hire-purchase agreement.

 S 6(1) - It is prohibited to limit or exclude liability of implied terms - e.g. you can’t exempt yourself from damage caused by not giving products of good title as  that is stated in S 12 of SOGA. 

S 6(2) - S 13-15 of SOGA which looks at fitness for purpose, sale by description etc is forbidden from being excluded. 

S 6(3) Businesses can have exemptions put against them unlike consumers but this rests on the reasonability test.

POINT 6 - So what defines a consumer?

A consumer is defined in section 12. 

“Dealing as a consumer”.

(1)A party to a contract “deals as consumer” in relation to another party if—
(a)he neither makes the contract in the course of a business nor holds himself out as doing so; and
(b)the other party does make the contract in the course of a business; and
(c)in the case of a contract governed by the law of sale of goods or hire-purchase, or by section 7 of this Act, the goods passing under or in pursuance of the contract are of a type ordinarily supplied for private use or consumption.
But if the first party mentioned in subsection (1) is an individual paragraph (c) of that subsection must be ignored.]

(2)But the buyer is not in any circumstances to be regarded as dealing as consumer—
(a)if he is an individual and the goods are second hand goods sold at public auction at which individuals have the opportunity of attending the sale in person;
(b)if he is not an individual and the goods are sold by auction or by competitive tender.]

(3)Subject to this, it is for those claiming that a party does not deal as consumer to show that he does not.

S 12 (1) - That a consumer does not in any way make the contract or pretend to make the contract, the terms lie with the other party

S12 (2) - Not a consumer if buying second hand goods or are at a public auction 

S12 (3) - The burden of proof lies with party that believe you are not a  consumer to prove it

Case Point ***

R & B Customs Brooken v United Dominions Trust 1988 

The claimant was a freight forwarding company that had a car for both business and personal use. When the car was discovered to be not fit for purpose, has it broke S14 of SOGA? That depends on if the claimant was a consumer or a business. The court held the claimant was a consumer as they don’t usually deal with cars and a car is also an ‘ordinary good’, this meant the reasonability test did not need to apply.

POINT 7: Other Sections 

S 13 - other types of exemption clauses such as ones which are more onerous and discusses the remedies for them.

S 4 - Is it reasonable to pass on the liability risk through indemnities

S 5 - by making guarantees, you exclude liabilities - so this section excludes such liabilities 

S 10 - You cant remove your liability by splitting it between two different contracts, courts see them as one. 

Monday, 28 January 2013

Endogeneous Theory of Money

In this video I explore the endogenous theory of money, by explaining what it is, how it differs from exogenous theory, its historical roots and the justifications/evidence for this theory. This video is created and presented by Komilla Chadha


Endogenous Theory of Money

What is it?

  • Idea that money grows from within, from within the economy  through money demand and economic activity.

  • Money exists as needed by the real economy, because bank system reserves vary to accommodate money demand via interest rates. 

  • Banks borrow from the fed reserve discount rate as much as needed to support consumer lending and endogenous money activity .

  • This why the money is always backed by productive assets - as it is given on the basis of the real economy not depending on savings/reserves present. 

  • loans are typically created ‘out of nothing’ then central bank accommodates this response to the real economy regardless of deposits

  • Point to note; two key characteristics: (i) money backed up by productive assets and (ii) money is lent out of nothing, the loans rely on central banks lending. 

How is this different to Neoclassicism and the exogenous theory of money?

  • ‘money multiplier’ - fractional reserve system - once reserves are created then they lend out and in this process create credit 
  • Whereas, in the endogenous theory of money first loans are given out in response to money demand then does the banks accommodate the loans with borrowing from central banks.


  • Post Keynesian - so money has three functions - unit of account - measure of value, means of payment - transitionary and store of value most important which is that it is an asset in itself - an explanation for hoarding which keynes was very interested in 

  • A lot of Keynes’ monetary idea was adopted from Marx especially where the need for fiscal policy is stated 

  • Basil Moore - banks cannot control reserves in a discretionary manner - they do it on basis of the money demanded and central banks accommodate. This can be linked to the Radcliffe Report.

  • In 1957, a report chaired by Lord Radcliffe essentially said  there are two reasons why central banks have a limited role/need when it comes to stability and that is that (i) central banks can never completely control money supply as there are many near-money substitutes such as savings deposits and (ii) velocity of money cannot be controlled and has the power to alter inflation significantly. The report was completely forgot about with the creation of the Quantity Theory of Money and the rise of the monetarist.

  • The interesting thing is that now, after the Financial Crisis, questions regarding the exogeneity of money supply and therefore the role of central banks have appeared again. Moore for instance says that central banks can maybe control the supply price of money via interest rates but cannot control the quantity of credit and by implication the need for central banks extinguishes into something quite menial. 
  • Keynes argued the demand to hoard - fetish for liquidity - causes unemployment because it keeps interest rates too high to permit sufficient investment to raise ad to the full employment level .

- Tobin stresses that banks have a profit motive and are thus responsive to the private sector, so although authorities control monetary policy instruments, money supply will always be dictated endogenously by the private sector. 


  1. Does reserves come first ?- evidence shows that reserves sometimes arrive many month after money supply as increase - links to banks being responsive to economic activity as opposed to the financial sector - in neoclassical model except for inflation central banks and neutral money doesn’t have a real process 

  1. Monetarism in the 80s did reduce inflation through this monetary aggregate system - which is not possible in endogenous theory of money as it is not central banks but each agent that creates the money. In  80s banks undershot money target and interest rate - controlling money supply essentially failed. 

  1. Evidence with private debt and consumption has been shown - link to prior to recession -- this correlation is strong in the endogenous model whereas the exogenous they are just intermediaries so just redistribution of credit so not emphasis with debt and growth 

  1. For exogenous money altering the money base should have an impact on lending and other economic indictors whereas for endogenous this is ‘oiling the wheels’ minimal it is endogenous economic activity - latest qe bad results could essentially been seen as proof for endogenous theory of demand.

  1. Also if central banks can only use overnight interest rate, which only has indirect impact on quantity of reserves - as main impact is deposits - then it is clear that this set by economic endogenous activity not reserves as it is indirect .

Links to recession

When demand is low the private sector will not create money endogenously 
therefore it is the role of government and fiscal policy to increase reserves to encourage central banks to do open market operations to prevent interest rates reaching to low 0. Open market operations is not a borrowing operation why would sovereign issuer need to borrow from public - it is an interest rate mechanism. There is an issue though because the government is right now in a lot of debt so how can it fulfill this role. 

Policy Implications 

The appropriate way to control the economy is to control money demand (all three types of demand especially hoarding) and it is impossible that monetary policy affects demand, since causation runs from demand to supply not the other way round. 

Sunday, 27 January 2013

Dependency Theory

Dependency Theory

Dependency theory is in essence, an extension of structuralism and rose out of the failures of ISI. Dependency theory was categorised in two groups; the first was the disillusioned structuralist and the radical neo-marxists. The essential difference between these two groups if that for the neo-marxist, revolutionary is key for development.

So what did the Neo-Marxist add to the structuralist theory?

  • The one capitalist world we live in originates from the centre, and why the periphery never developed was because the centre never required them to develop. In fact, they used the periphery. 
  • Development was blocked by the outflow of surplus from the centre to the periphery. 
  • This enhanced by the class system and maintained by dominant classes such as landlord who even in the periphery countries benefit.
  • The poor remain with the primary products because there is a dominant class in underdeveloped countries, who interests are aligned with centre interests.
  • This is why the only way to break out of this cycle is with a revolution.
  • This is not to say there hasn’t been any development at all, but what there has is self-sustaining and ISI just made it worse by increasing the dependency on the centre and dominant class for trade and capital. 
  • So this is why a radical political change is needed to eradicate these class incentives. 

So in what ways in the periphery depend?

  1. They are depend for foreign currency, as even for ISI you need imports. 
  2. Foreign financing - as even when you exports are struggling to take off, imports still required, and BoP crisis is still present. 
  3. Technology - even though the technology may not be in line with the periphery’s factors of production
  4. TNCs and their growing role also shows the growing reliance on the centre’s culture.

Prescriptions - How do neo-marixists suggest we rectify this development problem?

  • Except for political revolution there isn’t much they have to offer.
  • Sutcliffe’s propose a criteria for Independent Industrialisation, e.g. ‘diversify industrial base’ or ‘production for domestic market’ . However, again there is a lack of prescription, is he advocating a more Soviet Autarkic Socialist Development even though that failed for the USSR?


  1. Great analysis, but lack of an answer or solutions prescribed
  2. There isn’t much evidence to make their theories valid
  3. Their theory missing geographical and democratic factors which also play a key role in development
  4. What about the positive affects of TNCs and global capital
  5. Personally, I fail to see where this takes us in the development debate.

Criticisms of Structuralism

Criticisms of Structuralism 

  • Structuralism fundamentally disagrees with Samuelson’s Price Factor Theory which says that free trade over the long-term equalises, it is a matter of time , thing improve not become more worse as structuralist suggest.
  • For neo-classists the ultimate arbitrator is the market so government intervention as prescribed by structuralists creates imperfections and distorts markets. 
  • The PSH is sometimes referred to as a “myth” as there isn’t strong clear empirical evidence to back this theory up. 
  • Is terms of trade really the fundamentally reason behind underdevelopment?
  • The ISI protectionist stages are problematic. For example, the lack of price mechanism leads to inefficiencies and rent seeking (corrupt) behaviour by the firms that are protected. 

The ISI crisis in the mid-60s was self-critiqued in by the structuralist themselves

  • The results showed that ISI went no way in reducing inflation or the BoP crisis. 
  • Periphery countries were unable to reach scale and quality to move from stage one to stage two.
  • Inefficiency meant that centre countries had no incentive to import more from periphery countries. 


Development Economics:“Structuralism” by Komilla Chadha


  • Structuralism arose from the “Economic Commission for Latin America (ECLA)” which set out to find the major obstacles to development in Latin America (LA) and propose policy prescriptions.

  • This was as a result of the balance of payments and exchange rate crisis suffered by Argentina in the 1920s. Economist questioned the orthodox trade theory [comparative advantage]. 

The Proposition:

Development and underdevelopment are not stages in a process but rather structural conditions which are reinforced time and time again by international trade. 

Following this proposition, countries are classified as “centre”and “periphery” countries. Centre countries are those who have the structural condition of being developed and exporting non-primary products. Conversely, periphery countries are those who are underdeveloped and whose economies revolve around primary product exportation. 

These conditions are not new, they are historical but have been unable to change because of the repeated reinforcement of these condition via international trade.

How did the “structure”(i.e. centre/periphery) form? - A historical perspective

  1. Industrial Revolution in the centre - perhaps centre countries had this first because of their colonial pasts?

  1. The industrial revolution lead to dramatic increase in the productivity of factors of production

  1. Centre countries internalised the new technology new technical progress attained from industrial revolution and spread it all economic sectors.

  1. This resulted in a homogeneous and integrated economy

  1. Periphery countries not having attained the industrial revolution and more importantly same level of technology became import dependent for their modern sector.

  1. The periphery’s reliance on imports meant that exports remained primary products

  1. A dualist economy formed in the periphery: the traditional agrarian sector and the modern sector which exported these primary commodities using technology imported from the centre.

  1. Up till today periphery cannot develop because they are stuck in this negative circle of being reliant on imports for technical progress and international trade reinforces the structural conditions of development and underdevelopment time and time again. 

What point is the historical perspective trying to get at?

Essentially what it is trying to demonstrate is that actually  because of all these historical events, trade is not equally beneficial to both parties as suggested by neo-classists. This is why there is a structure in the first place. The implication is that to develop a new strategy must be sought to eradicate this trade asymmetry which would allow countries to equally trade and lead to that wonderful global Pareto efficiency of production.

Q: Explanation provided by structuralist: What mechanism explains the formation of trade asymmetries ?

A: By deteriorating “Terms of Trade”

The Prebisch-Singer Hypothesis (PSH) 

The PSH refers to the idea that there are deteriorating terms of trade and this is locks countries into the conditions of development and underdevelopment.

The PSH suggests that there are declining terms of trade because:

  1. The income elasticity of demand (YED) of primary products is much less than that of manufactured products. I was going to give an example here but I think it is more confusing than helpful so I will just say it how it is. When incomes go up, there is only a defined/limited amount of extra, better quality food you can eat, whereas your non-essential spending (for example on clothes, shoes, going out etc) will never stop increasing - it is an unlimited want. So what happens is when the world becomes richer, the demand for primary products does not rise as fast as the rise for manufactured which means again the centre has an advantage, an opportunity to grow (technologically as well as GDP) faster than underdeveloped countries. This cycle perpetuates until the underdeveloped countries can compete on manufactured goods.

  1. Political Reasons - For instance the existence of sophisticated trade unions in the centre meant that there were trade rigidities and in down times, the centre did not suffer as much as the periphery. Assuming the Lewis model, the excess supply in periphery countries also goes some way in suggesting the wage discrepancy and thus the crucial reason why trade is unequal. Furthermore, some economist such as Nurske argue that centre countries develop synthetic substitutes for primary products and this enhances the asymmetries in trade

So now that we established why there may exist trade asymmetries, we need to question why are they so important, particularly from a purely economic stance?

  1. Balance of Payments Crisis - demand for primary goods is not rising as much as the demand for manufactured goods, this leads to a BoP deficit for primary goods exporting countries i.e. periphery countries

  1. Domestic Inflation - inflation is structural issue and is caused in two ways for periphery countries. The first is the Dusenberry Effect, this is when incomes are low so when they rise, rises in consumption are disproportionate to the rises in savings thus spurring demand-pull inflation. The second is cost-push inflation caused by supply inelasticities of agricultural/primary goods.

Now that we know why there are declining terms of trade and economically why we should care, let us have a look at how this model develops. 

  1. In order to stop this trade asymmetry, periphery countries have to industrialise just as centre countries did.
  2. This industrialisation will not follow the same pattern as centre countries as periphery countries are already a trading actor, this is called structural sequencing. 
  3. The industrialisation need then, is Import Substituting Industrialisation (ISI), which requires government intervention. 
  4. A government is required to put in place key policies such as tariffs and quotas.
  5. The centre can also help through trade benefits and financial benefits.

A key to this growth then is Import Substituting Industrialisation, but what does that mean...

  • ISI is a type of growth which increases exports and in the long run leads to greater openness. It is a stage on the way to export led growth. 
  • Periphery should start by focusing on manufacturing consumer goods (different to the Soviet approach) as a market for them already exists.
  • Then with the surplus created from there you move to intermediate goods and then capital goods. “Structural Sequencing” becomes important here.
  • ISI is different to autarky, because even though some protectionist measures are put in place by the state, you are internalising import production but still conducting some extent of trade.

So what are the stages of ISI that led to Export Led Growth

Stage one:

  • At least, one prototype of the goods the country wishes to species in are imported. 
  • Primary products are this stage continue to be exported.

Stage Two

  • Technology is now imported so that periphery can learn to make them
  • Primary goods are still exported except in addition to some of the consumer goods that were made to a high standard. 

Stage Three - Export Orientated Growth

  • Technology continue to be imported but are limited now
  • C + I + K can now be exported and the unequal terms of trade have gone some way in being rectified. 

What was the government policy that structuralist prescribed?

  1. Continued wage and productivity in the agricultural sector.
  2. Following monetarist, control of money through the money supply 
  3. Reducing non-essential imports and reducing BoP deficit
  4. Picking the right sectors based on elasticities of what to import and what to export 
  5. The centre should be encouraged to reduce their protectionist measures and increase FDI