Decomposing terms of trade fluctuations in Ethiopia

Abstract

This article proposes a technique to decompose short-run fluctuations in the terms of trade. Using Ethiopia as an example, we decompose the commodity terms of trade into various components to measure the impact of price and volume shifts as well as export diversification. We use monthly data from the past decade, including periods during the global food and financial crises. Our findings suggest that diversification out of traditional coffee exports to other export commodities successfully mitigated the terms of trade shock. Continued export diversification will be beneficial.

Acknowledgements

The authors thank the anonymous reviewers, Yohannes Ayalew Birru, Fátima Cardoso and Paolo Soares Esteves for their helpful comments and discussion, as well as Yuya Oshima for the excellent research assistance. The views expressed in this article are entirely those of the authors; they do not necessarily represent the views of the World Bank and its affiliated organizations, or those of the executive directors of the World Bank or the governments they represent.

Notes

¹The export volume of coffee slightly declined whereas other commodities, such as pulses, rose.

²Another, more data-intensive approach to analyse income terms of trade, using a two-step variance decomposition technique, was proposed by Lloyd and Procter (1983).

³In the decompositions we prefer to use the terms of trade series omitting the Machinery and Transportation Equipment Unit Value Index because data on quality changes of manufactured goods are limited. Nevertheless, if we choose to include this index and make assumptions about quality changes (such as fluctuations within ±15%), our quantitative overall results would only be affected marginally.