Trading gains: terms‐of‐trade and real‐exchange‐rate effects

Abstract

AbstractThis paper considers alternative measures of a country's trading gains, i.e., the extra income that it earns (or loses) as the result of changes in the relative prices relevant for international trade, and which makes up the difference between real gross domestic product (GDP) and real gross domestic income (GDI). Looking at both the Laspeyres and the Törnqvist aggregation, we show that the trading gains really consist of two components, a terms‐of‐trade effect and a real‐exchange‐rate effect. Nearly all national statistical agencies, receiving no firm guidance from international organizations in this matter, merely consider the first effect, which suggests that the so‐called trading‐gain estimates they publish are incomplete and misnamed. Even more seriously, it implies that the corresponding measures of real GDI they derive are conceptually flawed. A straightforward way to circumvent these difficulties is to use the gross domestic final expenditure price index as deflator when computing real GDI and the trading gains. Some numerical estimates for Australia are provided as an illustration. The paper also identifies the underlying linear and Translog real GDI functions for which the Laspeyres and Törnqvist terms‐of‐trade and real‐exchange‐rate effects are exact.