Declining Terms of Trade
- The Terms of trade refer to the relative price of exports/imports.
- A decline in the terms of trade means the price of exports falls relative to imports. Imports become more expensive.
- Typically a country will have lower living standards and less ability to import.
Impact of decline in terms of trade on a developing economy
Suppose a developing country exports coffee beans and imports manufactured goods.
- A decline in the terms of trade will mean a country will see the price of coffee beans fall relative to the price of imported manufactured goods. This means it has to export relatively more coffee beans to get the same quantity of manufactured goods.
- A prolonged fall in the terms of trade could be seen as a problem because it can lead to declining living standards and lower GDP.
- It could also reduce export revenue and make it harder to pay foreign external debt. This would be a problem for developing economies with high external debt. TO meet the debt repayments may require a relatively higher percentage of national income on meeting repayments in foreign currency.
Cost of decline in terms of trade
World Bank estimates suggest that between 1970 and 1997 declining terms of trade cost non-oil-exporting countries in Africa the equivalent of 119 percent of their combined annual gross domestic product (GDP) in lost revenues. It will also be more difficult to earn more foreign currency to pay external debt. [1. State of Agricultural Markets FAO]
Many developing countries concentrate on producing primary products, but according to The Prebisch-Singer hypothesis, there is likely to be a fall in the terms of trade when you concentrate on primary products. This is because:
- Low income elasticity of demand. As incomes rise, demand doesn’t rise so much.
- Increased productivity (fertilizers e.t.c.) increases supply and reduces price.
Between 1961 and 2001, the average prices of agricultural commodities sold by LDCs fell by almost 70 percent relative to the price of manufactured goods purchased from developed countries [2. The State of Agricultural Markets 2004 FAO ]
- A decline in the terms of trade is not necessarily a bad thing. For example, a decline in the terms of trade may occur due to a devaluation in the exchange rate. This devaluation may enable a country to regain competitiveness and increase the quantity of exports. For example, the UK in 1992 benefited from a decline in the terms of trade.
- The impact of a decline in the terms of trade will depend on the elasticity of demand. If demand is elastic, the lower price of exports will cause a bigger % increase in demand.
- Some LDC’s have seen an improvement in terms of trade because of rising price of commodities and food post-2008. It is not always LDCs who see a decline in the terms of trade.
- It is important to distinguish between a short-term decline in terms of trade and a long-term decline. A long-term decline is more serious for reflecting a fall in living standards.
- Terms of trade and balance of trade
- Terms of trade effect in the UK
3 thoughts on “Declining Terms of Trade”
Discuss the secular declining hypothesis of terms of trade and its implication to project management. And, explain also how it is also connected with an informal network circumventing the overriding objective of government, market and NGOs.
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The Prebisch-Singer hypothesis is an economic theory that suggests that the prices of primary goods (such as raw materials and agricultural products) tend to decline relative to the prices of manufactured goods over time. This theory was developed by Raul Prebisch and Hans Singer in the 1950s and 1960s, and it has been influential in shaping policy debates about trade and development. According to the Prebisch-Singer hypothesis, the relative decline in the prices of primary goods has negative consequences for developing countries, which tend to be major exporters of primary goods and therefore rely on them for a significant portion of their foreign exchange earnings. As a result, the Prebisch-Singer hypothesis has been used to support policies such as import substitution (which promotes domestic production of goods that are normally imported) and export promotion (which encourages the export of goods to increase foreign exchange earnings).
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What were some of the key economic ideas of Raul Prebisch?
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Reinvestigating the prebisch-singer hypothesis.
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by: Shouvik Chakraborty
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PERI's Shouvik Chakraborty addresses the validity of the longstanding Prebisch-Singer Hypothesis that asserts the terms of trade between primary goods and manufactured products deteriorate over time. In this new assessment using the Grilli-Yang Commodity Price Index data spanning from 1900 to 2015, Chakraborty finds that, for the full time period, the empirical evidence supporting the hypothesis is weak. However, in considering only the time period since World War II, the evidence in favor of the hypothesis becomes much stronger.
This paper analyses the empirical validity of Prebisch-Singer hypothesis using the time series Grilli-Yang Commodity Price Index data spanning from 1900 to 2015. The methodology employed is encapsulated in a threefold approach: a) endogenous detection of structural breaks; b) estimation of trend through piece-wise linear regression; and c) validation of the statistical significance of the trends applying the Mann-Kendall test. The four structural breaks endogenously determined, primarily, coincides with four important historical/economic events over the last century: (a) World War I (1914 to 1918) and, thereafter, the Great Depression (1929 to 1939), (b) World War II (1939-1945) and immediate post war rebuilding (1950s), (c) First Oil Crisis (1973-74) and (d) Commodity Price Boom (late 1990s). From the trend results, the inference derived on the validity of Prebisch-Singer hypothesis is mixed. If the overall period of study is considered, then the empirical evidence in support of PS hypothesis is weak. However, if the terms of trade movement over the last century is considered, especially the second half, then the evidence in favor of Prebisch-Singer hypothesis is strong. The other important finding is that it also depends on the type of the commodities i.e. the terms of trade of agricultural commodities are more prone to secular decline than metals.
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The Prebisch-Singer Hypothesis: Four Centuries of Evidence
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David I Harvey , Neil M Kellard , Jakob B Madsen , Mark E Wohar; The Prebisch-Singer Hypothesis: Four Centuries of Evidence. The Review of Economics and Statistics 2010; 92 (2): 367–377. doi: https://doi.org/10.1162/rest.2010.12184
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We employ a unique data set and new time-series techniques to reexamine the existence of trends in relative primary commodity prices. The data set comprises 25 commodities and provides a new historical perspective, spanning the seventeenth to the twenty-first centuries. New tests for the trend function, robust to the order of integration of the series, are applied to the data. Results show that eleven price series present a significant and downward trend over all or some fraction of the sample period. In the very long run, a secular, deteriorating trend is a relevant phenomenon for a significant proportion of primary commodities.
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The prebisch-singer hypothesis and its policy implications, the evolution of the prebisch-singer hypothesis, the prebisch-singer hypothesis: different explanations, bibliography.
The classical economists believed that the terms-of-trade of primary products would show long-term improvement vis- à -vis manufactures due to the operation of the law of diminishing returns in primary production and the law of increasing returns in manufactures. The policy implication of this classical proposition is that a primary-producing country need not industrialize to enjoy the gains from technical progress taking place in manufactures; free play of international market forces will distribute the gains from the industrial countries to the primary-producing countries through the higher prices of their exports of primary products relative to the prices of their imports of manufactures (that is, the terms-of-trade will move in favor of primary-product exporting countries).
The opposite hypothesis — the Prebisch-Singer hypothesis of long-term deterioration in the terms-of-trade of primary products — can be traced back to the early mid-twentieth-century writings of Charles Kindleberger. He thought it inexorable for the terms-of-trade to turn against primary producing countries because of the operation of Engel ’ s law — which states the demand for goods needed for bare subsistence such as food rises less than proportionately while demand for other luxury consumption goods rises more than proportionately — in the process of world economic growth and improvements in the standard of living . It was, however, a 1945 League of Nations report prepared by Folke Hilgerdt and its subsequent follow-up by the United Nations in 1949 that is actually the origin of the Prebisch-Singer hypothesis and the related debate. It was observed in these reports that during the sixty years preceding 1938 primary product prices had fallen relative to prices of manufactures.
In the 1950s both Ra ú l Prebisch and Hans Singer referred to this so-called historical fact and questioned the classical proposition and its implicit support for the colonial pattern of trade. It was pointed out that productivity increased faster in the industrialized countries (constituting the North or the industrial center) than in the primary-producing countries (constituting the South or the raw-material supplying periphery), so that the terms-of-trade should have moved in favor of the South , given the factors of free trade and competition. The South could have enjoyed the fruits of technical progress taking place in industry through free trade and specialization (in primary production) without going for industrialization, as suggested in the classical writings. But this did not happen as the available evidence showed. So the primary-producing countries were advised to pursue a vigorous policy of industrialization with the suspension of the free play of international market forces.
In the post – World War II period, the Prebisch – Singer hypothesis provided the theoretical basis for the policy makers of the newly independent countries to adopt a path of import-substituting industrialization (ISI) through protective commercial policy. The path of ISI in basically agricultural countries required imports of machines and technology. So, in the process of industrialization these countries began to face acute balance-of-payments problems. This led many southern countries to follow the path of export-oriented industrialization. Dependence on a few primary-product exports was reduced and these began to be substituted by manufactured exports.
Meanwhile, the emphasis of the Prebisch – Singer hypothesis shifted from the relations between types of commodities to relations between types of countries. The shift of emphasis too had its origin in the writings of Kindleberger in the mid- to late 1950s. He found no conclusive evidence of deterioration in the terms-of-trade of primary products, but he did have some evidence of a decline in the terms-of-trade of the primary-producing countries (South) vis- à -vis the industrialized countries (North). In fact, both Prebisch and Singer had in mind the concept of terms-of-trade between the North and the South. But, in the absence of appropriate data, they used the series on terms-of-trade between primary products and manufactures as a proxy, with the logic that primary products dominated the then export structure of the South and manufactures dominated that of the North.
The Prebisch-Singer hypothesis generated much controversy in the academic world. In their published papers, critics such as Jacob Viner (1953), R. E. Baldwin (1955), G. M. Meier (1958), G. Haberler (1961), R. E. Lipsey (1963), Harry Johnson (1967), Paul Bairoch (1975), Ronald Findlay (1981), and many others raised different statistical questions and discarded the hypothesis. Since the 1980s, a series of studies undertaken by John Spraos (1980), David Sapsford (1985), Prabirjit Sarkar (1986a, b, 1994, 2005), Sarkar and Singer (1991), E. R. Grilli, and M.C. Yang (1988), and many others questioned the validity of the criticism and provided strong statistical support for the Prebisch – Singer hypothesis, thereby bringing it back into the limelight.
The question that logically follows is what explains the deteriorating trends in the terms-of-trade of the South? The factor highlighted by Singer is the raw-material saving and/or substituting technical progress in the North which created a demand bias against southern exports in the process of growth of northern manufactures leading to a fall in the southern terms-of-trade.
In his 1950 work Prebisch tried to explain the phenomenon in terms of the interaction of the diverse economic structures of the North and the South with different phases of business cycles. In an upswing, wages and profit, and so prices, rise more in the North than in the South due to stronger labor unions and higher monopoly power of the northern capitalists. In the downswing, northern profits and wages do not fall much due to the same reason. The burden of adjustment falls on the raw material suppliers of the South; their prices fall more than the prices of manufactures.
The diverse economic structures created an asymmetry in the mechanism of distribution of the fruits of technical progress, argued Prebisch, Singer, and Arthur Lewis in their individual works published in the 1950s. In the North, technical progress and productivity improvements led to higher wages and profit while in the South, these led to lower prices. The North-South models of Findlay (1980) and Sarkar (1997 and 2001b) supported this asymmetry. Granted this asymmetry, the terms-of-trade would turn against the interest of the South in the process of long-term growth and technical progress in both the North and the South.
In 1997 Sarkar provided another explanation in terms of product cycles. A new product is often introduced in the North. Initially there is a craze for this product and its income elasticity is very high. Owing to a lack of knowledge of its production technique, the South cannot start its production. The South produces comparatively older goods with lower income elasticity. By the time the South acquires the knowledge, the North has introduced another new product. In such a product cycle scenario, the income elasticity of southern demand for northern goods is likely to be higher than that of the northern demand for southern goods. Under these circumstances, if both the North and the South grow at the same rate (or the South tries to catch up by pressing for a higher rate of growth), the global macro balance requires a steady deterioration in the terms-of-trade of the South vis- à -vis the North.
Many other theoretical models exist to explain the Prebisch-Singer hypothesis. As it is increasingly recognized to be a fact, not a myth, many other models will be forthcoming.
SEE ALSO Development Economics; Prebisch, Ra ú l; Singer, Hans; Terms of Trade; Unequal Exchange
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Development Economics and Policy pp 63–85 Cite as
The Prebisch-Singer Hypothesis Revisited
- Alfred Maizels ,
- Theodosios B. Palaskas &
- Trevor Crowe
Since the seminal contributions of Raúl Prebisch (1950) and Hans Singer (1950) on the tendency of the terms of trade of developing countries with developed countries to deteriorate over the long term, the ensuing debate on this issue has focused, until quite recently, on the evidence provided by the relative movements in the price of non-oil commodities and the unit value of manufactures exported by the developed countries. This was understandable and, indeed, entirely relevant since the greater part of the merchandise trade between these two groups of countries before the oil price increases of the 1970s had consisted of a ‘vertical’ exchange of non-oil primary commodities from developing countries for manufactured goods from developed countries.
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Athukorala, P. (1993) ‘Manufactured Exports from Developing Countries and Their Terms of Trade: A Reexamination of the Sarkar-Singer Results’, World Development , vol. 21, pp. 1607–13.
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Cuddington, J.T. (1992) ‘Long-Run Trends in 26 Primary Commodity Prices: A Disaggregated Look at the Prebisch-Singer Hypothesis’, Journal of Development Economics , vol. 39, pp. 207–27.
Maizels, A. (1992) Commodities in Crisis (Oxford: Clarendon Press).
Prebisch, R. (1950) ‘ The Economic Development of Latin America and its Principal Problems ’ (New York: United Nations).
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Sapsford, D. (1985) ‘The Statistical Debate on the Net Barter Terms of Trade Between Primary Commodities and Manufactures: A Comment and Some Additional Evidence’, Economic Journal , vol. 95, pp. 781–8.
Sapsford, D., P. Sarkar and H. Singer (1992) ‘The Prebisch-Singer Terms of Trade Controversy Revisited’, Journal of International Development , vol. 4, pp. 315–32.
Sarkar, P. and H. Singer (1991) ‘Manufactured Exports of Developing Countries and Their Terms of Trade Since 1965’, World Development , vol. 19, pp. 333–40.
—— and —— (1993) ‘Manufacture-Manufacture Terms of Trade Deterioration: A Reply’, World Development , vol. 21, pp. 1617–20.
Singer, H. (1950) ‘The Distribution of Gains Between Investing and Borrowing Countries’, American Economic Review , Papers and Proceedings, vol. 40, pp. 473–85.
—— (1971) ‘The Distribution of Gains Revisited’, Paper presented at IDS, Sussex, reprinted in A. Cairncross and M. Puri (eds) The Strategy of International Development (London; Macmillan, 1975).
Spraos, J. (1983) Inequalising Trade? A Study of Traditional North-South Specialisation in the Context of Terms of Trade Concepts (Oxford University Press).
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Maizels, A., Palaskas, T.B., Crowe, T. (1998). The Prebisch-Singer Hypothesis Revisited. In: Sapsford, D., Chen, Jr. (eds) Development Economics and Policy. Palgrave Macmillan, London. https://doi.org/10.1007/978-1-349-26769-9_5
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Prebisch-Singer Thesis: Assumptions and Criticisms | Trade | Economics
In this article we will discuss about:- 1. Introduction to Prebisch-Singer Thesis 2. Assumptions in the Prebisch-Singer thesis 3. Criticisms.
Introduction to Prebisch-Singer Thesis:
There is empirical evidence related to the fact that the terms of trade have been continuously moving against the developing countries. On the basis of exports statistics concerning the United Kingdom between 1870 and 1940, Raul Prebisch demonstrated that the terms of trade had secular tendency to move against the primary products and in favour of the manufactured and capital goods.
This viewpoint has been strongly supported by H. W. Singer. The essence of Prebisch-Singer thesis is that the peripheral or LDC’s had to export large amounts of their primary products in order to import manufactured goods from the industrially advanced countries. The deterioration of terms of trade has been a major inhibitory factor in the growth of the LDC’s.
Prebisch and Singer maintain that there has been technical progress in the advanced countries, the fruit of which have not percolated to the LDC’s. In addition, the industrialised countries have maintained a monopoly control over the production of industrial goods. They could manipulate the prices of manufactured goods in their favour and against the interest of the LDC’s.
Except the success of OPEC in raising the prices of crude oil since mid 1970’s, there has been a relative decline in the international prices of farm and plantation products, minerals and forest products. Consequently, the terms of trade have remained unfavourable to the developing countries.
Assumptions in the Prebisch-Singer thesis:
The main assumptions in the Prebisch-Singer thesis are as under:
(i) As income rises in the advanced countries, the pattern of demand shifts from primary products to the manufactured products due to Engel’s law.
(ii) There is slow rise in demand for products in the developed countries.
(iii) The export market for product of LDC’s is competitive.
(iv) The export market for products of developed countries is monopolistic.
(v) Wages and prices are low in LDC’s.
(vi) The appearance of substitutes for products of LDC’s reduces demand for them.
(vii) The benefit of increased productivity is not passed by the producers of manufactured products in advanced countries to the LDC’s through lower prices.
(viii) The economic growth in the LDC’s is indicated by income terms of trade.
Singer has pointed out that the recent increase in debt problem of the LDC’s has imparted another twist to the hypothesis of secular deterioration of terms of trade for them in two ways. Firstly, a high proportion of proceeds from exports are not available for imports.
Secondly, there is an increased pressure upon the LDC’s to raise exports in order to repay external debts on account of IMF-induced adjustment polices. These pressures make the debt- ridden LDC’s to compete with other poor countries to enlarge their export earnings. It results in decline in the prices of export products of these countries.
Criticisms of Prebisch-Singer Thesis :
The Prebisch-Singer Thesis has come to be criticized on several grounds:
(i) Not Firm Basis for Inference:
The inference of secular deterioration of terms of trade for the LDC’s rests upon the exports of primary vis-a-vis manufactured products. In this regards, it should be remembered that the LDC’s export wide variety of primary products. Sometimes they export also certain manufactured products.
They, at the same time, do not import only manufactured products but also a number of primary products. It is, therefore, not proper to draw a firm inference about terms of trade just on the basis of primary versus manufactured exports.
(ii) Faulty Statement of Gains and Losses of Primary Exporters:
Jagdish Bhagwati has pointed out that the index of terms of trade employed in this thesis understates the gains of exporters of primary products. At the same time, there is overstatement of losses of primary producers.
(iii) Faulty Index of TOT:
The Prebisch- Singer hypothesis rests upon the index, which is the inverse of the British commodity terms of trade. This index overlooks the qualitative changes in products, appearance of new varieties of products, services like transport etc. The generalisation based on British terms of trade for the period 1870 to 1930, according to Kindleberger, is not true for the other developed countries of Europe.
(iv) Neglect of Supply Conditions:
In the determination of terms of trade, the Prebisch-Singer thesis considers only demand conditions. The supply conditions, which are likely to change significantly over time, have been neglected. The relative prices, in fact, depend not only upon the demand conditions but also on the supply conditions.
(v) Little Effect of Monopoly Power:
One of the arguments in support of this thesis was that the higher degree of monopoly power existing in industry than in agriculture led to secular deterioration of terms of trade for the developing countries. In this connection, it was also agreed that the monopoly element prohibited the percolation of benefits of technical progress to the LDC’s. The empirical evidence has not supported such a line of argument.
(vi) Inapplicability of Engel’s Law:
The secular decline in the demand for primary products in developed countries was attributed to Engel’s Law. But this is not true because this law is applicable to food and not to the raw materials, which constitute sizeable proportion of exports from, the LDC’s.
(vii) Benefits from Foreign Investment:
The deterioration of the terms of trade for the LDC’s is sometimes linked not to non-transmission of productivity gains to them by advanced countries through lower prices of manufactured goods, yet the benefits from foreign investments have percolated to the LDC’s through the product innovations, product improvement and product diversification. These benefits can amply offset any adverse effects of foreign investment upon terms of trade and the process of growth.
(viii) Difficult to Assess Variation in Demand for Primary Products:
The secular deterioration in terms of trade of the LDC’s during 1870 to 1930 period was supposed to be on account of the declining world demand for primary products. During that period, there were tremendous changes in world population, production techniques, living standards and means of transport. Given those extensive developments, it is extremely difficult to assess precisely the changes in world demand for primary products and the impact of those changes upon the terms of trade.
(ix) Export Instability and Price Variations:
The Prebisch-Singer thesis suggested that export instability in the LDC’s was basically due to variations in prices of primary products relative to those of manufactured products. Mc Been, on the contrary, held that the export instability in those countries could be on account of quantity variations rather than the price variations.
(x) Development of Export Sector not at the Expense of Domestic Sector:
In this thesis, Singer contended that foreign investments in poor countries, no doubt, enlarged the export sector but it was at the expense of the growth of domestic sector. This contention is, however, not always true because the foreign investments have not always crowded out the domestic investment. If foreign investments have helped exclusively the growth of export sector, even that should be treated as acceptable because some growth is better than no growth. It is farfetched to relate worsening of terms of trade to the non-growth of domestic sector.
(xi) Faulty Policy Prescription:
Prebisch prescribed the adoption of protectionist policies by LDC’s to offset the worsening terms of trade. Any gains from tariff or non-tariff restrictions upon imports from advanced countries can at best be only short-lived because they will provoke retaliatory actions from them causing still greater injury to the LDC’s.
In the present W.TO regime of dismantling of trade restrictions, Prebisch suggestion is practically not possible to implement. There should be rather greater recourse to export promotion, import substitution, favourable trade agreements and adoption of appropriate monetary and fiscal action for improving the terms of trade in the developing countries.
(xii) Lack of Empirical Support:
The studies made by Morgan, Ellsworth, Haberler, Kindelberger and Lipsey have not supported the secular deterioration of terms of trade hypothesis, Lipsey has observed, “Although there have been very large swings in U.S. terms of trade since 1879, no long term trend has emerged. The average level of U.S. terms of trade since World War II has been almost the same as before World War I.” This objection of lack of empirical support against the Prebisch-Singer hypothesis is actually not very sound. A number of more recent empirical studies have, in fact, gone in favour of this hypothesis.
Despite all the objections raised against the Prebisch-Singer thesis, the empirical evidence has accumulated in support of it. The studies made by UNCTAD for 1950-61 and 1960-73 periods showed that there was a relative decline in the terms of trade of LDC’s vis-a-vis the developed countries. A study attempted by Thirlwall and Bergevin for the period 1973-82 indicated that there was an annual decline of terms of trade of LDC’s for all the primary commodity exports at the rate of 0.36 percent.
On the basis of their study related to exports of manufactured products for LDC’s to the advanced countries during 1970-87 period, Singer and Sarkar found that the terms of trade of LDC’s declined by about 1 percent per annum. Even the World Development Report 1955 recognised that the world prices of primary products declined sharply during I980’s and the terms of trade of LDC’s deteriorated during 1980-93 period.
According to the 1997 Human Development Report of UNDP, the terms of trade for the least developed countries declined by a cumulative 50 percent over the past 25 years. According to South Commission, compared with 1980, the terms of trade of developing countries had deteriorated by 29 percent in 1988. The average real price of non-oil commodities had declined by 25 percent during 1980-88 period compared with the previous two decades. The terms of trade of non-oil developing countries had deteriorated during 1980-88 period by 8 percent compared with 1960’s and 13 percent compared with 1970’s.
- Reasons for Secular Deterioration of Terms of Trade | Economics
- Single Factorial Terms of Trade (With Criticisms) | Economics
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The Singer-Prebisch hypothesis a statistical evaluation
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Prabirjit Sarkar, The Singer-Prebisch hypothesis a statistical evaluation, Cambridge Journal of Economics , Volume 10, Issue 4, December 1986, Pages 355–371, https://doi.org/10.1093/oxfordjournals.cje.a035006
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