Do Terms of Trade and Its Volatility Matter? Evidence from Economic Escalation of China

This article makes a unique contribution to the literature with reference to China, being a pioneering attempt to investigate the effect of terms of trade and its volatility on economic growth of China by using annual time series data from 1980 to 2010 and by applying rigorous econometric techniques. Autoregressive distributed lag (ARDL) cointegration and Johansen and Juselius cointegration methods suggest the significant negative long-run relationship of terms of trade and volatility of terms of trade with economic growth. Four different sensitivity analyses indicate that initial results are robust. Rolling window analysis was performed to find the yearly effect of terms of trade and its volatility on the economic growth of China. Results show that the coefficient of terms of trade on economic growth remains negative from 1985 to 1988, 1994 to 1995, 1998 to 2002, and from 2006 to 2008. Variance decomposition method shows a unidirectional causal relationship between terms of trade and economic growth runs from terms of trade to economic growth and a bidirectional causal relationship between volatility of terms of trade and economic growth in China. It is concluded that less volatile terms of trade are better for economic growth. Policy makers should critically analyze the reasons for deterioration of terms of trade in the years 1985 to 1988, 1994 to 1995, 1998 to 2002 and from 2006 to 2008. Either this happened because of increases in import prices or decreases in export prices, or increases in export prices that are less than increases in import prices. This analysis will be beneficial in finding the contents of export and import by which terms of trade deteriorate and form growth-enhancing policies.