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|Studies in the Theory of International Trade; Viner, Jacob|
35 paragraphs found.
Vanderlint, Wood, and Harris, as has been shown, accepted the automatic regulation of the amount of money
in circulation, but still retained the mercantilist preoccupation with the amount of bullion in the country, as did Hume also to some extent. A few mercantilists after Hume tried to find a basis for rejecting the automatic mechanism, but with meager results. Wallace replies to Hume that if the amount of paper money increases, trade will increase. Making an unconscious substitution of "export trade" for "trade," he concludes: "And, as they don't take paper in payment from foreign nations, if they are gainers by trade, they must receive the balance in silver and gold."
Steuart rejects the quantity theory of money, on the ground that prices depend on the demand for, and supply of, commodities, and not on the quantity of specie. He tries half-heartedly to meet Hume's exposition of the self-regulating mechanism by stressing the transitory effects, with reference to hoarding and the volume of production, of the sudden change posited by Hume in the quantity of money. The removal of four-fifths of the money in circulation would annihilate both industry and the industrious. If as a result of the lower prices (all of ?) the stock of English goods were to be exported, it would mean the starvation of the English people.
If the quantity of money increases, on the other hand, hoarding will prevent this increase from acting on prices. In any case "reason and experience" refute the quantity theory.
At one point he suggests a self-regulating mechanism, whereby money goes into hoards when in excess and comes out when there is scarcity, essentially like North's except that Steuart explains the movement of specie into and out of hoards as governed by the possibility of lending it at interest:
While there is found a sufficient quantity of money for carrying
on reciprocal alienations, those money gatherers will not be able to employ their stagnated wealth within the nation; but so soon as this gathering has had the effect of diminishing the specie below the proportion found necessary to carry on the circulation, it will begin to be lent out, and so it will return to circulate for a time, until by the operation of the same causes it will fall back again into its former repositories.
The bullionist position is open to one further correction, but one of probably minor practical importance. Under a metallic standard, if due to foreign remittances or abnormally heavy grain imports there occurs a temporary rise in the relative demand for
foreign bills, an export of specie will tend to occur, which will operate both to lower the amount of the domestic circulation and directly to increase the supply of foreign bills by the amount for which the exported specie itself can be exchanged. Under an inconvertible currency which has been on a depreciated basis for some time, so that all the bullion has already either been exported or passed into more or less permanent hoards, there will be no specie export to constitute a direct equilibrating element in the international balance of indebtedness. With the same volume of foreign remittances to be made, a greater contraction of the currency, therefore, will be necessary under inconvertibility than under a metallic standard if the exchanges are to be kept from falling by more than the cost of shipping gold, and conversely, a fall of the exchanges by more than the cost of shipping gold will not be absolute proof that the currency has been contracted in less degree than would have been necessary if the standard were metallic.
If Wheatley and Ricardo erred in their exposition of the relation under inconvertible currency between the exchange rates and the state of the balance of payments, the anti-bullionists erred more grievously. The anti-bullionists insisted rightly that under inconvertibility the exchanges were immediately determined solely by the demand for and supply of foreign bills, but failed to see that this was equally true of a metallic standard and that a very important factor determining the relative demand for and supply
of foreign bills was the relative level of prices in the two countries, which in turn was determined largely by the relative amounts of currency. Many of the anti-bullionists, moreover, must have thought that in some way a fall in the foreign exchanges made possible the payment of foreign remittances without the need of a commodity export surplus. No other explanation is available of their repeated insistence that throughout the period of low exchanges England either had an unfavorable balance of payments on trade account, or else had a balance insufficiently favorable to offset the military expenditure abroad. As Ricardo pointed out, in reply to reasoning of this sort by Bosanquet, this left it a mystery how the military expenditures abroad were actually met, since specie was not available.
The Bank's abandonment of the bullion standard was more assuredly a mistake. The Bank, and other critics of Ricardo's plan, cited the absence of any immediate demand for ingots as a demonstration of its impracticability. But under the bullion standard, and in the absence of domestic gold hoarding, there could have been a demand for ingots only for industrial purposes and
for export. The fact, therefore, that from 1819 to 1821, when the Bank was contracting its discounts, when paper was not at a discount, and when the exchanges were favorable, there was no demand for ingots, in no way reflected on the practicability or the desirability of the bullion standard. If the Bank had not withdrawn its small notes from circulation, there would have been no demand for
coin or ingots.
The chief virtue of the ingot plan lay in the fact that at a time when the general return to metallic currencies was threatening to cause a price deflation, it would enable England to make her return to the gold standard with a minimum drain on the world supply of gold. It had the additional virtue that in times of depression, when there was still confidence in the paper currency but impaired confidence in the profitability of investment, the desire for cash liquidity could be met wholly in notes instead of in bullion, thus avoiding forced deflation by the Bank of England. It was open to the objection, however, that it would lessen the stabilizing influence of the pressure brought to bear on the Bank of England by an increase in active circulation during periods of credit expansion and of the leeway given to the Bank to expand credit in times of depression by the decline in active circulation and the consequent influx of gold to the Bank.
Although Ricardo conceded that a sharp fall in prices was a serious evil, the only undesirable consequence of such a fall which he emphasized was the arbitrary redistribution of wealth which resulted therefrom.
He admitted also that economic depression was likely to follow the end of war, but he attributed it to a relative shift in the demands for particular commodities, to which the capital equipment of the country had not yet had time to adjust itself.
Ricardo's position on these questions was closely related to his acceptance of the James Mill-J. B. Say doctrine that production, if properly directed, created the demand for its product, and that a general insufficiency of demand to absorb all of the possible output of industry was impossible. This doctrine leads naturally to a denial that a fall in prices would operate to
restrict production or a rise in prices to increase it. It rests on concepts of "supply" and "demand" too physical and an implicit assumption of price and money-cost flexbility too unrealistic to serve adequately the purposes of analysis of short-run disturbances in a monetary economy. If "supply" and "demand" are interpreted, as they should be, not as simply quantities of commodities but, in the modern manner, as
schedules of quantities which would be produced or purchased, respectively, at specified schedules of prices, it becomes easy to see that if money costs are inflexible the schedules of demand prices may fall more rapidly than the schedules of supply prices, with a consequent reduction, not only in prices, but also in volume of sales, in output, in employment, in willingness of capitalists to invest, and in willingness of bankers to lend even if there were would-be borrowers.
Malthus was convinced that there was something wrong in the James Mill doctrine, including its Ricardian version. He failed, however, ever satisfactorily to expose the fallacy which underlay it, because he was himself insufficiently emancipated from the purely physical interpretation of "supply" and "demand." In the following passage, confused though it is, it appears to me that he comes nearest to exposing this fallacy successfully:
The fallacy of Mr. Mill's argument depends entirely upon the effect of quantity on price and value. Mr. Mill says that the supply and demand of every individual are of necessity equal. But as supply is always estimated by quantity, and demand only by price and value; and as increase of quantity often diminishes price and value, it follows, according to all just theory, that so far from being always equal, they must of necessity be often very unequal, as we find by experience. If it be said that reckoning both the demand and supply of commodities by value, they will then be equal; this may be allowed; but it is obvious that they may then both greatly fall in value compared with money and labor; and the will and power of capitalists to set industry in motion, which is the most general and important of all kinds of demand, may be decidedly diminished at the very time that the quantity of produce, however well proportioned each part may be to the other, is decidedly increased.
It was not Malthus
but the two Attwoods, and especially
Thomas Attwood, who first explained in reasonably satisfactory fashion the dependence of the "demand and supply" of price theory on the state of the currency:
...while it is certain that a reduction of the quantity of money in circulation necessarily occasions a reduction in the monied prices of all commodities; it is of equal necessity, that the price of no commodity whatever can decline, without some alternation in its relative proportion of supply and demand. The manner, therefore, in which a lessened quantity of money reduces monied prices, is by operating on those ulterior principles by which supply and demand are themselves governed. A scarcity of money makes an abundance of goods. Increase the quantity of money, and goods become scarce. The relative proportion between money and commodities can never alter without producing these appearances. Mr. Tooke, and Mr. Ricardo, will find in this obvious principle an exposition of many of the difficulties and inconsistencies in which they have involved the subject.
Money is as necessary to constitute price, as commodities: increase the supply of money, and you increase the demand for commodities; diminish the supply of money, and you diminish the demand for commodities. The supply of commodities is the demand for money, and the supply of money is the demand for commodities. The prices of commodities, therefore, depend quite as much upon the "proportion" between the supply of, and demand for, money, as they do upon the "proportion" between the supply of, and demand for, commodities. This is a truth which Sir Henry Parnell has altogether overlooked, and his neglect in this respect has led him into a labyrinth of errors. He has considered the supply of, and demand for, commodities as acted upon by some obscure, uncontrollable, and capricious principles, having no reference to the state of the currency, and none to the legislative enactments, which, at one period, have introduced cheap money and high prices, and, when enormous monied obligations have been contracted in such cheap money, have then, at another period, introduced dear money and low prices, and have
thus strangled the industry of the country by compelling it to discharge monied obligations which its monied prices will not redeem.
Several writers proposed schemes designed to render the purchasing power of the currency stable in the short run, but not necessarily in the long run. Poulett Scrope insisted that there were important possibilities of short-run stabilization of the price level even under a fixed metallic standard through appropriate regulation of its note issues by the Bank of England. He anticipated so strikingly later views on this question that his exposition deserves quotation at some length:
When gold is, for commercial, financial, or political purposes, drawn away from this country in any quantity, it is chiefly from the treasure of the Bank that it is taken, and it is for the Bank
exclusively to determine, whether the drain shall or shall not have any influence on our home prices. If the Bank choose to keep up its circulation of paper to the same point as before, no effect is felt in our markets. It may even reverse the natural effect of the drain, which is to lower prices, by increasing its issues as the gold flows out, and thereby raising our prices to an unnatural height. When the gold returns on this country by the spontaneous reaction of the exchanges, it is for the Bank to determine whether it shall have any effect upon our circulation or not. If they buy the gold as it comes in, and yet make no corresponding increase of their paper, the money of this country is in no degree enlarged; and should the Bank contract its issues while purchasing gold, our prices are actually depressed at a time when the influx would naturally have raised them....It is only when the Bank contracts its paper exactly as it parts with gold for a foreign drain, and expands it as the gold flows back again, that the effect of these local variations in the demand and supply of bullion are [
sic] reduced to that which our metallic standard necessarily occasions, and which would happen all the same even though our circulation were purely metallic.
It is evident, then, that the power of the Bank over prices in the British markets is confined within no narrow limits through the obligation of paying its notes in gold; that by its conduct in extending and contracting its paper, and purchasing or selling bullion, the value of gold itself, first in this country and ultimately in others, is arbitrarily influenced to a very great extent; that the Bank has the power of determining the exchanges, and, consequently, whether gold shall flow into or out of this country; that, by accumulating gold at one time in its vaults, to the extent of fifteen or more millions, at another allowing them to be nearly emptied, before any attempt is made to restore the equilibrium, the Bank can influence the market for gold as well as that of every other commodity.
Wheatley defended his denial that crop failures or foreign subsidy payments would disturb the balance of payments by more adequate reasoning. He maintained that crop failures, or the payment of subsidies, would immediately alter the relative demands of the two regions for each other's products in such manner and degree that the commodity balance of trade would at once undergo the manner and degree of change necessary to maintain equilibrium in the balance of payments. This shift in relative demand would result from the alteration brought about by the crop failure or the subsidy in the relative ability of the two countries to buy each other's commodities:
If, then, it be correct in theory, that the exports and imports to and from independent states have a reciprocal action on each other, and that the extent of the one is necessarily limited by the extent of the other, it is obvious, that if no demand had subsisted in this country from 1793 to 1797 for corn and naval stores, the countries that furnished the supply would have possessed so much less means
of expending our exports, as an inability to sell would of course have created an equal inability to buy. It is totally irregular, therefore, to infer, that our exports would have amounted to the same sum, had the import of the corn and naval stores been withheld, as those who provided the supply would have been utterly incapable of purchasing them.
Taussig, in his brief rejoinder, confined his discussion in the main to other points and did not adequately meet the fundamental issue raised by Wicksell as to the role played by changes in demand in the equilibrating process. To Wicksell's denial of the necessity of specie movements at an early stage of the process of adjustment, he made an effective reply: "I find it difficult to conceive how 'increased demand for commodities' will cause a rise in the price of commodities, unless more money is offered for them; and no more money can be offered for them unless the supply of money is larger."
This may seem to imply an acceptance by Taussig of Wicksell's doctrine at least to the extent of recognition that changes in demand do play an equilibrating part aside from price changes, for if there is an increase in demand it operates to increase the amount taken at the
same prices as well as to increase the prices, but I cannot find a clear statement to this effect either here or in his later writings. Taussig also pointed out that Wicksell's denial of the possibility that relative price changes could be an important equilibrating factor, since, transportation costs aside, commodities tend to have uniform prices everywhere, overlooked the existence of "domestic" commodities not entering into international trade, whose price movements could diverge from the movements of the prices of international commodities and thus contribute to the establishment of a new international equilibrium.
To an objection to his analysis made by some unspecified person
to the effect that the flow of gold from lending to borrowing country, by raising money prices and incomes generally in the borrowing country, and lowering them generally in the lending country, will make the prices of the productive services and therefore also of their products, in domestic and export industries alike, rise in the borrowing country and fall in the lending country, Wilson replies that: "mere changes in money costs of production are not sufficient in themselves to cause a change in prices. If prices are to be affected by changes in costs of production, it can only come about through a change in the relative demand and supply of those goods whose money costs of production are affected," and that the relative changes in price which such changes in cost would tend to produce would tend to be checked by diversion of expenditures to or from other classes of goods not so affected.
This reply bears only on the
degree of relative price changes needed, whereas the issue is whether
any price changes are needed, and if so, in what directions. It, moreover, misses the character of the valid objection to which his analysis is open, which is not the common but fallacious argument that relative changes in the amounts available for expenditure in the two countries must necessarily result in changes in the same direction in the prices of the productive services and therefore also in the money costs of production of the two countries,
but that changes in the relative aggregate demands for the commodities of the respective countries will do so. If, as is possible, but, as will later
be shown, improbable, a transfer of funds on loan from country A to country B results in an increase in the aggregate demand of the two countries for A's products and a decrease in their aggregate demand for B's products, it will be the prices of A's, and not of B's, factors of production which will rise.
Yntema applies to the problem a powerful mathematical technique, and analyzes it on the basis of a wide range of assumptions.
For cases such as those contemplated by the older writers, he reaches conclusions substantially in accord with theirs, especially with reference to the relative movement of the prices of the domestic commodities of the two countries and of their double factoral terms of trade.
But Yntema's analysis rests throughout on certain assumptions which seriously limit the significance of his results. He assumes that when a relative change in the amount of money in two countries occurs as a result of loans or tributes or other disturbances in the international balances, there will occur in the country whose stock of money has increased a rise not only in all of that country's demand schedules (in the simple Marshallian sense), but also in the prices of the factors of production and in the supply schedules of that country's products, and that there will similarly occur in the country whose stock of money has decreased a fall not only in all of that country's demand schedules, but also in the prices of its factors of production and in the supply schedules of that country's products, though these rises or falls need not be uniform in degree within each country. But a rise in all the demand schedules of a country does not necessarily lead to or require a rise in its supply schedules or in the prices of its factors of production. What will be the effect of an international transfer of income on the
direction of the relative movement of the prices of the factors in the two countries is itself the question relating to the equilibrating process awaiting solution, but in Yntema's analysis it is unfortunately decided by arbitrary assumption. Yntema's conclusion that under constant cost the terms of trade must necessarily shift in favor of the receiving country results from his assumption that the prices of the factors and the money costs of production will necessarily
rise in the receiving country. As had been argued above, this is not a valid assumption.
Demand and supply curves in terms of money prices of the ordinary Marshallian type cannot legitimately be used in the solution of the reparations transfer problem, since they abstract from the interrelationships between demands, supplies, and incomes.
Nor can the problem be solved through the use of Marshallian reciprocal-demand curves without additional information, since the problem turns on what happens as the result of reparations payments to the position and shape of the reciprocal-demand curves, and this depends on the utility functions in both countries, and cannot be determined without reference, direct or indirect, to these functions.
Hume conceded that the fall in the exchange value of a country's currency when for any reason there was adverse pressure on its balance of payments tended to exercise an equilibrating influence by providing an extra incentive to commodity export and a deterrent to commodity import. He held, however, that this could be but a minor factor in the process of adjustment, and although he gave no reasons it may be presumed that he saw that under a metallic standard the maximum possible range of variation of the exchanges, i.e., between the specie export and import points, was so limited as to make it extremely unlikely that such variation could exert an appreciable direct influence on the course of trade.
Since his time the maximum range of variation has become still narrower under normal conditions because of reduction in the cost of transporting specie, and scarcely anyone today would dispute that under an international metallic standard exchange variations are a negligible factor as far as their direct
influence on commodity trade is concerned.
It has sometimes been suggested, however, that this narrowing of the range between the gold points has not been an unalloyed benefit, since by its facilitation of specie shipments it has contributed to the instability of national credit structures. Proposals have been made, starting with Torrens in 1819,
artificially to widen the margin between the specie points, by seigniorage charges, premiums on gold for export, different buying and selling prices for gold at the Central Bank, generous tolerance for underweight in the internal specie circulation, differential buying or selling prices for the gold of the particular degrees of fineness most in supply or demand abroad, and other similar devices, and such practices have, for this or other reasons, been followed. To the extent that such practices exist, the range of possible exchange fluctuations under a metallic standard, and therefore the possible influence of exchange variations on the course of trade, can of course be somewhat increased. In effect this is an attempt to retain the advantages of an international metallic standard while escaping in part one of its incidents, namely, the direct dependence of the national stock of money, or of the specie reserves upon which it rests, on the state of the foreign exchanges. But the same advantages of partial freedom of the quantity of the circulating medium from dependence on the vagaries of the exchanges can be more safely, and especially for an important financial center whose effectiveness depends largely on its ability to attract foreign short-term funds, more cheaply obtained, by the maintenance of excess specie reserves, than by artificial widening of the range between the gold points. Even with such widening, moreover, unless it were carried to much greater lengths than has ever been customary, the direct influence of exchange rate fluctuations on the course
of commodity trade would still be negligible. But even small variations in the exchanges can exert an appreciable influence on the movement of short-term capital funds, and through them on the mechanism of adjustment. This phase of the mechanism is discussed in the next chapter, in connection with the discussion of the relation of banking processes to the mechanism.
That this is a correct interpretation of Angell's position is indicated by the following and other similar passages: "The crux of the explanation is the proposition that the importation of capital increases the supply of bills offered in the local exchange market for discount relative to the demand, thus increasing the bank's average holdings of such bills. A
corresponding increase in the volume of bank deposits results; and if it is on a large scale produces the indicated effects on prices and the commodity balance of trade."
(Theory of international prices, p. 173, note. Italics not in original text.) If the fluctuations in deposits "corresponded" with the fluctuations in holdings of foreign "bills," the fluctuations in deposits would be solely primary. Angell sometimes speaks of the bills being "discounted," and sometimes of their being "exchanged" for deposits, and treats these as identical phenomena. The latter was the usual procedure, as the bills were predominantly sight bills, frequently drawn on an outside agency of a Canadian bank. Under the former procedure, an original secondary expansion would be transformed, after a few weeks, into a primary expansion when the bills became due and their proceeds were used by their owners to liquidate their indebtedness to the Canadian banks. The volume of Canadian deposits would not change, but the offsetting bank assets would change from loans to holdings of foreign funds.
The relation of transportation costs to production costs and the terms of trade can be illustrated by chart X, a slight modification
of Marshall's graphic method of dealing with foreign-trade problems. In country A a given amount of labor can produce either one unit of copper or one unit of wheat, and in country B a given amount of labor can produce either 3/2 units copper or ½ unit wheat. Country A will export wheat, and country B will export copper. In the absence of transportation costs, wheat will exchange for copper on terms within the limits of 1 wheat = 1 copper ( =
OA in chart) and 1 wheat = 3 copper ( =
OB = 3 ×
OA, in chart).
AA' represents the export supply curve of wheat in terms of copper of country A.
BB' represents the import demand curve of wheat in terms of copper of country B. The chart as drawn implies that in the absence of trade (or with trade on terms of 1 wheat = 1 copper) country A would consume (
AE) units of copper, and that in the absence of trade (or with trade on terms of 1 wheat = 3 copper) country B would consume
The actual transportation is assumed to be provided by the exporter. The charges for transportation are assumed to be 1 unit wheat payable in the export country for each 9 units of wheat transported and 1 unit copper payable in the export country for each 5 units of copper transported. With the transportation costs in the specified amounts, the possible limits of the terms of trade will be 1 wheat = 1.2 or
Oa copper and 1 wheat = 2.7 or
Ob copper. Country A's export supply curve for wheat in terms of copper will be
aa', and country B's import demand curve for wheat in terms of copper will be
bb'. The equilibrium terms of trade, which would have been 1 wheat =
OK copper in the absence of transportation costs, will be 1 wheat =
mr copper, net after payment of transportation costs, for country A, and 1 wheat =
ml copper, net after payment of transportation costs, for country B. It is to be noted that with the existence of transportation costs the terms of trade net after payment of transportation costs will be different for the two countries, the difference being absorbed in meeting the costs of transportation. Given elasticities greater than unity for both the foreign-trade curves, volume of trade will be smaller and the net terms of trade will be less favorable for both countries when there are transportation costs than when these are zero. In the present case the existence of transportation costs will reduce the amount of wheat imported by country B from
Om units, and will reduce the amount of copper imported by
country A from (
OK) units to (
The division of the costs of transportation as between the two countries will, as J. S. Mill contended, be determined by "the play of international demand."
Shadwell later objected that Mill had not really solved the problem by his "equation" or "law," but had merely stated the truism that "the ratio of exchange is such that the exports pay for the imports,"
and Graham makes substantially the same criticism.
Except for the case of pure barter, however, there is nothing "truistic" about the equality in value of imports and exports, and in fact they would ordinarily not be equal even after allowance for "invisible" items if, as is proper for present purposes, money and the money metals were not counted as exports or imports. It
would be true, however, that Mill would not have accomplished very much if he had merely established the necessity under equilibrium of equality in value between imports and exports. But as Bastable pointed out in reply to Shadwell, "Mill's theory does not consist merely in the statement of the equation of reciprocal demand, but [also] in the indication of the forces which are in operation to produce that equation."
The terms of trade, according to Mill, are determined by the reciprocal demands, conceived in the schedule or function sense, subject to the condition that imports shall equal exports in value. A fair reading of Mill's chapter warrants no other interpretation. There is, moreover, supporting evidence for this interpretation. Mill, as we have seen, stated that "This law of international values is but an extension of the more general law of value, which we called the equation of supply and demand." To what appears to have been a criticism similar to Shadwell's made by Cairnes against Mill's use of the analogous "equation of supply and demand" in his general value theory, Mill replied:
I think that the proposition as laid down [i.e., "the equation of supply and demand"] is something more than an identical proposition. It does not define—nor did it, as I stated it, affect to define—the causes of variations in value. But it declares the
condition of all such variations and the necessary
modus operandi of their causes, viz., that they operate by moving the supply to equality with the demand or the demand to equality with the supply.
Marshall's treatment of the relation of reciprocal demand to terms of trade is in the main an exposition and elaboration in geometrical form of Mill's analysis.
Marshall invented for this purpose a new type of supply-and-demand diagram, in which the vertical and the horizontal axes each represent the total quantity of one of the two commodities, thus differing from his domestic-trade diagrams, where only one commodity, and money prices, are involved, and where the vertical axis represents price per unit.
As against the alternative procedure followed here in
charts VII, X, and XII, of making the vertical axis in the international-trade diagrams represent the terms of trade, equivalent to price, Marshall claims for his own procedure: first, that it makes the curves of the two countries "symmetrical" and, second, that the alternative procedure would have some (unspecified) advantages, but "this want of symmetry would have marred, though it would not have rendered impracticable, the application of the method of diagrams to the more elementary portions of the theory; but in other portions it would have led to unmanageable complications."
Marshall's proposition is tested with reference to the influence of the elasticity of
Germany's curve in chart XIII, where
EE is the original English supply curve (equivalent to Marshall's original English curve), E'E' is the increased English supply curve,
GG is the less elastic and G'G' is the more elastic German demand curve. The more elastic the German demand curve: (1) the greater is the increase in the German exports (i.e., the rectangle
aomt); (2) the greater is the increase in German imports (i.e.,
om); and (3) the smaller is the amount of
movement favorable to Germany in the terms of trade (i.e.,
Aa). These results are all in conformity with Marshall's—and Graham's—findings.
There remains to be considered Marshall's finding that the greater the elasticity of the English curve the greater will be the increase in the English imports when the English reciprocal demand increases, and Graham's contrary finding that the increase in the amount of English imports will be negatively correlated with the elasticity of the English curve. Marshall says, in effect,
that in chart XIV
a'om't', while Graham contends that
a'om't'. Their conclusions, it is to be remembered, are here being checked only for the cases where all the curves have demand elasticities greater than unity. Since the less elastic the original English supply curve, the further to the right from
T along the
GG curve is the intersection of the increased English supply curve with the German curve (i.e.,
t' is to the right of
t), and since, because
GG has an elasticity of demand greater than unity, the further from the zero vertical axis is the point of intersection of the increased English curve with the German curve the greater must be the size of the rectangle bounded by the perpendiculars dropped from that point to the zero axes, therefore,
aomt. Graham, therefore, is here again right, and Marshall wrong. The unnecessary complexity of Marshall's diagram seems to have concealed from him the fact that it provided no answers to the questions which he was putting, for the diagram by which he attempts to demonstrate the nature of the dependence of the results of an increase in the English reciprocal demand on the degree of elasticity of that curve shows three
original English curves, different in locus as well as elasticity, and fails to
present a comparison of the effects of an
increase in an original English curve according as that original curve has high or low elasticity.
Graham claims that where there are more than two commodities and more than two countries (all of them able to produce all or most of the commodities) fluctuations in the rate of interchange between the various commodities must be confined within a rather narrow range.
This is due to the fact that any alteration in the rate of interchange will affect the margin of comparative advantage of some country in the production of some one of the commodities concerned, will bring that country in as an exporter where formerly it was an importer, or as an importer where formerly it was an exporter, according as the terms of interchange move one way or the other, and, by the affected country's addition to the supply or demand side, will keep the terms of interchange from moving far from their original position.
The proposition that movement along a Marshallian reciprocal-demand curve from its point of origin tends on ordinarily reasonable assumptions to be movement towards a position of greater advantage can be accepted. But Edgeworth derives from it conclusions which differ substantially from those reached in the preceding two sections. These differences in conclusions can be summarized in the proposition that (with the exception of one special case, to be examined later) in Edgeworth's results the direction of change in the amount of gain from trade and the direction of change in the commodity terms of trade always correspond,
whereas it has here been argued that in many types of situations the commodity terms of trade and the amount of gain from trade may move in opposite directions was due to his failure, in his interpretation of his diagrams, to distinguish between disturbances involving movement along a
given reciprocal-demand curve and disturbances involving movement to a
new reciprocal-demand curve. One of Edgeworth's diagrams, reproduced here as chart XVIII,
is supposed to cover all cases where (1) the gain consequences for country E are alone being considered, (2) the disturbance originates in country E, and (3) the specific nature of the disturbance can be described as "H, where the change originates on the side of supply: such as increased facility of producing or exporting native commodities; [or] h, on the side of demand: such as an increased desire for, or facility in admitting foreign commodities."
OE is E's reciprocal-demand curve and
OG is G's reciprocal-demand curve, and under the original equilibrium conditions
OM of E-goods is given by E in exchange for
ON of G-goods. A disturbance ensues, which is assumed to
be an impediment rather than an encouragement to trade, and to result in the
OE curve becoming "transformed" (the term is Edgeworth's) to
OE'. Edgeworth traces the effects of the disturbance as follows:
In the new equilibrium indicated by the point
Q, RQ of
X is given in exchange for
Q cannot be a position of greater advantage than
P', where the horizontal through
Q cuts the original curve. For, on the most favorable supposition that the impediment affects only exportation, not production for internal consumption, (for instance, a transit duty imposed by a third country) England's offer in exchange for
OR would be reduced by the impediment from
OS, so that
Q would be a position of just equal advantage as
P' is a position of less advantage than
P (being nearer the origin as you move along the curve). Thus the native country is prejudiced by the change.
But the same objections,
in kind, can be made to the use of money prices as a measure of value in domestic-trade theory, and it is a difference in the nature of the questions examined in the two bodies of theory, involving a difference in the degree of error resulting from abstraction from the variations in the value of money, which provides any basis for tolerating this error in domestic-value theory in the interest of simplicity while refusing to tolerate it in the field of international values. The substitution for the price-quantity demand and supply functions for single commodities used in domestic-trade theory of some such concept as reciprocal demand becomes almost inevitable if what is being studied is the value relationships between all the elements of the economy, grouped into broad classes, instead of the relative variations in value of money and one single presumably minor commodity.
Marshall, who wrote during a period when the exponents of the substitution throughout the field of value theory of general-for partial-equilibrium analysis were carrying on vigorous propaganda for their cause, cannot be supposed to have been unaware of the full significance of his departure in the field of the theory of international value from the partial-equilibrium method which otherwise he uniformly followed. It is regrettable, therefore, that he not only failed to emphasize the differences between his methods
of analysis in the two fields, but that he expounded the two types of theory in such closely similar terminology as to lead some students to postulate a closer resemblance between the two bodies of analysis than could rightly be attributed to them. He must be held largely to blame, therefore, for the fact that able writers have supposed that his reciprocal-demand or foreign-trade curves and his domestic demand and supply curves in terms of money were so closely related that the former were simple derivatives of the latter.
The two types of curves rest on radically different and irreconcilable sets of assumptions, so that it is impossible to derive one set from the other or to trace a definite relationship between them.
There exists, however, a considerable literature, mainly of Continental origin, and still being added to, in which the problems of international value are analyzed in terms of absolute money prices and of independence of particular demand or supply curves in terms of money prices from each other. Of the many variants of the monetary approach to the problem of international value there will be selected for comment here the three types which appear to have had the greatest influence on later writers.
Cunynghame, in 1904, expounded the theory of international value with the aid of a type of graphical illustration related to the ordinary Marshallian domestic-trade demand and supply diagrams in terms of money prices and derivable from them.
In Cunynghame's diagrams, as in Marshall's domestic-trade diagrams, only one commodity at a time is under consideration, and the diagrams relating to the two regions are set back to back for purposes of comparison and analysis. Cunynghame did not draw any conclusions with respect to gain from trade from his diagrams, but Barone, in 1908, used the Cunynghame back-to-back diagram to reach such conclusions.
Chart XX is a reproduction of Barone's basic diagram.
The demand and supply curves of the particular commodity under consideration, expressed in terms of money in a currency common to both countries, are given separately for each country, with the
two diagrams set back to back. In the absence of international trade in this commodity, its price would be
1N in England and
PM in Germany. If trade is opened, England will therefore be the importer of the commodity and Germany the exporter. The cost of transportation per unit is assumed to be
1, and after trade, therefore, the price in England must be the price in Germany plus
1. Equilibrium will be established at the price, f.o.b. Germany, at which the quantity England would import,
CT, is equal to the quantity Germany would export,
EF. The price, therefore, will be
RE in Germany and
1) in England. Each country, says Barone, will gain as the result of the trade. In England the gain to consumers will be
1CAB monetary units, which is greater than the loss to producers,
1TAB. In Germany the gain to producers will be
AZPF, which is greater than the loss to consumers,
The grounds on which this reasoning must be regarded as inconclusive are many and formidable. First, it ignores the effect
which the removal of barriers to trade would have on gold movements and therefore on the heights of the demand-and-supply schedules and the prices in the two countries. Second, the area
CP1W included by Barone in the gain to English consumers is not homogeneous with the area
BP1WA, the latter being an actual saving in money (waiving the first objection), whereas the former is a "consumer's surplus" of indefinable meaning as compared to the area
BP1WA. A similar objection applies to the inclusion of the area
EVP in the loss accruing to German consumers. These areas are akin to a portion of Marshall's consumer's surpluses in his domestic-trade theory, and are subject to the same criticisms. Third, the calculation of gain or loss to producers from changes in price and output assumes that the "producer's rent" areas represent net real income to producers without involving real costs to anyone else in the community, an assumption inconsistent with normal reality in the one respect or in the other, or partly in both. Fourth, the supply and demand curves in terms of money for each country are assumed to be independent of each other, and of the amount of national real income, an assumption always logically invalid, but seriously in conflict with the realities if the commodity under consideration represents, or is taken as representative of, a large fraction of the total national output or consumption, as distinguished from the theory of domestic value. Barone's technique of analysis is invalid, therefore, even if what is in issue is the gain or loss resulting from the removal of a single minor import duty, although the results which he obtains are for most situations probably the same
in direction as those which would be obtainable by more acceptable methods. But Barone claimed that his conclusions are "manifestly" applicable, without need of additional qualification, to the case of the removal of an entire tariff.
Auspitz and Lieben attempt to trace the gain or loss effects of trade and of the imposition or removal of single duties by means of graphical constructions, independently devised by them, which are in some respects intermediate between the Marshallian domestic-trade diagrams and the Marshall-Edgeworth foreign-trade diagrams.
In their diagrams only a single commodity and money are represented, as in the Marshallian domestic-trade diagrams, but the vertical axis represents total amount of money instead of price per unit, and for each country the demand or supply situation is represented by two curves. In the case of the exporting country, one of these curves represents the total amounts of money in return for which the country would carry its export to the volumes indicated by the horizontal axis, while the other represents the total amounts of money which the country could accept for the indicated volumes of export without losing from the trade as a whole. This last curve, therefore, is a species of indifference curve corresponding to one of Edgeworth's "no-gain from trade" curves. It is assumed throughout that the money has constant marginal utility, and the effects of trade, or of duties, on the amount of gain from trade are measured by the vertical distances between the two curves. The restriction to single commodities makes the Auspitz and Lieben constructions akin to Barone's as far as the objective effects of trade and of duties are concerned, and open to the same
objections, but their method of measuring gain, while not satisfactory because of the assumption of constant marginal utility of one of the constituent items in the trade, is superior to Marshall's because of its use of the indifference curve as an element in the measurement.
Ashley ed., p. 592:
The law...may be appropriately named the equation of international demand. It may be concisely stated as follows. The produce of a country exchanges for the produce of other countries at such values as are required in order that the whole of her exports may exactly pay for the whole of her imports. This law of international values is but an extension of the more general law of value, which we called the equation of supply and demand.
The differences in the methods of constructing Marshall's and my curves do not call for differences in the elasticity formulae, if the same symbols are used to represent the same variables in the two diagrams. In both diagrams each curve can be regarded either as a demand
curve or as a supply
curve, each with a distinct elasticity coefficient. There will thus be a total of four elasticities. Write
for the total amount of E-goods,
for the total amount of G-goods, the subscripts
for the countries England and Germany respectively,
for the price of E-goods in G-goods, and 1/
for the price of G-goods in E-goods. Then if
is the elasticity of English "demand
" or willingness to buy German goods,
is the elasticity of English willingness to sell English goods,
is the elasticity of German willingness to buy English goods, and
is the elasticity of German willingness to sell German goods, then:
The demand elasticity and the supply elasticity of each country are of course closely related to each other, as they are but different aspects of the same phenomenon. The relationship between the two elasticities for England can readily be shown:
When the coefficient of demand elasticity of a country is unity, therefore, thecoefficient of its supply elasticity is zero. In the text, reciprocal-demand curves are referred to as "elastic" if the coefficient of their demand elasticity is numerically greater than unity and of their supply elasticity is algebraically greater than zero and as "inelastic" if the coefficient of their demand elasticity is numerically smaller than unity and of their supply elasticity is algebraically smaller than zero.
Although expressed in different terms, this usage corresponds to Marshall's use of the terms "elastic" and "inelastic" in connection with his reciprocal demand curves. (Cf. Marshall,
Money credit & commerce, pp. 337-38, note.)
The nearest approach to this proposition that I have found in the literature is the following, by Haberler: "Marshall employs...so-called reciprocal supply-and-demand curves. This theory forms an essential supplement to the theory of comparative costs; indeed, the latter, if carried through to its logical conclusion, merges into the former."
(The theory of international trade, 1936, p. 123.)
See H. Cunynghame,
A geometrical political economy,
1904, p. 97. (But cf.
pp. 114 ff.)
See also T.O. Yntema,
A mathematical reformulation of the general theory of international trade, 1932, pp. 47-50. In a footnote
(ibid., p. 48) Yntema concedes that the foreign trade curves which he derives from domestic demand and supply curves in terms of money may not be equivalent to Marshall's reciprocal demand curves:
This derivation is based on the assumption that the import demand price on its fixed-height schedule is a function only of quantity imported and that the export supply price on its fixed height schedule is a function only of quantity exported. Marshall's comments on the interdependence of import demand and export supply seem to refer not to a functional interrelation of fixed-height schedules but to the interdependence which arises out of the necessity of balancing international debits and credits. Where a functional relation between fixed-height schedules does exist, Marshall's curves are still applicable, but they cannot be derived from their component elements by two-dimensional graphs.
The "fixed-height schedules" referred to here are supply and demand schedules of two commodities in terms of adjusted money prices. Marshall nowhere explains the derivation of his reciprocal-demand curves from the complex factors operating within each economy. As Edgeworth comments: "A movement along a supply-and-demand curve of international trade should be considered as attended with rearrangements of internal trade; as the movement of the hand of a clock corresponds to considerable unseen movements of the machinery"
(Papers, II, 32). Marshall allowed the operations of the internal machinery to remain unseen, but since his reciprocal-demand curves relate to two "commodities" taken as constituting the entire range of commodities, it seems necessary to assume that Marshall would not have regarded the demand functions and the supply functions of these respective commodities within each country as independent functions.
Cf., however, J. W. Angell,
The theory of international prices, 1926, p. 454: "First, the assumptions on which the [Marshallian foreign-trade] curves are based, and the limitations to which they are subject, are precisely the same as for composite demand and supply curves of the more familiar sort [i.e., the ordinary domestic-trade theory curves?]. The preference for them is based simply on their greater advantage, for certain purposes, as a graphic device." Cf. also,
ibid., pp. 456-57: "The curves also permit an easy measurement of the direct benefits from trade....