Studies in the Theory of International Trade

Since the reciprocal demands are not shown in this chart, it does not show how the comparative wage rates are determined. It shows, however, given the real costs in each country and the comparative wages as determined by reciprocal demand, what commodities each country will export and import, respectively,
and on what terms. If the wage rates are as indicated in chart VIII (a), the money costs of production will be higher in country I for commodities a, b, and c, and lower in country I for commodities d and e, then in country II. Country I will therefore export d and e, and import a, b, and c. The commodity terms of trade as between each pair of export and import commodities will be indicated by their comparative prices: e.g., the number of units of commodity a obtained by country I in return for 1 unit of d will be
the number of units of b obtained by country I in return for one unit of e will be
and so forth. If there were a commodity with equal money costs of production in both countries, that commodity might be exported or imported by either country, might not move at all in foreign trade, or might be exported from one country to the other while being produced in both countries, quite consistently in each case with the conditions stated.

Whatever commodities country I will export and whatever ones she will import, the ratio of the logarithms of the real costs, and therefore also the ratio of the real costs in country I to the real costs in country II, will be lower for each of the commodities exported by country I than for any of the commodities imported by country I. Thus in (a) of the above chart, where country I exports commodities d and e and imports commodities a, b, and c,
and
are both smaller than
or
*62 But as Edgeworth points out:
*63

This theory brings into view an incident which is apt to be masked as long as we confine ourselves to the case of two commodities,…namely, that it is not in general possible to determine
a priori, from a mere observation of the [real] costs of production in the respective countries before the opening of the trade, which commodities will be imported and which produced at home…. Thus if
o‘ in the figure be pushed up a little, the distances
o’a’, o’b’ etc., being preserved constant,
e will become an export (from country no. I) instead of an import. But the position of
o‘ depends not only the cost of production in each country, but also on the law of demand in each country for the different commodities.

IV. TRADE BETWEEN MORE THAN TWO COUNTRIES

William Ellis, in an attempt to meet the argument current in his time that England would suffer injury if competition with her staple export industries should develop abroad, introduced for the first time a third country into arithmetical illustrations of the type used by Ricardo and James Mill in their exposition of the doctrine of comparative costs.
*64 He began with England and France engaged in trade, with England having a comparative advantage in cottons and France in silk. He then showed that the entrance into the trade of a third country, Brazil, with a comparative advantage in sugar, did not result in a loss to England. This, of course, did not meet the issue, and to have made his point he would have had to show that England could not lose from the entrance of Brazil into trade even if Brazil’s comparative advantage was in the same commodity, cotton, as England’s.
*65

In his only reference to a third country, J. S. Mill first considered the effect on the terms of trade of England with Germany of the entrance into trade of a third country exporting the same commodity as Germany, namely, linen, and concluded that in consequence England would get her linen more cheaply in terms of English cloth. He then assumed that the third country produces neither linen nor any other commodity in demand in England, but has a demand for English cloth, and produces commodities which are in demand in Germany, and concluded that here also England’s terms of trade with Germany would improve as the result of the entrance of the third country into trade, as Germany would have to induce England to take more of her linen in order to obtain the means of paying for her imports from the third country.
*66 This seems to me to be correct reasoning as far as it goes. But there are other possibilities, unfavorable for England, which Mill left unmentioned, as, for instance, if this third country had no demand for English cloth but was herself a potential exporter of cloth and importer of German linen.

Torrens, in
The Budget, had argued that if Cuba imposed a duty on English cloth, the restoration of equilibrium in the trade balance of the two countries would require a relative fall in the price of English cloth as compared to Cuban sugar. Merivale replied that if an alternative source for sugar was available to England, although at a somewhat higher price than that at which Cuban sugar was available before the imposition of the Cuban duty on cloth, the rise in the price of Cuban sugar and the fall in the price of English cloth “would soon bring into play the competition of the next cheapest country producing the same commodities as Cuba.” While the Cuban duty, therefore, would affect adversely the terms of trade of England, the injury to her would
be much less than if Cuba were the only source of sugar.
*67 Torrens, in reply, criticized some of the details of Merivale’s argument, but conceded that on Merivale’s assumption that sugar could be obtained from other sources at a price not much higher than the Cuban price prior to the imposition of the Cuban duty on English cloth, the terms of trade would not shift seriously against England.
*68

Cairnes claimed that, while if there were only two countries with wide differences in their comparative costs of producing the staple articles of trade there would be a very considerable range within which the terms of trade could be determined under the influence of comparative costs, if there were more countries competition from one or more of these countries would prevent the terms of trade from settling at either of the limiting rates.
*69 This is valid as a probability, but Cairnes proceeded to too rigorous a conclusion:

…it is not the difference in the comparative costs of production in each pair of trading countries that fixes the limits to the possible variations of international values under the influence of reciprocal demand, but, among all countries mutually accessible for commercial intercourse, the difference of comparative costs, as it exists in the particular countries in which that difference is least. The limits of variation are thus set by the minimum, not by the maximum, difference in comparative cost among the various exchanging and competing countries.
*70

There is no such necessity. Assume the following situation:

If at the ratio of three of N for one of M country III is willing to supply all of commodity N which all three countries want, then this will be the effective rate of exchange of the two commodities, and trade between country I and country III will take place on terms corresponding to the “maximum difference in comparative cost among the various exchanging and competing countries.”

Triangular (or multiangular) trade has been examined by Graham,
*71 Taussig,
*72 von Mering,
*73 and earlier writers,
*74 by means of arithmetical examples of one type or another. Edgeworth’s logarithmic illustration, modified so as to apply to more than
two countries, seems to me, however, to be better suited to the purpose than arithmetical illustrations.

Chart IX is constructed on the same principles as chart VIII, except that four countries are included, instead of only two. What commodities each country will export and import and on what terms will be determined by the comparative costs in conjunction with the comparative wage rates, and the latter in turn will be determined, in part, by the reciprocal demands. For chart IX (a), the following situation will prevail under equilibrium conditions:

In addition, country I may either export or import or not trade in commodities B and E, and country IV may either import or export or not trade in commodity E, these commodities being on the margin of trade for those countries. The ratios in which the commodities will exchange for each other will, of course, be the reciprocals of their price ratios in a common currency. Their prices will be the antilogs of the logarithms of lowest money costs represented by the vertical distances from O
₁ on a right line, as indicated below:

In IX, (b) all the real costs are the same as in (a), but because the reciprocal demands are different in (b) from what they are in (a), money costs, prices, and the conditions of trade are also different, as compared to (a). Under equilibrium conditions, the following situation will prevail in (b):

In addition, country II may either import, export, or not trade in commodity A, this commodity being on the margin of trade for that country. The prices of the commodities will be as follows, measured as before by the antilogs of the indicated vertical distances:

V. TRANSPORTATION COSTS

The theory of international trade is usually expounded on the assumption that there are no transportation costs, and this has occasionally been made a basis of criticism. But abstraction from transportation costs is also a common feature of the exposition of the theory of trade in a single market—”closed economy”—and such abstraction does not apear to be logically less permissible in the one case than in the other. Notwithstanding, moreover, the common assumption that transportation costs are relatively much more important in foreign than in domestic trade, it is by no means clear that such is the general situation. Cases are common where internal freight costs from producer to consumer are higher than international freight costs from producer to consumer, as can be seen from a study of the transportation item in the reports on costs of production in different countries made by the United States Tariff Commission.
*75 The role of transportation costs, both of products and of factors of production, in contributing
to regional differences of prices is an important field for study. It has not, however, been historically the particular responsibility of the theory of international trade, and judging what has so far been done in this field, under the name of
Standortslehre, it is not yet apparent, in spite of the claims of its exponents,
*76 that the indebtedness will be by the theory of international trade to
Standortslehre rather than the other way round.

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 (
OA ×
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
BF wheat.

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
OH to
Om units, and will reduce the amount of copper imported by
country A from (
OH ×
OK) units to (
Om ×
Or) units.
*77 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.”
*78

VI. INCREASING AND DECREASING COSTS

Ricardo, in his statement of the doctrine of comparative costs, assumed that costs of production were constant as output was varied, and this assumption has been followed, explicitly or implicitly, in much of the later literature, and in this chapter so far. Where costs are constant no issue arises as between average and marginal costs, since these are identical. If costs to the individual producer increase as output is increased, the doctrine of comparative costs still holds, but must be stated in terms of comparative marginal costs.

If there are no external economies or diseconomies of large production, pecuniary or technological, i.e., if a producer who keeps his own output constant experiences no change in costs as the result of a change in the output of his industry as a whole, then either in an isolated country or under free trade labor will tend to be distributed among the respective industries until, at equilibrium, its marginal value return
to the industry as a whole per unit of labor is equal in all industries. Assuming only two commodities and two countries and labor as the only factor of production, abstracting as usual from transportation costs, and assuming that before trade country A has a comparative advantage in marginal cost in the production of commodity M, it will be to the advantage of country A under trade to transfer its labor from the production of N to the production of M until the point is reached where its comparative marginal cost advantage ceases.
*79 Under constant cost, there is an apparent
*80 gain from trade, measured in saving in cost on the imported commodity, even on the marginal unit of trade, unless the terms of trade correspond to the relative costs of production of the country in question, when there is no gain for that country from any part of the trade. But under increasing costs, the saving in costs is confined to the infra-marginal units of trade.
*81

Under constant costs, a country will not both import and produce
for itself any commodity unless the price relations between that and other commodities produced in that country correspond to their relative costs of production in that country, i.e., unless that country is deriving no benefit from the import of that particular commodity. This does not hold true, however, for commodities produced under conditions of increasing costs, when simultaneous importation and domestic production of a commodity indicate that all (except the marginal unit) of the imports are obtained at lower real costs than those at which they could be produced at home. Under increasing costs, both (all) commodities can conceivably be produced simultaneously under equilibrium conditions in both (all) countries. When trade is carried to the equilibrium point under increasing costs, i.e., to the point where each country is fully exploiting the possible gains from trade, the ratios of marginal real costs as between the two (all) countries will be the same for all commodities being simultaneously produced in both (all) of these countries, and it will be the comparative differences in the marginal costs which would result if the existing trade were altered in volume or direction, rather than any prevailing difference in actual marginal costs, which would explain the existing trade.

Schüller has made an elaborate critique of free trade which rests in large part on considerations which must be regarded as
essentially short run in character or as inconsistent with free competition, and therefore as outside the scope of the present discussion.
*82 Such, for instance, is his argument that factors of production which are displaced from their original employment by foreign competition ordinarily fail in substantial degree to find alternative employment. His argument also that commercial policy may either attract productive resources from abroad or induce them to emigrate, and that the former is desirable and the latter undesirable, whatever its validity—and his argument is exceedingly one-sided, since if the injury to one industry from free trade in its product tends to drive its factors out of the country, the benefit to other industries and to consumers should in like manner tend to induce immigration and check emigration of the factors not engaged in this industry—is also outside the scope of this article. But an essential portion of his case is made to rest on the existence of a wide range between the money costs at which different producers within an industry can produce their output. In the long run, and even in the short run under free competition, there must necessarily be a tendency for equality of marginal money costs for all producers in a given industry, and it is these marginal costs, and not the average costs which Schüller alone considers, which are the regulator of value. None of his inferences unfavorable to free trade as a long-run policy which depend for their validity on the simultaneous existence of different costs for different producers therefore has any force.
*83

It has frequently been claimed by economists that if a country has a comparative advantage in costs in an industry or industries subject to increasing costs as output is increased and has a comparative disadvantage in an industry or industries subject to decreasing costs, it may not be to the interest of this country to specialize in accordance with comparative costs. All of the attempts which have been made to demonstrate this proposition follow the same general line of argument. It will be conceded beforehand that there is a trace of validity in this proposition,
but a very faint one, long-run considerations alone being understood to be relevant.

All of the many attempts to demonstrate the possibility that specialization in accordance with comparative costs by a country with a comparative cost advantage in increasing-cost industries and a comparative cost disadvantage in decreasing-cost industries may be unprofitable for it have much in common, and only three of the more elaborate ones will be examined here, and only one
in detail.
*84 Nicholson makes such an attempt,
*85 which is open to other criticism, but which can be disposed of on the ground that his analysis is not completely in marginal-cost and marginal-return terms. He posits the case of a country with a comparative advantage in the production of wheat subject to increasing costs and a comparative disadvantage in manufacturing subject to decreasing costs. As the result of the opening of trade, manufacturing becomes unprofitable, and the factors are shifted to wheat-growing, manufactures being imported in exchange for wheat. There results for the country, in an extreme case, no increase in the amount of wheat available for consumption and a decrease in manufactures. Nicholson bases his conclusions on marginal-cost analysis as far as wheat is concerned, but on average-cost analysis for manufacturing. Had he applied marginal-cost analysis to both, he could not have obtained results of this kind.

Francis Walker obtains similar results by means of arithmetical computations in terms of money income from charts showing monetary-demand and average-cost curves before and after trade.
*86 His procedure is defective in almost every conceivable particular. He at no point carries his analysis to a stage consistent with long-run equilibrium. He fails to provide for full employment of all the factors both before and after trade. He keeps all of his analysis on a superficial monetary level, and makes no attempt to allow for changes in the significance of the monetary unit as the result of trade, even though he includes “consumers surpluses” measured in money in his computations. His results are totally devoid of significance.

Graham
*87 also obtains similar results by a method of analysis not differing in any essential from that used by Nicholson, although he makes no reference to him. Graham, however, sets forth his argument in much greater detail, with less ambiguity in use of terms, and with at least passing reference to the objections
which might be raised against his reasoning on value-theory grounds. He supports his argument with arithmetical illustrations, which will be reproduced here with modifications which do no violence to the original but facilitate their appraisal.

Trade is carried further, on the same terms of exchange of wheat for watches, country B increasing her specialization in the production of wheat and country A in the production of watches. But in both countries the production of wheat is subject to increasing costs and the production of watches to decreasing costs. Each unit of trade still seems to yield gain to both the participants, since country A gets each 4 units of wheat at a
labor cost at which she could only produce 3½ wheat at home, and country B gets 3½ watches at a labor cost at which she could produce only 2 2/7 watches at home. But country B is really losing from the trade, since as she increases her total output of wheat and decreases her total output of watches, the productivity of labor falls in both industries. If in case I the total trade consisted of an exchange of 4 wheat for 3.5 watches and in case II the total trade consisted of an exchange of 320 wheat for 280 watches, then in case I country B would have as its total income 796 wheat + 603.5 watches, and in case II only 730 wheat + 480 watches.

Except for 1 unit of labor, each country is now completely specialized in the employment in which it is at a comparative advantage. But it is profitable to the participants in trade to carry specialization to the fullest extent possible, for if the day’s labor still engaged in producing watches in country B were to be diverted to growing wheat, it could with the ½ unit wheat so obtained secure in exchange 7/16 of a watch, instead of only the ¼ watch which it can produce directly. Country B has nevertheless lost severely as the result of specialization in accordance with comparative advantage. If in case III it exchanges a total of 120 wheat for 105 watches, its income will consist of 79.5 wheat + 105¼ watches, as compared to 730 wheat + 480 watches under partial specialization (case II), 796 wheat + 603.5 watches under only incipient specialization (case I), and 800 wheat + 600 watches in the total absence of trade! Trade, which economists have regarded as a beneficent activity, appears under these conditions to be for one of the countries rather a form of economic suicide, and the protectionist a wise benefactor.

These extraordinary results are the consequence, and wholly the consequence, of value-theory reasoning, implicit or explicit in Graham’s argument, which is either unambiguously erroneous or is of very limited practical significance. As his argument has so far been reproduced it rests on analysis in terms of average money costs for both the increasing-cost and the decreasing-cost industries. Graham concedes that in the increasing-cost industry marginal and not average costs will guide the producer, and that if the figures for output which he gives for wheat are marginal, then the increase of rent to landlords will be an offsetting item not accounted for in his analysis, which may more than compensate for the loss to B shown by his illustrations. He claims, however, that his conclusion that country B under the conditions assumed must lose by free trade is “inevitable” if his figures for wheat costs are interpreted as figures of average cost,
*89 provided the marginal costs are not such as to make trade unprofitable to the individuals participating therein at the terms of trade assumed by him. Graham here both concedes too much and claims too much. His interpretation of marginal cost as the cost of the most expensive unit to produce is faulty, and the excess of the marginal cost of wheat over its average cost would necessarily be much higher than he indicates, and therefore the range of trade profitable to individual traders in B, granting his other assumptions, much less than he indicates. On the other hand, he concedes too much when he says that the increase in rent to landlords when the output of wheat is increased will be an offsetting item which may more than compensate for the loss to B shown by his illustrations. The loss to B shown there exceeds the increase in the cost of producing wheat and includes this plus the increase in the cost of producing watches. But rent in terms of wheat cannot increase with an increase in the production of wheat unless the average cost exclusive of rent rises, and the increase in average
cost of wheat, inclusive of rent, must therefore be greater than the increase in average rent per unit of wheat.

Regardless of whatever defects there may be in Graham’s handling of the costs of wheatgrowing, his general conclusions would still be acceptable if his treatment of the costs of watch-making could be accepted as satisfactory. It is in his treatment of decreasing costs that the fatal flaw in his argument is to be found. A decrease in unit costs as output is increased may be due either to “internal” economies, i.e., economies accruing to an individual producer because
he expands his output, or to “external” economies, i.e., economies accruing to an individual producer because the industry as a whole is expanding its output. Graham says that “the reasoning in the text simply assumes that a decreasing unit cost is obtained by an expansion of the production of watches; whether the cause of it be external or internal economies is immaterial to the theory….”
*90 It is, on the contrary, very material to the theory, as Knight has shown in a reply to Graham’s argument to which the present analysis is greatly indebted.
*91

Suppose, first, that the economies in the watch industry are internal. Then, since the larger the scale of plant the lower the unit costs, competition will be inconsistent with long-run equilibrium, and there will be a tendency toward the monopolization of the industry by a single concern. The principle governing the relation of cost to price is, of course, different for a monopoly than for a competitive industry, but marginal rather than average cost remains the determining factor of price and no resources will be transferred from watchmaking to wheatgrowing if a loss in value of product results therefrom. But even if, by exception, we depart from long-run assumptions and take the situation prevailing while competition still continues to be effective in the watchmaking industry, it still remains true that no resources will be transferred from watchmaking to wheatgrowing if the transfer would involve a loss in value of product. Any producer of watches in country B who reduces his output of watches to produce wheat instead loses thereby the marginal output in watches and gains only the marginal increment of wheat. If, as indicated in cases I
and II above, 100 units of labor are diverted in country B from producing watches to producing wheat, the transfer of the units of labor would involve a loss of 400 watches to get 250 wheat at a time when 400 watches are worth 457 wheat. Assuming internal economies in the watch industry, there simply would be no such transfer of labor. Had Graham dealt with his problem in terms of marginal costs and marginal returns for both industries, he could not have obtained results unfavorable to free trade.

A conceivable case for protection on the basis of the existence of external economies in an industry which from the individual producer’s point of view is at a comparative disadvantage in costs
can be made out, therefore, only where these external economies are (a) dependent on the size of the national and not the world industry and (b) are technological rather than pecuniary, or, if pecuniary, are not at the expense of domestic sellers of services or materials to the industry. The scope for the application of the argument is extremely limited, especially as it seems difficult even to suggest plausible hypothetical cases of the existence of genuine technological external economies. Instead of providing a substantial “scientific” basis for the popularity of protection among the vulgar, as Graham seems to think, his thesis reduces to little more than a theoretical curiosity.

Knight goes still further in his rejection of Graham’s argument. He claims that there cannot be external economies for a concern (“business unit”) A which are not internal economies for another concern B within the same industry; that under these circumstances the industry will tend to be a monopoly and that the principles which will then regulate value will not be those appropriate
to competitive conditions.
*92 I see no logical necessity that external economies to one concern must be internal economies to any other concern, whether in the same or in another industry. But suppose it be granted that external economies to industry C are internal economies to industry D, and suppose it be granted further that industry D is under monopoly control. It will still be possible that as C’s demand for D’s produce increases, D’s prices will decrease, if production by D is subject to decreasing costs. External economies can therefore still accrue to industry C even though these economies, external to C, are internal for another, monopolized, industry D.

Knight claims further that even if decreasing costs existed in the watch industry, country B specializing in wheat would get the same benefit from these economies by importing the watches from A as by producing them at home.
*93 This would be true only if as B proceeded with its specialization in wheat the terms of exchange between watches and wheat moved against watches sufficiently to offset the opposite movement of their relative marginal costs
to the industries as a whole in B. Now the whole point of the argument from external economies is that where they exist, relative prices need conform only to relative marginal costs to individual producers and need not conform to relative marginal costs to the industries as a whole. The price of watches, if watch-making is subject to external economies, will be higher than their marginal money cost to the industry as a whole.

Haberler has characterized Graham’s argument as but a variant of the infant-industry argument for protection.
*94 But the validity of Graham’s thesis, if it is valid at all, is not dependent upon short-run considerations. Decreasing marginal costs are not necessarily nor typically a short-run phenomenon,
*95 and it is Graham’s contention that if an industry is operating under decreasing costs it may pay to protect it even if it has a permanent and irremovable comparative disadvantage in costs.

VII. PRICES, MONEY COSTS, AND REAL COSTS

For all the classical writers it was common doctrine, as has already been argued,
*96 that under free trade, and in the absence of transportation costs, prices of identical internationally-traded commodities would be uniform in all countries when expressed in the same currency. It was also common doctrine that the prices of commodities produced within a country would be, or would tend to be, proportional to their money costs of production, that differences in supply prices were the immediate determinant of the course of trade, and, therefore, that differences in money costs of production determined the course of trade. They extended their analysis to real costs not as a substitute for analysis in terms of money costs, but in order to show that, although trade was immediately governed by price and money-cost differences, these differences in prices and money costs reflected differences in real costs and were therefore significant for welfare appraisals.
*97 The real-cost analysis was intended, therefore, to give significance to the analysis in pecuniary terms, and not to replace it.

For the classical school, the immediate determinant of whether a particular commodity will be obtained abroad or at home, or
exported, is the
absolute difference in the prices at which domestic and foreign producers are willing to furnish it.
*98 Actual market prices being assumed to be everywhere equal in the absence of transportation costs, commodities will be exported or imported according as their domestic
supply prices or money costs of production are
absolutely lower or higher than their foreign supply prices or money costs of production expressed in the same currency. Some writers, however, transferring Ricardo’s comparative-cost doctrine too abruptly into the realm of money costs and prices, have argued that trade is, or should be, governed by comparative differences in money costs even in the absence of absolute differences in money costs.

A glaring case is an anonymous pamphlet published in 1818, which has been reprinted and recommended to the favorable attention of modern scholars by Arnold Plant.
*99 The main thesis of the pamphlet is that it is profitable to merchants to export a commodity, A, selling at a higher price at home than abroad and to import a commodity, B, if the ratio of the home price of A to the home price of B is lower than the ratio of the foreign price of A to the foreign price of B:

The advantage of any trade, where one article is to be exported, and either mediately or immediately to be exchanged for another to be imported, depends on the proportion between the quantities of the two articles that may be bought for the same price in the one market being effectually different from the proportion between the quantities of the same two articles that may be bought in the other market for one and the same price: that article, the home price of any proposed quantity of which will buy less of the other article (at home) than the foreign price of the
same quantity of that article will
abroad, being the one to export, and the other the one to import: in other words, that article (of the two) which is, relatively to the other, cheaper at home than abroad, being the one to export, and the other the one to import.

Observe: it matters nothing whether the article, thus comparatively cheaper, be
really cheaper ordearer than in the other market; but only that it should be cheaper, if paid for in that other article. As for example, silk stockings, bought with brandy in England, may be cheaper than in France. A gallon of brandy may buy more than in France; though perhaps, absolutely, silk stockings may be as cheap in France as in England, or cheaper.
*100

But if the supply price of silk stockings is higher in England than in France, no sensible merchant will voluntarily export stockings to France in exchange for brandy when money can be exported instead.
*101 As Plant points out, the author’s exposition, much of it algebraic, is of excellent quality. Unfortunately, however, the algebra is wasted on the exposition of a fallacy. This and other similar instances,
*102 of failure to see that it is
absolute differences and not merely comparative ones which matter when it is prices and money costs and not real costs which are under consideration, were sometimes the result of a laudable desire to
meet the argument, that in the absence of protection a country might find it impossible to withstand foreign competition abroad or in its domestic market because its price level was too high, by demonstrating that export could be profitably carried on regardless of the general price level. The classical economists would of course have met this argument in another manner, by contending that England could not long maintain a price level so high as to shut off all exports and that forces would operate automatically, through gold movements, to restore a relationship between the English and the outside price levels under which a normal volume of exports could be maintained with profit to the individual exporters.

Notre pays serait arrivé, en dernière analyse, à faire du blé en faisant du drap. II aurait ainsi substitue les coéfficients de fabrication de l’eé;tranger aux siens propres pour le blé, en même temps que l’etranger opérait la substitution inverse pour le drap. Là est l’essence du libre exchange, et les deux substitutions sont correalatives.
*103

What Walras’s proposition amounts to is that under trade the prices of the products of the two countries must be proportional to their real costs. Instead of being universally valid, this proposition will be valid only in the special case where—assuming labor to be the only cost—wage rates are uniform in both countries under trade. The only generally valid proposition which can be made as to the real costs at which imports are obtained is that they will be lower than—or in the limiting case equal to—the real costs at which they could have been produced at home. If each country has an absolute advantage in the production of its export commodity, and if wage rates are not uniform in both countries, one of the countries will obtain its import commodity at a real cost to itself
lower than its real cost in its country of origin while the other country will obtain its import commodity at a real cost to itself
higher than its real cost in its country of origin. If one of the countries is at an absolute disadvantage in the production
of both commodities, that country cannot possibly obtain its import commodity at a real cost to itself as low as that at which it is produced in its country of origin.

The same rule which regulates the relative value of commodities in one country does not regulate the relative value of the commodities exchanged between two or more countries…. In one and the same country, profits are, generally speaking, always on the same level; or differ only as the employment of capital may be more or less secure and agreeable. It is not so between different countries.
*104

Other classical economists as a rule took this proposition over from Ricardo without question.
*105 It seems, however, to have worried Torrens. While he stated the doctrine himself at times, he seemed at one time to believe that in doing so he was disagreeing with Ricardo,
*106 perhaps because he had heard McCulloch expound
it incorrectly,
*107 and still later he raised the question as to whether the doctrine was valid at all.
*108

Sidgwick, it will be remembered,
*109 took issue with the doctrine that the relative values of the products of different countries were not proportional to their relative costs, but in his argument he seemed to mean money cost rather than real cost by “cost,” whereas in the Ricardian doctrine “cost” meant real cost. At one point, however, Sidgwick presents some conclusions which would be true if he used cost to mean real cost, but would not be true if he used cost to mean money cost.
*110 He repeats an illustration of J. S. Mill’s, where England exports cloth in exchange for Spanish wine, and adds a third commodity, corn, which is produced in both countries. He argues that since in England, where both cloth and corn are produced, their values must be determined by their relative costs of production, and similarly in Spain the values of corn and wine must also be determined by their relative costs of production, therefore the relative values of cloth and wine must also be determined by their relative costs of production, if there are no transportation costs. If values here mean prices and if “costs” mean “money costs,” this is correct, and Mill would have agreed. Since the price of corn must be the same in both countries, and since in England the price of cloth:
price of corn: :money cost of cloth:money cost of corn, and in Spain the price of wine:price of corn: :money cost of wine:money cost of corn, therefore the price of cloth:price of wine: :money cost of cloth:money cost of wine. So far there is no difficulty, except in seeing why Sidgwick thought that he was differing from Mill. But at this point Sidgwick appends a note which is not intelligible if he is not using cost to mean real cost, and is simply a concession of his whole case against Mill if he is so using it: “It does not of course follow that the wine and cloth will exchange for each other in proportion to their respective costs; since, if (as Mill supposes) labor and capital are imperfectly mobile, the cost of producing corn may be different in the two countries.”
*111 If Sidgwick is conceding that the prices of wine and cloth will not be proportional to their real costs of production, he is accepting Mill’s entire case. If he is denying that the prices of wine and cloth will be proportional to their money costs of production, he is denying his own theory of value, and apparently contradicting the accompanying text.
*112

VIII. DEPENDENCE OF COMPARATIVE COST DOCTRINE ON A REAL-COST THEORY OF VALUE

The Ricardian exposition of the doctrine of comparative costs stated costs in terms of units of labor-time and assumed that the values of commodities produced within a country would be proportional to their labor-time costs. The same procedure was followed by many of the leading exponents of the doctrine of comparative costs, and this chapter has so far not questioned its validity. But the labor-cost theory of value could find few, if any, serious defenders today, and many writers have claimed either that the doctrine of comparative costs must be rejected because of its dependence on a labor-cost theory of value, or else that it
must be restated in terms of “modern” value theory without reference to labor costs. The remainder of this chapter deals with various phases of this question.

There are serious difficulties here for the doctrine of comparative costs, but they arise from the necessary dependence of its normative aspects on some form of “real-cost” theory of value and not from its relationship with the “labor-cost” theory of value, which can easily be severed. The association of the comparative-cost doctrine with the labor-cost theory of value is a historical accident, a result merely of the fact that Ricardo, in his pioneer exposition of it, expressed real costs in terms of quantities of labor. Except for Ricardo, none of the classical expounders of the doctrine of comparative costs, with the relatively unimportant and partial exception of James Mill, was an exponent of a labor-cost theory of value. Ricardo, himself, made important qualifications from the start for the influence of capital costs on relative values, and attached increasing importance to them as time went on. Malthus and Torrens expressly rejected the labor-cost theory. Senior and Cairnes dealt with real costs in terms of “labor and abstinence”
*113 or “labor and capital.” J. S. Mill in his earliest writings dissociated himself from the strict labor-cost theory, and in his
Principles expressly rejected it in his discussion of general value theory, although he expounded the doctrine of comparative costs, as did Cairnes, as a rule, in the terminology of the labor-cost theory. Later writers, such as Bastable and Edgeworth, substituted “units of productive power,” or similar expressions, for quantities of labor in expounding the doctrine,
*114 or else, like Marshall,
*115 made “quantities of labor” stand for combinations of the factors. Taussig, almost alone among modern writers, has adhered, with qualifications, to a labor-cost theory of value, but with full recognition of the objections which have been made against it, and on the ground not that these
objections are theoretically invalid but that their practical importance can reasonably be questioned. Economists who in general would deny that prices were necessarily proportional to labor costs may have fallen back on the labor-cost formula when expounding the theory of international trade because of the aid this formula provides in avoiding—or evading—serious logical difficulties in appraising from a welfare point of view the consequences of trade. While, therefore, evidence seems completely lacking which will support Knight’s dictum that “historically the whole doctrine of comparative cost was a prop for a laborcost theory of value,”
*116 the converse proposition is arguable that historically the labor-cost theory of value has been used, even by writers who did not believe in it, as a prop for the doctrine of comparative costs. But now that there is almost universal and vigorous rejection of the labor-cost theory, its historical association with that theory is proving for the comparative-cost doctrine a hindrance rather than an aid to its general acceptance. Although for some of its critics this would make little difference, it is therefore important to emphasize that the doctrine of comparative costs has for most of its exponents derived its cogency from their acceptance of a real-cost theory of value which was not simply a labor-cost theory of value, even when expressed in its terms.

Before proceeding to an examination of the possibility of upholding the validity of the doctrine of comparative costs on the basis of real-cost theorizing, I should make it clear what meaning I attach to the phrase “real-cost theory of value.” I understand by a “real-cost theory of value” a theory which holds that there is at least a strong presumption of rough proportionality between market prices and real costs, and that therefore propositions which depend for their validity on the existence of such rough proportionality are not for that reason to be regarded as invalid unless and until evidence is produced tending to show that in the particular situation under examination no such approach to proportionality between prices and real costs exists. Real-cost theorizing, therefore, even if valid, yields presumptions, but only presumptions, as distinguished from certainties. But presumptions are all that economic theory can be expected to yield in this field. But even if no presumptions as to proportionality of prices to
“real costs” can be established, general value theory must, of course, take account of “real costs” in so far as they exist and influence relative prices in any manner. Demolition of the “real-cost theory of value,” therefore, does not have as an appropriate sequel abandonment of “real-cost” analysis.

The question next arises as to what is to be understood by “real costs.” As applied to Ricardo’s labor-cost theory, it would appear to mean cost in terms of day’s labor, or the labor technical coefficients of production, where “real” would serve merely to distinguish quantities of the services of the factors necessary for production from money expenses of production, in the same manner in which “real” is applied to income to distinguish the commodities which money income can buy from the money income itself. It is clear, however, that the classical writers, when dealing with questions of public policy, were concerned with subjective costs, or “disutilities,” and that although they generally assumed that disutilities were proportional to quantities of the services of the factors, they meant by real costs all subjective costs directly associated with production. The irksomeness of labor, whether in comparison with leisure or with some other kind of labor, and the “abstinence” associated with voluntary postponement of consumption, were for them the important real costs. They recognized, of course, that the economic process involved choice between products as well as choice between activities, but they treated choice between products as an income phenomenon and not as a cost phenomenon. When dealing with costs, they assumed income to remain constant, and examined the means by which it could be procured at the minimum cost. When dealing with income, they assumed cost to remain constant, and examined the means by which income could be maximized. That this was the only possible, or even the best, procedure, whether with respect to terminology or to mode of analysis, there would be no point in insisting upon, since there is always a choice of terms and of methods of analysis, and which is chosen is often determined mainly by some intellectual fashion of the moment. While there were imperfections in their doctrine, the only one I see which can conceivably be attributable to their technique was the one pointed out by Barone and Pareto,
*117 their unsatisfactory method of handling
land services (or, in general, services supposed not to involve real costs) as a factor in production.
*118

The course of international trade is governed immediately by prices. Unless the prices of commodities within a country are at least roughly proportional to their real costs, the doctrine of comparative costs is insufficient to establish a presumption in favor of free trade and, in fact, may provide a presumption in favor of interference with trade in order to bring it into conformity with comparative real costs.
*119 The following sections examine the bearing on the doctrine of comparative costs of certain factors which are commonly held to operate against the existence of any significant correspondence between money costs and real costs, namely, differences in wage rates in different employments, and the use of the factors of production in different proportions in different industries.

IX. DIFFERENCES IN WAGE RATES IN DIFFERENT OCCUPATIONS

If different wages are paid to different kinds of labor and these different kinds of labor are used in different proportions by different industries, or if the same kind of labor is paid different
wages in different industries, then, assuming labor to be the only factor of production, prices of commodities produced within a country, though proportional to wages costs, will not be proportional to labor-time costs. It will follow that the course of trade under free trade will be governed by wages costs (i.e., labor-quantity costs times wage rates) and not, as posited by Ricardo, by comparative labor-quantity costs. This was seen and clearly stated by Longfield:

The next circumstance which gives a direction to the stream of commerce, is, that the relative wages of labor in one country may vary by a different law from that which is observed in another. In one country, honesty and skill may be rare and high-priced qualities, and add much to the relative wages of the laborer who is required to possess them. In another country, the general comfortable condition of the people may render the laborer most unwilling to encounter severe toil, and a great increase of price may be necessary to induce him to engage in a disagreeable or unhealthy occupation. In this latter country, honesty, and that attentive disposition which quickly produces skill, may be the general qualifications of the people. On this supposition, if no disturbing causes exist, manufactures which require honesty and skill, will exist in the latter country; as the laborers possessing those qualities will sell their labor cheaper in proportion to its productiveness. In these two circumstances all commerce may be said to originate—namely, a difference in the proportion of the productiveness of labor of different kinds, in different countries; and the different scales by which the relative wages of labor vary in different countries.
*120

But when Longfield proceeded to deal with the advantages to be gained from free trade, he tacitly assumed that a country with an absolute advantage in money costs in the production of a particular commodity would also have a comparative advantage in real costs with respect to that commodity, and made no further mention of the complication which he had previously introduced.
*121

Cairnes pointed out that international trade is proximately regulated by prices and not by comparative real costs, and that the prices of commodities produced within a country by different noncompeting groups will not be proportional to real costs in terms either of quantities of labor expended thereon or of “labor sacrifice.”
*122 But Cairnes apparently did not see the problem which this created for the free-trade doctrine, or else deliberately abstracted from it, for later he states that “it has been seen that nations only trade with one another when by doing so they can satisfy their desires at smaller sacrifice or cost than by direct production of the commodities which minister to them,”
*123 whereas all that he had shown was that they trade with one another when the imported commodities can thereby be obtained at a saving in money costs. In his discussion of the tariff issue he tacitly makes the assumption, against which he had objected as illegitimate when dealing with general value theory and with the theory of international trade, that wages costs throughout the range of a nation’s industries are an adequately accurate measure of relative real costs.
*124 Thus even the economist most responsible for directing attention to the significance of differences in wages in different occupations ignored these differences when dealing with the tariff problem.

The problem does not appear to have received any further attention until we come to Professor Taussig’s treatment. Taussig presents a clear and unambiguous demonstration, with the aid of arithmetical illustrations, of how differences in wages in different occupations may cause relative prices to diverge from relative labor-quantity costs, and how in consequence international specialization under free trade may not conform with comparative advantage in terms of labor-time costs.
*125

Taussig, however, claims that there is at least a rough correspondence between the hierarchy of occupations in advanced
countries,
*126 and that the exceptions, though important, are essentially temporary in character. He concedes that differences between countries in this hierarchy will operate to make the course of trade diverge from what it would be if prices were regulated by labor-time costs, and gives some concrete examples of such divergence. He maintains, however, that if the hierarchies are identical in different countries, “trade will develop as it would if prices within each country were governed by labor costs alone.” I believe that Taussig has shown that the greater the approach to similarity in different countries in the hierarchy of wages the smaller will be the deviation of trade from the course it would follow if wages within each country were uniform, but that he has failed to show that with complete similarity in the hierarchies there would be
no deviation from the course trade would follow if wages within each country were uniform in all occupations.

Taussig presents his reasoning with the aid of a series of arithmetical illustrations based on two somewhat different types of assumptions with respect to the nature of the non-competing groups. He illustrates the first type by the following example:
*127

Country		Labor-time costs (in days)	Wages per day (in $)	Total wages (in $)	Produce	Domestic supply price (in $)
United States…		10	1.00	10.00	20 wheat	0.50
		10	1.50	15.00	20 linen	0.75
Germany…		10	0.66 2/3	6.66	10 wheat	0.66 2/3
		10	1.00	10.00	15 linen	0.66 2/3

In this illustration there are differences in wages as between the different industries, but the order and percentage degree of difference are identical in the two countries. Taussig concludes
that the course of trade will be precisely the same as if supply prices within each country were regulated by labor-time costs. Ohlin has pointed out, however, that while the commodities exported and imported by each country remain the same the terms of trade may be different in the two cases. With labor-time costs regulating, i.e., with wages the same in both occupations, trade can take place anywhere within the limits of 1 wheat for 1 linen and 1 wheat for 1.5 linen. With the differences in wages in the two industries trade can take place only within the limits of 1 wheat for 2/3 linen and 1 wheat for 1 linen, a change to the disadvantage of the country with a comparative advantage in the product of the low-wage industry.
*128 But Taussig has shown that the deviation from trade in accordance with comparative labor-time costs will tend to be less when the direction and degree of difference in wages in the two industries are the same in the two countries than when they are not the same.

In his second type of illustration, Taussig deals with differences in wages of different classes of labor, each of which finds employment throughout the range of industry. He then shows, successfully as far as I can see, that if the hierarchy is the same in different countries both as to rank and as to percentage differences in wages, and if all industries in both of the countries use labor coming in the same proportions from the different social classes of labor, the course of trade, although then as always immediately regulated by prices and money costs, will be precisely the same as if it were governed by labor-quantity costs.
*129 The assumptions on which this conclusion rests seems to me, however, seriously to restrict its significance, especially as departure from any one of them would force a modification of the conclusion. But Taussig’s analysis turns rather on the existence of fixed scales of relative wages than on the question of occupational mobility of labor,
*130 and it seems to me that more fruitful results can be obtained
by the application to the problem of Taussing’s general mode of analysis of the origin and significance of differences in wages.
*131

First, differences of wages in different occupations may be what Taussig has called “equalizing” differences, i.e., may be wholly due to and proportional to differences in the attractiveness, or irksomeness, of the occupations, and not to the absence of complete mobility between the occupations. Specialization in accordance with money costs will then also be in accordance with comparative real costs measured in terms of “disutilities” or of irksomeness of the occupations or of the living conditions associated with such occupations, even though it is not in accordance with comparative labor-time costs. In such cases the doctrine of comparative real costs holds unequivocally, in spite of the differences in wage rates in different occupations.
*132

Next, let us suppose that the differences in wages are due to absolute labor monopolies in the high-wage groups, and that the hierarchy of labor is according to industry or product, rather than, or more than, across industry in general.
*133 Given the absence
of the possibility of movement of labor from the low-wage to the high-wage industry, then the amount of labor available for the latter industry has only the limited degree of variability resulting from the dependence of the amount of labor offered for employment by the members of the high-wage group on the wage obtainable. Abstracting from such variability of the amount of labor as is internal to the group and not due to migration of labor from other groups, if the high-wage industry is at a comparative advantage in terms of real costs but, because of the limitations on the number of laborers who have access to employment in that industry, competing products continue to be imported, the imposition of a tariff on its product will not appreciably affect the volume of its domestic production, and its significant results will be confined to changes in the volume of foreign trade, the relative prices of commodities, and the relative wages paid in different industries. The inequality in wages would be further accentuated, and the power of the monopoly labor group to exploit the rest of the community would be increased, but there would be no improvement in the apportionment of labor among the different occupations.

Finally, suppose that there is complete mobility between occupations, but that by law, custom, or trade-union regulation wages in some of the industries which are in a position of comparative advantage in terms of real costs are maintained at so high a level that the domestic market for their products is shared with imports of competing products. Under these conditions a protective duty on imports of the commodities produced by the high-wage industries would increase the amount of employment provided by those industries and would result in a shift of labor from occupations of lower to occupations of higher productivity. The conditions of this hypothesis would not be consistent with long-run assumptions, but recent experience has shown that wages in some occupations can persist for long periods at levels high enough seriously to restrict the volume of employment, even when the only alternatives for those not securing employment therein are either
unemployment or the acceptance of much lower wages in other occupations.

The doctrine of comparative costs emerges, therefore, very nearly intact even from a test about whose results some of its most ardent adherents have had misgivings. Although reached by a somewhat different method, the foregoing results amply confirm the conclusion of Professor Taussig that the existence of differences in wages does not suffice to overturn the doctrine of comparative costs.
*134

X. VARIABLE PROPORTIONS OF THE FACTORS AND INTERNATIONAL SPECIALIZATION

Ohlin, the most outstanding and vigorous of the critics of the doctrine of comparative costs, bases his criticism on an interpre
of the doctrine as representing the attempt of the classical school to explain the forces which determine the specific nature of the course of trade and of international specialization. Except for one paragraph, he has given no sign of recognition that this was not the sole nor even the main purpose of the doctrine, and this paragraph, appearing as the final paragraph of a book of 590 pages in which the doctrine is treated throughout as erroneous and irrelevant, is clearly a last-minute afterthought.
*135 Ohlin’s own explanation of the forces which determine the nature of international specialization is in its general lines admirable, and, I am convinced, will help to set the pattern of future discussion of this question. Ohlin goes into considerable detail but the general frame-work of his theory can be summarized in several sentences. A country exports those commodities which it can produce at lower money costs than any other country and imports those commodities which other countries can produce at lower money costs. What the relative money costs of production of different commodities will be in any country depends on the relative prices of the different factors of production, on the productivity functions of these factors, and on the extent to which production is carried in the different industries, and some of these in turn depend on the demands, domestic and foreign, for the various commodities. On empirical grounds, however, the conclusion may be reached that the most important single factor explaining the nature of international specialization is the differences as between different countries in the relative abundance, and therefore in the relative prices, of different factors. These international differences in the relative prices of different factors tend to result in the money costs of production of particular commodities being low in those countries where the factors entering heavily into the production of these commodities are relatively abundant and therefore low in price.
*136

There is no doubt that varying productive factor equipment is the main cause of those inequalities in [money] costs of production and commodity prices which lead to trade…. The fact that the productive factors enter into the production of different commodities in very different proportions and that therefore (relative prices of the factors being different in different countries) an international specialization
of production is profitable, is so obvious that it can hardly have escaped notice. Yet this fact has been given no attention in international trade theory. There can hardly be any other explanation than the dominance of the Ricardian labor cost theory—in the form of the doctrine of comparative cost—which is built on the explicit assumption of proportionality between the quantities of all factors except land in all industries. This precludes the study of varying proportions.
*137

Ohlin, accordingly, finds it not surprising that the influence on the course of trade of differences between countries in the relative abundance of the different factors was “first touched upon, not by the English classical school, but in French works.”
*138 Unfortunately for his thesis, however, the only French work which he cites is Sismondi’s
De la richesse commerciale, published in 1803, while with the exception of the
Wealth of Nations the earliest work of the classical school in the field of international trade came later than 1803. Sismondi, moreover, was at this time still a rather slavish disciple of Adam Smith and may conceivably have found his inspiration even on this question in the
Wealth of Nations.*139 Of early writers in English, Ohlin cites only Longfield
*140 as offering an explanation of international specialization in which differences as between countries in the relative abundance
of different factors are treated as important, but he apparently does not regard Longfield as a “classical” economist.

In the distribution of employments amongst all countries, the capital of poorer nations will be naturally employed in those pursuits, wherein a great quantity of labor is supported at home, because in such countries the food and necessaries for an increasing population can be most easily procured. In rich countries, on the contrary, where food is dear, capital will naturally flow, when trade is free, into those occupations wherein the least quantity of labor is required to be maintained at home: such as the carrying trade, the distant foreign trade, and trades where expensive machinery is required; to trades where profits are in proportion to the capital, and not in proportion to the quantity of labor employed.
*141

In dealing with the effect of a tax on agricultural raw materials which raised their price relative to other elements entering into production, Ricardo states:

…as the value of commodities is very differently made up of raw material and labor; as some commodities, for instance, all those made from the metals, would be unaffected by the rise of raw produce from the surface of the earth, it is evident that there would be the greatest variety in the effects produced on the value of commodities, by a tax on raw produce. As far as this effect was produced, it would stimulate
or retard the exportation of particular commodities,…it would destroy the natural relation between the value of each…and therefore rather a different direction might be given to foreign trade.
*142

Malthus, dealing with the question of why in England, as compared to the Continent, wages were relatively high, or, as he put it, the value of money was relatively low, offered the following answer:

The lower value of money in England compared with the value of money in most of the states of Europe, has appeared to arise principally from the cheapness of our exportable manufactures, derived from our superior machinery, skill, and capital. The still lower value of money in the United States is occasioned by the cheapness and abundance of her raw products derived from the advantages of her soil, climate, and situation…neither the difference in profits, nor the difference in the price of labor, is such as to counterbalance this facility of production, and prevent the abundance of exports.
*143

McCulloch, to illustrate the effect on foreign trade of changes in the rate of wages, presents a hypothetical case in which wages and facilities of production are equal in France and England for all of a range of commodities, so that both countries are on equal terms in the export trade of these commodities to the United States. He assumes also that capital, in the form of durable machinery, enters into the cost of production of these commodities in different proportions for different commodities. He next supposes that wages rise in England while they remain stationary in France, and concludes that “England will henceforth have a decided advantage over France in the production and sale of those commodities that are produced chiefly by machinery; while France will, on her part, have an equally decided advantage over England in the production and sale of those commodities that are chiefly the direct produce of the hand.” He finds, moreover, that this hypothetical case fits the facts:

The bulk of our exports consists of cotton goods and other products of machinery; whereas the bulk of the exports of France consists of the productions of her soil, and of jewellery and fancy articles, principally the product of manual labor. It is, therefore, difficult to suppose that a rise of wages should be fatal to the foreign commerce of a country, except by reducing profits, and creating a temptation to employ capital abroad. It can hardly fail, however, to turn it, to some extent at least, into new channels: for if, on the one hand, it raises the value of certain descriptions of commodities and checks their exportation, on the other, it proportionally lowers the value of other descriptions, and fits them the better for the foreign market.
*144

Cairnes, in a discussion of the type of specialization in which a new country would tend to engage, gave consideration to the relative abundance of capital and natural resources:

The class of commodities in the production of which the facilities possessed by new communities, as compared with old, attain their greatest height, are those of which timber and meat may be taken as the type, and comprises such articles as wool, game, furs, hides, horns, pitch, resin, etc. The characteristic of all such products is, that they admit of being raised with little previous outlay, and, therefore, with comparatively little capital, and in general require for their production a large extent of ground. Now capital is the industrial agent which new countries are least able to command, while they commonly possess land in unlimited abundance. There can, therefore, be no difficulty in perceiving that, for the production of the class of commodities mentioned above, newly-settled communities are especially adapted, and that, consequently, the value of all such commodities will be in them exceptionally low.
*145

These references to recognition of the influence of the relative abundance of the factors are confined to writers generally recognized as belonging to the classical school, and can be extended by citations from minor writers of the classical period,
*146 as well as by citations from later writers, American and Continental, who were more or less under the classical school influence.
*147 Such recognition has been an especially prominent feature of Taussig’s analysis,
*148 although in his earlier treatments there seems to be no reference to the relative abundance of capital. An allied problem, which Taussig dealt with at length,
*149 the influence of differences in the relative supplies of the different factors on the techniques whereby different countries produce the
same commodities, does, however, seem to have been left almost completely untouched by the early classical economists. It was, nevertheless, a question of widespread interest at the beginning of the nineteenth century, especially in connection with the contrast between the prevalent “high” farming in England and extensive cultivation in the United States. Not only did almost every traveler attempt to explain these differences in technology in terms of the relative abundance of the respective factors, but acute discussion of the question is to be found in the correspondence or other writings of such early American statesmen as Benjamin Franklin, George Washington, and Thomas Jefferson.

XI. VARIABLE PROPORTIONS OF THE FACTOR AND COMPARATIVE REAL COSTS

It is remarkable how completely the early exponents of the doctrine of comparative costs were able to avoid discussing this fundamental issue without encountering hostile comment from opponents of the free-trade principle in whose support the doctrine was expounded. When the doctrine was formulated in terms of labor-time costs, this involved the implicit assumptions that prices were proportional to subjective labor costs, and that no other real costs were involved in the productive process, assumptions which clearly never commanded wide acceptance as conforming to reality. Those writers, who, like Senior and Cairnes, wrote in terms of the proportionality of prices to “labor and abstinence” costs, or who, like Bastable, Edgeworth, and Marshall, accepted money costs of production as proportional to the number of “units of productive power” used in the production of the respective commodities, and accepted the quantity of such units of productive power as a measure of the “real” costs involved in production, never explained how subjective costs associated with the use of different factors of production could be equated with one another.
*150 Although it is hard to believe that
it was the first in fact, the earliest criticism of the doctrine of comparative costs along these lines that I have been able to find was by Lexis, in 1891.
*151 Lexis pointed out that the doctrine as expounded by Ricardo rested on labor-cost theory of value assumptions, and that these assumptions required for their validity the unlikely circumstances that labor and capital should in each country enter into the production of all commodities in uniform proportions.

A few years later, Pareto, commenting on Cairnes’s exposition of the doctrine, objected to the ambiguity of his treatment of the significant aspect of costs as “sacrifice,” and to his lumping together of “labor” and “abstinence” as if they were homogeneous quantities capable of summation. He claimed that the significant cost factors which determined prices and the allocation of resources among different employments were the individual
“coûts en ophélimité,” both direct and indirect, the “direct” costs being the “real” costs of the classical school and the “indirect” costs the utility from the consumption of the (best) alternative product B which must be forgone when product A is produced instead.
*152 The “indirect” costs of Pareto are therefore the subjective equivalent of the alternative product costs of recent neo-Austrian theorizing. Unlike the neo-Austrians, however, Pareto introduced the “indirect” costs into his analysis as a supplement to, instead of as a substitute for, the “real” or “direct” costs, although he attributed to the former a much greater importance in influencing economic behavior than to the latter. Also unlike the later writers who have introduced alternative product-cost theory into the theory of international trade as a correction of the comparative-cost theory in terms of real costs, Pareto succeeded in exposing a genuine error in the comparative-cost doctrine when expounded in terms of “direct” costs alone, namely, the error of giving no consideration to the indirect costs of exports to the extent that such exports are produced by land, or other factors, with which no “direct” costs are associated but which could otherwise have been used to produce other (or the same?)
commodities for domestic consumption.
*153 The doctrine of comparative costs, to meet this criticism, would have to be restated in terms of “real” costs plus those indirect costs not already covered in the real-cost accounting.

In the last few years the value theory assumptions of the doctrine of comparative costs have been subjected to extended criticism, most notably by Ohlin,
*154 Haberler,
*155 and Mason.
*156 Taussig, on the other hand, has defended the value assumptions of the doctrine as sufficiently in accordance with the facts to provide a substantial foundation for the conclusions made to rest thereon.
*157

Taussig concedes that the real costs or the “sacrifices” associated with labor and capital are “in their nature incommensurable,”
*158 as they are not, or are not in the same degree, as between different types of labor. He makes no attempt to reduce them to commensurability or to find a basis for restating the doctrine of comparative costs in terms of labor-plus-capital real costs. He attempts to show, however, that over a wide range of cases where labor and capital both enter into production, the presence of capital charges will not make the comparative money-cost ratios different from what they would be in the absence of capital charges.
*159 Where this is the case, then the course of trade—i.e., the commodities which each country imports or exports and the limiting ratios within which they can exchange for each other—will be the same as if there were no capital costs.

Taussig succeeds in showing that there are many cases in which the introduction of capital costs, although it changes absolute money costs or even relative money costs within a country, leaves comparative money costs the same as they would be if there were no capital costs. All of these cases fall under one
general category, however, where, assuming that there are no other expenses at the margin except wages and interest, the ratio between the percentages of wage (or interest) expense to total marginal expense for the two commodities is the same in both countries.

Let the two commodities be designated by
a and
b, respectively, the two countries by 1 and 2 respectively, wage cost at the margin by
w, capital cost at the margin by
c, and total marginal cost per unit by
t. Then:

Suppose that if trade is opened with the outside world copper will be imported from abroad in exchange for wheat on the terms indicated by the slope of the
FF’ line, which is tangent at
G to the production curve,
AB, and at
H to another consumption indifference curve of our country,
NN’, which is higher than
MM’, and is therefore taken to represent a greater total utility than
MM’. If the slope of
FF’ is taken to represent the equilibrium terms of exchange of copper for wheat under foreign trade, our country will under equilibrium produce
og copper and
oe wheat; will consume
oh copper and
of wheat; and will import
gh copper and export
fe wheat. The amount of copper and of wheat available to it for consumption will therefore both be greater under foreign trade than in the absence of such trade. Whatever the slope or the point of tangency with the production curve
AB of the
FF’ line, provided it is not the same as the
mm’ line, foreign trade will result in our country having available for consumption a combination of copper and wheat which will be on a higher consumption-indifference curve than
MM’ and therefore will indicate a greater total utility than
MM’, although less may be consumed of one of the commodities under foreign trade than in the absence of such trade. Foreign trade, therefore, necessarily results in gain. Such is the opportunity-cost theory as applied to the problem of gain from trade.

The opportunity-cost approach encounters, therefore, on the income side, the same type of difficulty of weighting in the absence of knowledge of the proper weights as does the real-cost approach on the cost side. It remains to be demonstrated that the opportunity-cost approach avoids the difficulties on the cost side only by avoiding recognition of the considerations which give rise to these difficulties. Let us return to the production or
AB curve, and examine its implications. On a true production-indifference curve, any two points would represent the product-combinations resulting from two allocations of productive activity equally attractive to the choosing agent after due consideration had been given to everything associated with such activity except the product outcome. As presented, the
AB curve constitutes merely a series of maximum-possible combinations of product when a given stock of productive factors is employed, presumably to its physical maximum. In an actual situation, the actual product-combination would not be on this curve, but would be somewhere below it, if the amounts of the factors, or the extent to which they prefer leisure to employment, were dependent on the rates of remuneration and if the equilibrium rates of remuneration were lower (or higher) than those rates which would induce each factor to render the maximum amount of productive service of which it was physically capable. Even if the extent of employment of the factors was fixed, their allocation as between copper and wheat would be dependent, not only, as is assumed in the diagram and in the opportunity-cost
theory, by the relative demands for copper and wheat and the productivity functions of the factors with respect to copper and wheat, but also by the relative preferences of the factors as between employment in copper production and in wheat production. Given the existence of such preferences, then even for a single individual the true production-indifference curve would not be
AB, but some other curve lower than
AB at some points at least, and higher at none. The opportunity-cost theory thus escapes the difficulties connected with preferences for leisure as compared to employment, preferences as between employments and variability of the supplies of the factor, only by ignoring them.

Haberler, in his later and more qualified exposition of the opportunity-cost theory as a substitute for the doctrine of comparative real costs, does take up the case of equalizing differences in wages, which I claim presents a difficulty for the opportunity-cost theory but not for the doctrine of comparative costs. He confines himself, however, to saying that “obviously the correct procedure” is “to take into account the advantages and disadvantages of different occupations other than the money wages”
*175 which appears to me like an abandonment of the opportunity-cost doctrine as an alternative
product-cost doctrine. He gives a reference, however, to an article by Lionel Robbins, “where it is shown how this and similar cases can be dealt with by the opportunity-cost doctrine.” The only relevant material I can find in this article is the following passage:
*176

All economic changes are capable of being exhibited as forms of exchange. And hence, as Wicksteed has shown, they can be exhibited further as the resultant of demand operating within a given technical environment. It has been said that this becomes impossible if account be taken of the so-called other advantages and disadvantages of different occupations. Professor Viner…has urged this particular objection. The difficulty, however, seems to be capable of a simple
solution. If the other advantages and disadvantages are treated as joint products, the Wicksteed constructions can still be maintained.

In this passage, and elsewhere in the same article, except for the suggestion he makes that, in effect, “value of alternative product” be substituted for “alternative product” in the formula, Robbins is
verbally adhering to the original opportunity-cost doctrine, the doctrine that the cost of production of product A is the alternative product, B, whose production is forgone if A is produced. But the doctrine which he here expounds has no point of conflict with analysis in terms of real costs except in choice of terminology and in its implied suggestions that its emphasis upon choice between alternatives is novel and that, even in this vale of tears, man is required to choose only between
attractive alternatives. By calling the excess of pleasurableness of occupation A over occupation B a “joint product” of A—and presumably by calling the excess of irksomeness of occupation C over occupation D a subtraction from the product of C, or, perhaps, by denying that occupations can be irksome—the “product” terminology is retained while proper account is taken of the significance for prices of choices between other alternatives than products. By the same terminological procedure, I suppose, if the alternative to producing E were producing F plus increased leisure, the increased leisure would also be termed a product, of “not-working,” I take it. If a smaller product
now should be chosen in preference to a larger product of the same kind
in the future, such terminological virtuosity would not be overtaxed if required to find some way of expressing this preference as a preference for a larger “product” over a smaller one. But if the opportunity-cost theorists are now prepared to admit that all of the factors regarded by the real-cost theorists as influencing the determination of prices should be taken into account in explaining their determination and in appraising their significance, their insistence upon calling all of these factors “products” and their imputation of serious error to those of us who persist in regarding “real costs” as a better term for some of them, will not dampen the ardor of my welcome to them as belated converts to analysis in terms of
real costs. Even with the aid, however, of the genuine contribution which the opportunity-cost technique can make to the treatment of land-use costs, the doctrine of comparative costs succeeds in demonstrating
the profitability of trade only subject to the fairly important assumptions and qualifications examined above. In the next chapter I will endeavor to show that analysis of the strictly income aspects of foreign trade adds strength in certain respects to, but reveals additional weaknesses in other respects in, the case for free trade, and leaves it in that state of persuasiveness associated with incomplete demonstration which seems to be a universal characteristic of propositions of economic theory relating to questions involving human welfare.

61.

Edgeworth presents only chart VIII (a) as drawn above. If wages were equal in both countries, then
would be zero, and
o and
o‘ would be on a level with each other.