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EXCHANGE - John Stuart Mill, The Collected Works of John Stuart Mill, Volume II - The Principles of Political Economy with Some of Their Applications to Social Philosophy (Books I-II) 
The Collected Works of John Stuart Mill, Volume II - The Principles of Political Economy with Some of Their Applications to Social Philosophy (Books I-II), ed. John M. Robson, introduction by V.W. Bladen (Toronto: University of Toronto Press, London: Routledge and Kegan Paul, 1965).
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“Happily,” said Mill, “there is nothing in the laws of value which remains for the present or any future writer to clear up; the theory of the subject is complete.” This was injudicious. Professor Schumpeter, commenting on the state of the economic science just before World War I in his Preface to Dr. Zeuthen’s Problems of Monopoly,40 gave one reason for thinking it injudicious:
There was a belief that the great work had been done—a belief very similar to that expressed by Mill in that famous passage. . . . In a sense, this attitude was both right and fruitful. Great work had undoubtedly been done, and it was certainly necessary to bend to the task of defending, expounding and applying it. Yet there was some danger of petrifaction ahead, and the almost immediate rise of anti-theoretic schools of thought . . . is the proof that Theory was about to pay the penalty for that air of finality which was beginning to get on the nerves of the rising generation in very much the same way as it did in the case of Mill.
It appeared injudicious, too, in the light of the new theory of the “neoclassics” which soon emerged as victor (albeit a relatively considerate and co-operative victor) in the “war of the methods.” Because there has been some misunderstanding as to the nature of the advance made from Mill to Jevons, and consequently some misunderstanding of Mill, I propose to state very briefly what I consider to have been the real improvements.
The new analysis of marginal utility seems to me to be the least important element: the solution of the paradox of water and diamonds was academically interesting but little was added, if anything, to the understanding of the role of demand in the process of exchange. The essential notion of elasticity of demand, present in Adam Smith, was clarified in Mill and only waited to be christened by Marshall. The notion of “consumers’ sovereignty,” again without the name, was basic to the economics of Mill, as of Adam Smith: and it might well be argued that this general notion of appropriate economic organization makes more sense than the precision of the demonstrations of the conditions for maximizing utility, having in mind the fact that the utility for any individual is unmeasurable and that interpersonal comparisons are strictly impossible. Edgeworth’s verdict on Mill’s performance, in his article in Palgrave’s Dictionary of Political Economy, is just: “The general theory of demand and supply seems to be stated by Mill as clearly as is possible without the aid of mathematical apparatus.”41 If utility analysis added little to the general theory of demand, the utility theorists did make very important advances. Perhaps the most important advances lay in the clear recognition of the simultaneous pricing of goods and factors of production, and of the generality of the notion of “variable proportions” leading to elucidation of the role of substitution. Closely related was the development of the concept of “alternative opportunity” as the basis of cost. Much of the confusion of the classics in dealing with capital appears to me to have been compounded by the capital theory of Jevons and Bohm Bawerk, but the way out was demonstrated by Walras when he treated the pricing of the services of people and of durable goods as essentially the same and went on to discuss the pricing of the durable goods as the sources of those services. Perhaps equally important with these specific advances lay the advance towards more precision in the specification of models with the promise of more rigorous theory and with the clearer obligation to recognize the difficulty of using such theory in understanding the real economic process, in diagnosing its ills and in prescribing remedies.
When the pricing of the factors of production is seen as part of a whole process of equilibrium, the organization of Mill’s Principles appears very odd. Distribution is the subject of Book II; pricing is left to Book III. It is true that he says that he has not “escaped the necessity of anticipating some small portion of the theory of Value, especially as to the value of labour and of land” (II.455.12-3), but, at the end of Book III, the chapter on “Distribution as Affected by Exchange” is devoted to the thesis that distribution is not affected by exchange. “Wages depend on the ratio between population and capital; and would do so if all the capital in the world were the property of one association, or if the capitalists among whom it is shared maintained each an establishment for the production of every article consumed in the community, exchange of commodities having no existence” (II.695.26—696.2). Similarly, rent: “Exchange, and money, therefore, make no difference in the law of rent” (II.698.9-10). And profits: “Wages and Rent being thus regulated by the same principles when paid in money, as they would be if apportioned in kind, it follows that Profits are so likewise. For the surplus, after replacing wages and paying rent, constitutes Profits” (II.698.18-21). The verdict of Alfred Marshall is found in his Appendix J:
By putting his main theory of wages before his account of supply and demand, he cut himself off from the chance of treating that theory in a satisfactory way. . . . The fact is that the theories of Distribution and Exchange are so intimately connected as to be little more than two sides of the same problem. . . . If Mill had recognized this great truth he would not have been drawn on to appear to substitute, as he did in his second Book, the statement of the problem of wages for its solution: but he would have combined the description and analysis in his second Book, with the short but profound study of the causes that govern the distribution of the national dividend, given in his fourth Book.42
Noting Marshall’s assessment of the profundity of Book IV, perhaps one should remember the limitation, as well as the value, of the new pricing theory: Mill ignored the importance of the pricing process in the theory of distribution but his successors were too readily content with a static solution. Mill may have been unsatisfactory in his explanation of why factor prices were what they were, but he had brilliant insights into the probable trend of change. And his successors were too ready to accept a theory of the pricing of factors as a theory (not just a part of a theory) of distribution ignoring the really exciting problems of why particular people had particular factors for sale at these prices.
To the thesis that distribution is not affected by exchange is added the further thesis that the process of exchange is unaffected by money:
There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order.
The introduction of money does not interfere with the operation of any of the Laws of Value laid down in the preceding chapters.
What follows is a sequence of chapters on money, monetary theory, and monetary policy, which indicate that he knew that the “machinery” very easily got out of order, so that money was in fact far from “insignificant.” I do not propose to examine these chapters in detail but I assert that they wear well. They need to be read, however, with patience; an initial dogmatic statement is later qualified. His assertion of the “quantity theory,” for instance, is followed by qualifications which “under a complex system of credit like that existing in England, render the proposition an extremely incorrect expression of the fact” (II.516.32-4). Professor Schumpeter has said of these chapters that “they contain some of Mill’s best work. [They display] indeed some contradictions, hesitations, and unassimilated compromises . . . but even these were not unmixed evils since they brought out, in strange contrast to Mill’s own belief in the finality of his teaching, the unfinished state of the analysis of that time, and thus indicated lines for further research to follow.”43 Of the chapters on international trade the judgment is more universally favourable, the development of the relationship between reciprocal demand and the commodity terms of trade being considered by Professor Viner to constitute “his chief claim to originality in the field of economics.”44 This favourable judgment is related to his performance in the static sphere; it is only in recent years that the dynamic aspect of his trade theory has been revived. When Mill denounced the fallacy of Adam Smith’s “vent for surplus” approach to the benefit of foreign trade, “that it afforded an outlet for the surplus produce of a country” (II.592.12-3), he turned his back on the development aspects of the problem of unproductive labour, and argued on the level of the static theorists. The new concern for the economics of growth has brought new appreciation of the Adam Smith approach. Professor Allyn Young45 and J. H. Williams46 were among the first in this generation to recognize the value of that part of international trade theory that had been considered “crude” and fallacious by the orthodox. Professor Myint47 has shown that “in general, the ‘vent-for-surplus’ theory produces a more effective approach than the comparative costs theory to the international trade of the underdeveloped countries.” He recognized that this theory “does not provide an exact fit to all the particular patterns of development,” but that it is more relevant than a theory which “assumes that the resources of a country are given and fully employed before it enters into international trade.” Professor Myint was concerned with the relatively backward countries: but no countries are “fully developed” and in all it is necessary to consider more than effective allocation of given resources, in all there are some unused productive capacities, some additional resources to develop. We should pay attention therefore to what Mill has to say about the “indirect effects” of international trade “which must be counted as benefits of a high order” (II.593.24-5). One of these indirect effects is “the tendency of every extension of the market to improve the processes of production” (II.593.25-6); another is that the opening of a new market “sometimes works a sort of industrial revolution in a country whose resources were previously undeveloped for want of energy and ambition in the people” (II.593.39—594.2).
[40 ]J. A. Schumpeter, Preface to F. Zeuthen, Problems of Monopoly (London, 1930), vii-viii.
[41 ]Edgeworth, Dictionary, 760.
[42 ]Marshall, Principles, Appendix J.
[43 ]Schumpeter, History, 689.
[44 ]J. Viner, Studies in the Theory of International Trade (New York, 1957), 535.
[45 ]A. A. Young, “Increasing Returns and Economic Progress,” Economic Journal, XXXVIII (1928), 527-42.
[46 ]J. H. Williams, “The Theory of International Trade Reconsidered,” Economic Journal, XXXIX (1929), 195-209.
[47 ]H. Myint, “The ‘Classical Theory’ of International Trade and the Underdeveloped Countries,” Economic Journal, LXVIII (1958), 317-37.