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• Preface
• Studies In the Theory of International Trade
• Chapter I: English Theories of Foreign Trade, Before Adam Smith: I
• I. Introduction
• II. “ Mercantilism” and “bullionism”
• III. the Balance-of-trade Doctrine
• IV. Reasons For Wanting More Bullion
• V. Employment and the Balance of Trade
• Chapter II: English Theories of Foreign Trade, Before Adam Smith: Ii
• I. Legislative Proposals of Mercantilists
• II. the Collapse of Mercantilist Doctrine
• III. Some Modern Interpretations of English Mercantilism
• Chapter III: The Bullionist Controversies: I. The Inflation Phase
• I. the Participants In the Controversy
• II. the Factual Background
• III. Premium On Bullion As Evidence of Excess Issue: the Bullionist Position
• IV. Qualifications Conceded By the Bullionists
• V. Possible Objections to the Bullionist Position
• VI. the Anti-bullionist Position
• VII. the Balance of Payments Argument
• VIII. the Possibility of Excess Issue By Banks
• IX. Responsibility For the Excess Issue: Bank of England Vs. Country Banks
• X. Responsibility For Excess Issue: the Credit Policy of the Bank of England
• Chapter IV: The Bullionist Controversies: II. The Deflation Phase
• I. the Resumption of Cash Payments
• II. Responsibility of Resumption For the Fall In Prices
• III. the Economic Effect of Changing Price Levels
• IV. Ricardo's Position On the Gold Standard
• V. Reform Without Departure From the Metallic Standard
• VI. Paper Standard Currencies
• Chapter V: English Currency Controversies, 1825–1865
• I. Introduction
• II. the “currency School” -“banking School” Controversy
• III. the “palmer Rule ”
• IV. the Bank Act of 1844
• V. the Possibility of Overissue of Convertible Bank Notes
• VI. the Role of Deposits, Bills of Exchange, and “credit” In the Currency System
• VII. the Technique of Credit Control
• VIII. the Relation Between Bank of England Operations and Specie Movements
• IX. Currency Reform Proposals
• Chapter VI: The International Mechanism Under a Simple Specie Currency
• I. Introductory
• II. the Mechanism According to Hume
• III. an Omitted Factor? Relative Changes In Demand As an Equilibrating Force
• IV. Prices In the Mechanism: the Concept of “price Levels ”
• V. the “terms-of-trade” Concept
• VI. the Prices of “domestic” Commodities
• VII. the Mechanism of Transfer of Unilateral Payments In Some Recent Literature
• VIII. a Graphical Examination of Pigou's Analysis 1
• IX. Some Elaborations On the Basis of Pigou's Analysis
• X. an Alternative Solution
• XI. Types of Disturbance In International Equilibrium
• XII. Specie Movements and Velocity of Money
• XIII. Commodity Flows and Relative Price Levels
• XIV. Exchange Rates
• XV. A Criticism of the Purchasing-power Parity Theory 1
• Chapter VII: The International Mechanism In Relation to Modern Banking Processes
• I. Automatic Vs. Managed Currencies
• II. Primary and Secondary Expansion of Means of Payments
• III. Short-term Loans In the International Mechanism
• IV. Primary and Secondary Expansion In Canada , 1900–13
• V. the International Mechanism and Business Cycles
• Chapter VIII: Gains From Trade: the Doctrine of Comparative Costs
• I. the Nature and Origin of the Doctrine
• II. the Division of the Gain From Trade
• III. Trade In More Than Two Commodities
• IV. Trade Between More Than Two Countries
• V. Transportation Costs
• VI. Increasing and Decreasing Costs
• VII. Prices, Money Costs, and Real Costs
• VIII. Dependence of Comparative Cost Doctrine On a Real-cost Theory of Value
• IX. Differences In Wage Rates In Different Occupations
• X. Variable Proportions of the Factors and International Specialization
• XI. Variable Proportions of the Factor and Comparative Real Costs
• XII. “ Opportunity Cost” Analysis As a Substitute For Real Cost Analysis
• Chapter IX: Gains From Trade: the Maximization of Real Income
• I. “ Mass of Commodities” and “sum of Enjoyments”: Ricardo and Malthus
• II. Reciprocal Demand and the Terms of Trade
• III. Terms of Trade and the Amount of Gain From Trade
• IV. “ Net Benefit” In International Trade: Marshall
• V. Total Net Utility Derived From International Trade: Edgeworth
• VI. the Gain From Trade Measured In Money
• Appendix: a Note On the Scope and Method of the Theory of International Trade

IV. Prices in the Mechanism: the Concept of “Price Levels”

An adequate exposition of the role of price changes in the mechanism of international trade as it affects a particular country would explain both what would be the necessary relationship under equilibrium between prices in that country and prices abroad, and in what manner if any fluctuations of prices would contribute to, or would be associated with, the restoration of equilibrium when it had been disturbed. In tracing the development of doctrine on these questions, it is once more convenient to begin with Hume. For our present purposes it is convenient to accept as the predominant criterion of equilibrium in international trade under an international metallic standard a situation in which there is an even balance of payments, i.e., no flow, and no tendency to flow, of bullion or specie from country to country.1

Hume held that when the balance of payments of England with the outside world was even, the “level of money” in England and in neighboring countries would also be equal, subject to minor qualifications. The mechanism of international trade operated to bring money to a common level in all countries, just as “all water, wherever it communicates, remains always at a level.” Hume meant by “level of money” the proportion between money and commodities:

It must carefully be remarked, that throughout this discourse, whenever I speak of the level of money, I mean always its proportional level to the commodities, labor, industry, and skill, which is in the several states. And I assert that where these advantages are double, triple, quadruple, to what they are in the neighboring states, the money infallibly will also be double, triple, quadruple.2

Modern usage makes it tempting to translate “level of money” by average value or purchasing power of money as against commodities in general, with some statistical average of prices as its reciprocal. But this would be an anachronism as far as Hume, or even as the classical school as a whole, was concerned. Hume wrote before the first attempt in England, that of Evelyn in 1798, to measure changes in price levels by means of statistical averages.3 Even after 1798, the leading economists until the time of Jevons either revealed no acquaintance with the notion of representing, by means of statistical averages, either a level of prices, or changes in such level, or found it inacceptable for various reasons, good and bad.4 While a number of crude index numbers were constructed during the first half of the nineteenth century, none of the classical economists, with the single exception of Wheatley, would have anything to do with them.5

Hume's use of the term “level” troubled some of the classical economists. Wheatley claimed that Hume was inconsistent in arguing both that money everywhere maintained its level and that one country might retain a greater relative quantity than another, “which is incompatible with the nature of a level.” 6 Ricardo, in his published writings, seems to have avoided the use of the term “level” for the general state of prices, although he used it in this sense freely in his private correspondence.7 He refused to acknowledge that there was any satisfactory way of comparing the value of money, or of bullion, in different countries:

When we speak of the high or low value of gold, silver, or any other commodity in different countries, we should always mention some medium in which we are estimating them, or no idea can be attached to the proposition. Thus, when gold is said to be dearer in England than in Spain, if no commodity is mentioned, what notion does the assertion convey? If corn, olives, oil, wine, and wool, be at a cheaper price in Spain than in England, estimated in those commodities, gold is dearer in Spain. If, again, hardware, sugar, cloth, &c., be at a lower price in England than in Spain, then, estimated in those commodities, gold is dearer in England. Thus gold appears dearer or cheaper in Spain, as the fancy of the observer may fix on the medium by which he estimates its value.8

Malthus denied that money necessarily maintained a uniform level in different countries, if by uniformity of level was to be understood necessary equality of the prices of some specified commodity or of the “mass of commodities.” 9

What then were the views of the classical writers with respect to the relationship of prices and of the value of gold in different countries? The following seems to be a correct interpretation of their general position: (1) When they speak of the value of money or of the level of prices without explicit qualification, they mean the array of prices, of both commodities and services, in all its particularity and without conscious implication of any kind of statistical average; (2) when they postulate a tendency for the uniformity of the value of money, or of prices, in different countries, they have reference only to particular identical commodities taken one at a time, and only to transportable commodities, and they claim such a tendency for uniformity only subject to allowance for transportation costs both for the commodities and for the specie; (3) where the monetary units are not the same, or where different standards are in use, they postulate uniformity in the prices of identical commodities only after conversion into a common currency unit at the prevailing rate of exchange, and they postulate uniform ratios between the prices of different transportable commodities in the currencies of the respective countries.10

Most of these propositions are implied in the following passage from Hume:

The only circumstance that can obstruct the exactness of these proportions, is the expense of transporting the commodities from one place to another; and this expense is sometimes unequal. Thus the corn, cattle, cheese, butter, of Derbyshire, cannot draw the money of London, so much as the manufactures of London draw the money of Derbyshire. But this objection is only a seeming one; for so far as the transport of commodities is expensive, so far is the communication between the places obstructed and imperfect.11

In spite of the obscurity of his exposition, it seems clear that Ricardo would have subscribed to these propositions, and that where occasional statements in his writings appear to conflict with them the inconsistency is only apparent. Thus Ricardo says at one point that “the value of money is never the same in any two countries” and that “the prices of the commodities which are common to most countries are also subject to considerable difference” 12 but the context shows that he had in mind the differences in different countries in the purchasing power of gold over particular commodities which were due to the cost of transporting gold, to bounties and tariffs, to the cost of transporting goods, and to the existence of non-transportable “home commodities” which, according to him, would be higher in price in countries where the effectiveness of labor in export industries and therefore also the wages of labor were comparatively high, and he included as an element in the value of money its purchasing power in terms of labor, which he assumed to be a non-transportable commodity.13 In a letter to Malthus, Ricardo conceded that the situation suggested by Blake, where gold moved from France to England although the value of gold in terms of commodities was constant in France and rising in England, was possible though improbable, and explained the possibility of such divergent trends of the value of gold by reference to the transportation costs of commodities and the existence of non-transportable commodities.14

Wheatley held that in the absence of tariff barriers “corn and manufactures ... would always be brought, or have a constant tendency to be brought to the same proportion and price in all countries, with the exception of the charge of transit between them. A difference to the extent of this charge might always exist; but if trade were open, the difference in the price of corn and manufactures, in any two countries, could never exceed the expense of bringing in the one and taking out the other.” 15

The classical school and its important followers all held the same views on this point: after allowance for transportation costs, the market prices of identical transportable commodities must everywhere be equal or tend to be equal when expressed in or converted to a common currency.16 When, therefore, critics of the classical theory have taken it to task on the ground that it explained the adjustment of international balances by the influence on the course of trade of divergent market prices in different markets of identical transportable commodities,17 or when followers of the classical theory have attempted to defend it although themselves giving it such an interpretation,18 they have misinterpreted the classical doctrine.

When costs connected with transportation, including tariff duties as such, are taken into account, prices in two markets for identical commodities can vary independently of each other within the limits of the transportation costs in either direction between these markets, except as a connection of both markets with a third market may impose narrower limits. Assuming only two markets, A and B, a cost of transportation from A to B of m, and from B to A of n, and a technological possibility of the production of the commodity in either A or B, and it is possible, (1) when P_a is the price in A, for the price in B to be anywhere from P_a+m to P_an, and (2) when P_b is the price in B, for the price in A to be anywhere from P_b+n to P_b—m. If the commodity is regularly moving from one market to the other, the price in the buying market must obviously be higher than the price in the selling market by exactly the cost of transportation, but the possibility of reversal of direction of movement, or of cessation or initiation of movement because of substitution in one country of domestic production for import or of import for domestic production, makes the double-transportation-cost range of possible relative variation in price potentially of practical significance.19

It may be objected that some difference, slight though it may be, must exist between the market prices of identical commodities in different regions, even in the absence of transportation costs, if there is to be any inducement to move the commodities from one region to the other. This is not true, however, with respect either to intranational or to international trade. When there is no intermediary between buyer and seller, the selling price and the buying price, f.o.b., are the same price whether the buyer is here or abroad. The only difference in price necessary to induce export from A to B of a particular commodity, transportation costs being assumed to be zero, is an excess in the actual or potential supply price at which B can procure the commodity from any source other than A in the quantities required by B over the price at which it can be procured from A.

Such changes in relative sales prices of identical commodities in different markets as may occur within the limits of the transportation costs and may result in the complete cessation or initiation of movement, or in a reversal of the direction of movement, of the particular commodities affected, can ordinarily be a minor, but only a minor, factor in bringing about adjustments of the course of trade to disturbances of moderate duration such as international loans. It is relative changes in the supply prices of identical commodities as between different potential sources of supply, and, above all, relative changes in the actual sales prices of different commodities which, through their influence on the direction and extent of trade, exercise a significant role in the mechanism of adjustment of international balances.

[1]This definition, of course, would fit only either a static world in which the world stock of monetary gold was subject neither to accretion from mines nor to depletion by wear and tear or industrial use, or else a world in which each country produces the gold it needs for industrial consumption or to replace monetary wear and tear.

[2]Essays, 1875 ed., I, 335–36, note.

[3]Sir George Shuckburgh Evelyn, “An account of some endeavours to ascertain a standard of weight and measure,” Philosophical transactions of the Royal Society of London, 1798, part 1, pp. 175–76.

[4]Cf., e.g.: Ricardo, Proposals for an economical and secure currency [1816], Works, p. 400:

It has indeed been said that we might judge of its value [i.e., the value of money] by its relation, not to one, but to the mass of commodities. If it should be conceded, which it cannot be, that the issuers of paper money would be willing to regulate the amount of their circulation by such a test, they would have no means of so doing; for when we consider that commodities are continually varying in value, as compared with each other; and that when such variation takes place, it is impossible to ascertain which commodity has increased, which diminished in value, it must be allowed that such a test would be of no use whatever. Cf. also, Malthus, review of Tooke, Quarterly review, XXIX (1823), pp. 234–35: ibid., Principles of political economy, 1st ed., 1820, p. 126; William Jacob, An historical inquiry into the production and consumption of the precious metals, 1831, II, 375–76; Arthur Young, An inquiry into the progressive value of money in England, 1812, p. 134; Tooke, in Report from Select Committee on banks of issue, 1840, p. 337.

[5]Wheatley was sharply rebuked by Francis Horner for his reliance on Evelyn's index number, with which Horner found fault on the basis both of genuine shortcomings in its mode of construction and of objections, weighty and otherwise, to the index number logic.—“Wheatley on currency and commerce,” Edinburgh review, III (1803), 246 ff.

[6]Essay on the theory of money, I (1807), 2–3. The inconsistency is not apparent. The equality of level which Hume posited was not between absolute quantities of money but between the proportions of quantities of money to quantities of commodities, i.e., prices and he conceded the possibility of differences in these proportions only if money was hoarded, or, for metallic money, if paper money was also used, or where equality of proportions was disturbed by differences in transportation costs as between export and import.

[7]E.g., Letters to Malthus, pp. 16, 34, 57, 196.

[8]Principles, Works, p. 228.

[9]Inquiry into the nature and progress of rent, 1815, p. 46, note.

[10]The uniformity posited, it must be noted, is between sale or market prices in the two areas, not between cost prices.

[11]Essays, 1875 ed, I, 336, note.

[12]Principles, Works, p. 81.

[13]Cl. ibid., pp. 81 ff. Cf. also High price of bullion, appendix to 4th ed. (1811), Works, p. 293.

[14]Letters of Ricardo to Malthus (May 3, 1823), p. 151.

[15]Essay on the theory of money, II (1822), 103.

[16]Torrens (The budget, 1844 ed., Introduction, pp. liii ff.) shows that an attempt by Lawson to refute his argument based on the Cuban illustration rests on the “absurd assumption” that there could prevail great differences in price for identical commodities in Cuba and England, whereas his conclusions “had been deduced from the assumption, that (carriage and merchant's profit being excluded from the calculation, for the sake of simplicity and brevity) when the price of cloth fell to 20 s. per bale in England, it would be sold for 20 s. per bale in the markets of Cuba; and that, when the price of sugar in Cuba rose to 40 s. per cwt., it would be sold in the markets of England for 40 s. per cwt.”

Whewell, in 1856, in what was presented as mainly an uncritical mathematical exposition of J. S. Mill's doctrines on international trade, formulated what he called the “principle of uniformity of international prices,” to the effect that, transportation costs being abstracted from, “when the international trade has been established, the relative value of all commodities which are exported and imported is the same in the two countries.” —“Mathematical exposition of some doctrines of political economy. Second memoir,” Transactions of the Cambridge Philosophical Society, IX, part I (1856), 137–39.

See also, for similar reasoning: Longfield, Three lectures on commerce, 1835, p. a5; Cairnes, Essays in political economy, 1873, pp. 70 ff.; ibid., Some leading principles, 1874, p. 409; Marshall, Money credit & commerce, 1923, p. 228; Taussig, “International freights and prices,” Quarterly journal of economics, XXXII (1918), 411–12.

[17]E.g., Laughlin, Principles of money, 1903, p. 379: “Evidently, the classical theory counted on a change of all prices in England in such a manner that the whole English level would be, for a time, higher or lower than the general level in the United States, and would, in this manner, occation new exports or new imports.” Cf. also: Nicholson, Principles of political economy, II (1897), 288; Wicksell, “International freights and prices,” Quarterly journal of economics, XXXII (1918), 405.

[18]Cf. A. C. Whitaker, “The Ricardian theory of gold movements,” Quarterly journal of economics, XVIII (1904), 236 ff., and my comments thereon in Canada's balance, pp. 206 ff.

[19]Convinced apparently that a reversal in the direction of movement of a commodity is practically inconceivable, one writer has found something absurd in my statement of these elementary propositions in my Canada's balance.—See L. B. Zapoleon, “International and domestic commodities and the theory of prices,” Quarterly journal of economics, XLV (1931), 425, note.—But such instances have occurred in the past, and it was the case of butter in Canada before 1913, which shifted from the export to the import class, which brought their possibility to my attention.

To my argument that a substantial range of fluctuation of the relative prices of the same commodity in two different markets is possible if the commodities are bulky or are subject to import duty, Bresciani-Turroni has replied: “Experience however shows that in many cases even for commodities for which transportation costs or import duties are very high there exists an equilibrium between prices in different countries and that goods move from one country to another as soon as the equilibrium is disturbed.” (Inductive verification of the theory of international payments, 1932, p. 97. note.) He claims that for international commodities there is a “normal difference” in their prices in two markets, corresponding to the costs of transportation and of duties, and that “When the actual agread in prices is not equal to this ‘normal difference,’ the disturbed ‘parity’ will soon be reestablished through movements of goods” (ibid). What he says is, indispetable, and has not been, disputed for commodities which do commodity move in international trade and always move only in one particular direction. But it does not cover adequately the full range of possibilities, and takes no account, in particular, of two possibilities, for, let us say, a commodity, wheat, which has been moving from country A to country B. First, the departure from “parity” in the price of wheat in country B may be such as to stop raffer than to stimulate the movement of wheat, i.e., the price of wheat in B may fall below its import parity, with the result that import ceases, perhaps permanently. Secondly, the fall in the price of wheat in country B relative to its price in country A may be so great as to carry the price in B from import parity with respect to country A to export parity with respect to country A, i.e., may reverse the direction of movement of the wheat.