Front Page Titles (by Subject) V. The Terms-of-Trade Concept - Studies in the Theory of International Trade
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V. The “Terms-of-Trade” Concept - Jacob Viner, Studies in the Theory of International Trade 
Studies in the Theory of International Trade (New York: Harper and Brothers, 1965).
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V. The “Terms-of-Trade” Concept
In the classical theory, the discussion of the role of variations in prices in the mechanism of adjustment of international balances relates not to relative variations in prices of identical commodities in different markets, but to relative variations in prices of different commodities in the same markets, and primarily to relative variations in prices as between export and import commodities. It concerns itself, therefore, with the effect of disturbances on what are now called the “terms of trade.” Changes in the terms of trade were discussed, however, with reference to two essentially distinct though related problems; first, their role in the mechanism of adjustment and, second, their significance as measures of gain or loss from foreign trade. It is only the former of these problems that concerns us in this chapter.1
The most familiar concept of the terms of trade measures these terms by the ratio of export prices to import prices, what Taussig has called the “net barter terms of trade,” and I prefer to designate as the “commodity terms of trade.” The classical economists, however, had also another concept of terms of trade, for which they tacitly accepted the commodity terms of trade as an accurate measure, so that they used the two concepts as quantitatively identical although logically distinct. This second concept, which I would designate as the “double factoral terms of trade,” is the ratio between the quantities of the productive factors in the two countries necessary to produce quantities of product of equal value in foreign trade.
From Hume on, there was general agreement that some or all types of disturbances in international balances would result in changes in the terms of trade, and that these changes would contribute to the restoration of equilibrium. As has been shown, Hume held that a relative change in the quantity of money in one country as compared to other countries would result in a rise in the prices of its products relative to the prices of foreign products, until, as the result of the influence of this relative change in prices on the course of trade and on the flow of specie, the “level of money” had again been equalized internationally. This was almost universally accepted doctrine during the next century. Thornton and Malthus claimed, with Wheatley and Ricardo dissenting, that a similar change in relative prices would occur and would operate to restore equilibrium in the balance of payments when it had been disturbed by a crop failure or the remittance of a subsidy, and this also came to receive wide acceptance, under the erroneous designation of the “Ricardian theory.” Ricardo conceded, however, that there were some types of disturbance in an existing international equilibrium other than those originating in the currency which would affect the terms of trade, and he specified an original change in the relative demand of two countries for each other's products and a tariff change as disturbances of this sort.2 There is ground for distinguishing in this connection between different types of disturbances, and Ricardo's distinctions have some measure of validity. In the account which follows of later treatments of the question, only the historically most important controversies are referred to.
Irish Absenteeism.—The economic consequences for Ireland of the absenteeism of Irish landlords was a burning issue in the eighteenth and nineteenth centuries and gave rise to extensive discussion. The Irish complaints against absenteeism often rested on mercantilist arguments to the effect that the remittance of the rents abroad represented an equivalent loss of specie to Ireland. The English classical economists, notably McCulloch, tended to be satisfied that when they had demonstrated that the remittances were ultimately transferred in the form of goods rather than in specie they had also demonstrated that absenteeism was not economically injurious to Ireland. An early instance of this argument follows:
When it is considered that, if in the natural order of things, undisturbed by such a measure as the restriction on specie, the remittances to absentees, by causing a balance of pecuniary intercourse against Ireland, would force an export from thence wherewith to pay it, and restore the level, it may be fairly concluded that the absentees, by bringing over their money to England, force the manufacture or produce to follow them, which, but for their coming, they would necessarily have caused to be used at home, the only difference is, that the produce or manufactures which their incomes naturally promote, would come to be consumed or used in England, in the stead of being consumed or used in Ireland; and thus the encouragement to the productive industry of Ireland may be said to operate in both cases ... 3
Longfield4 introduced into the controversy the question of the effect of absenteeism on the Irish terms of trade, apparently for the first time in print.5 He insisted that it was important to examine whether the increase in Irish exports resulting from absenteeism took place “in consequence of a diminished demand [for Irish products] at home, or an increased demand abroad,” and claimed that the former was the case, because Irish landlords living abroad would not have the same demand for Irish commodities and services as would the same landlords if living in Ireland. In order to induce acceptance of the rents in goods instead of money, therefore, the Irish tenants would have to offer more goods to liquidate their indebtedness to absentee landlords than would be necessary if the landlords lived in Ireland, i.e., there would have to be a fall in the prices of Irish export products relative to the prices of imports.6
Tariff Changes.—Torrens's discussion of the effect of a tariff on the terms of trade has already been referred to.7 In his basic illustration, Torrens assumed unit elasticities of demand for sugar and cloth in both countries, production of sugar only in Cuba and of cloth only in England, and production under conditions of constant costs for both countries, and he concluded that both the commodity and the factoral terms of trade would move in favor of Cuba, the tariff-levying country. His argument was on the whole received unsympathetically by most of the economists of his time, because it seemed to them to undermine the case for free trade.8 But their criticisms, in so far as they were deserving of consideration at all, bore only on the conformity of the assumptions to real conditions. Of these criticisms, the most important was the argument by Merivale that if sugar could be produced in England as well as in Cuba, or if a third country which could produce sugar were brought into the hypothesis, the English elasticity of demand for Cuban sugar would be greatly increased, and the shift in the terms of trade in favor of Cuba would in consequence be much lessened in degree.9 The only favorable comments on Torrens's argument were by an anonymous writer in the Dublin University magazine,10 who may perhaps have been Longfield, and by J. S. Mill, who made the publication of Torrens's The budget the occasion for the publication of his own Essays on some unsettled questions, which had been written some fifteen years before, and of which the first essay presented a similar argument as to the effect of import duties on the terms of trade.
See infra, pp. 555 ff., for a detailed discussion of the terms of trade as an index of gain or loss from trade.
Cf. his evidence before (Lords) Committee on resumption of cash payments. 1819, p. 192: “Q. Do you mean that you doubt whether an increase of foreign demand has not always a tendency to increase the production and wealth of a nation? A. In no other way than by procuring for us a greater quantity of the commodities we desire in exchange for a given quantity of our own commodities, or rather for a given quantity of the produce of our land an labor.”
Report from the Committee on the circulating paper of Ireland, 1804, p. 20. Cf. also, to the same effect: Lord King, Thoughts on the effects of the Bank restrictions, 2d ed., 1804, pp. 85–86; J. R. McCulloch, “Essay showing the erroneousness of the prevailing opinions in regard to absenteeism,” reprinted from Edinburgh review, November, 1825, in his Treatises and essays, 2d ed., 1859, pp. 223–49 (in a new introduction, McCulloch says of this essay that “It helped to stem the torrent of abuse, and has yet to be answered,” p. 224); N. W. Senior, Political economy, 4th ed., 1858, pp. 155 ff.; J. Tozer, “On the effect of the non-residence of landlords, &c. on the wealth of a community,” Transactions of the Cambridge Philosophical Society, VII (1842), 189–96 (a mathematical study which begs the crucial question: “When the proprietor becomes non-resident the capital C2 + C2′ will be disengaged, because his absence destroys the demand on which its employment depended; but a new demand for such commodities as can be exported with advantage will be created by the absence, because the rent of the proprietor must now be exported”); J. L. Shadwell, A system of political economy, 1877, pp. 395–96.
M. Longfield, Three lectures on commerce and one on absenteeism, 1835, pp. 82, 88 ff., 107 ff. He discusses along similar lines the effect of an import duty on the terms of trade. Ibid., pp. 70, 105.
This claim is made for Longfield by Isaac Butt, Protection to home industry, 1846, p. 93. Cf., however, J. S. Mill, Some unsettled questions in political economy [written 1829–30], 1844, p. 43: “Ireland pays dearer for her imports in consequence of her absentees; a circumstance which the assailants of Mr. M'Culloch, whether political economists or not, have not, we believe, hitherto thought of producing against him.”
Three lectures on commerce, p. 82.
The budget, 1841–1844, passim. See supra, pp. 298–99.
A request by Torrens in 1835 to discuss some question—probably the one here under discussion—was rejected unanimously by the Political Economy Club on the ground, according to Mallet, that it turned “upon an impossible case” and “did not go to establish but to disturb a principle, that of free trade, upon grounds altogether hypothetical.” —Political Economy Club, Minutes of proceedings, VI (1921), 270. Cf. also ibid., pp. 54, 284.
Herman Merivale, Lectures on colonisation and colonies, 1842, II, 308 ff.
XXIV (1844), 721–24.