The Online Library of Liberty

A project of Liberty Fund, Inc.

• 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

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.1 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.2

Although Ohlin presents this analysis in a controversial manner and as a radical correction of the errors of the classical school, the appearance of conflict between his own position in this respect and that of the classical writers and their followers is in large part the result of Ohlin's treatment of the doctrine of comparative costs in terms of labor costs as the only classical attempt to explain the forces determining the nature of international specialization and of his failure to allow for the fact that this doctrine was directed primarily to answering another question, the question of gain or loss from foreign trade. Ohlin is correct in his claim that the doctrine of comparative costs when expounded in terms of a single factor, or of fixed and uniform combinations of the factors, cannot serve effectively to explain the influence on the course of international trade of teh differences in the proportions in which the different factors enter into the production of different commodities and the differences as between different countries in the relative abundance of the different factors. But he goes further, and claims that by their adherence to the doctrine of comparative costs the classical school were prevented from even dealing with these considerations:

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.3

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.” 4 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.5 Of early writers in English, Ohlin cites only Longfield6 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.

The classical economists, it is true, revealed no great interest in the detailed explanation of the forces which determined the nature of the international specialization existing in their time. But they did not wholly ignore the question, and when they did touch on it their adherence to the doctrine of comparative costs did not prevent them from dealing with it on lines similar in essentials to those followed by Ohlin.

In the course of critical comment on Adam Smith's doctrine that capital employed in agriculture gave more employment to labor than capital employed in other industries, Ricardo explained as follows the forces determining the nature of international specialization:

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.7

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.8

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.9

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.10

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.11

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,12 as well as by citations from later writers, American and Continental, who were more or less under the classical school influence.13 Such recognition has been an especially prominent feature of Taussig's analysis,14 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,15 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.

[1]Interregional and international trade, 1933, p. 590.

[2]Ohlin recognizes that different rates of remuneration in different industries will also be a factor in determining the nature of a country's specialization. He would grant also, I suppose, that relative differences between countries in the prices of the factors and in their effectiveness result in differences in the methods by which the same commodities are produced, as well as in differences in the commodities produced, and that the abundance and quality of “free goods” is an important element in determining the productivities of the “scarce” factors.

In his general mathematical exposition of international equilibrium, Ohlin treats as the same factor in the two regions “only factors of identical quality in the two regions” (ibid., p. 560, note), thus abstracting from the necessity of dealing expressly with the role in international trade of comparative differences in “effectiveness” of the factors as between the different industries and regions. (For the purposes of international trade theory, the “effectiveness” of a factor should be understood to mean its marginal physical productivity function with respect to variations both in the amount of that factor and the amounts of the other factors associated with it in production.) Ohlin, in his criticism of Taussig's analysis, seems to forget, for the time being, that Taussig had not made the same abstraction, but that, on the contrary, he had always placed marked emphasis on the importance of comparative differences in “effectiveness.” Unless it is assumed that each factor, in each industry, has identical “quality” or effectiveness in the two regions, Ohlin's contention that international trade would be impossible if Taussig's assumption of identical relative scales of wages and interest in the two regions were applicable to all factors, or if Taussig's assumption of identical proportions of labor and capital in all industries were applicable to all factors and both regions (ibid., pp. 561–62), is incorrect in both cases. In each case, the existence of comparative differences in effectiveness would suffice to provide a basis for trade.

[3]Interregional and international trade, pp. 30–31. It obviously does not preclude the study of varying proportions between labor and land. Ohlin lays special emphasis on the variable proportions between labor and capital, as a reaction, no doubt, against the Ricardian assumption—at times—of fixed proportions between labor and capital. But the Ricardian analysis is more vulnerable in its treatment of land as an element in cost than in its treatment of capital. I venture the guess, moreover, that the relative abundance of natural resources as compared to all other factors taken together has been in the past, and continues to be today, a much more important element in determining the nature of international specialization than the relative abundance of capital as compared to labor. Cf., to the same effect, N. G. Pierson, Principles of economics (translated from the Dutch), II (1912), 195.

[4]Ibid., pp. 30–31.

[5]Cf. Wealth of nations, Cannan ed. II, 100: Our merchants frequently complain of the high wages of British labor as the cause of their manufactures being undersold in foreign markets; but they are silent about the high profits of stock. They complain of the extravagant gain of other people; but they say nothing of their own. The high profits of British stock, however, may contribute towards raising the price of British manufactures in many cases as much, and in some perhaps more, than the high wages of British labor.

[6]See supra, p. 494.

[7]Principles, Works, p. 211. In a footnote Ricardo adds: “If countries with limited capitals, but with abundance of fertile land, do not early engage in foreign trade [i.e., the carrying and entrepót trade?], the reason is, because it is less profitable to individuals, and therefore also less profitable to the State.” It was a familiar doctrine in the eighteenth century that only countries like Holland, rich in capital and poor in natural resources, could specialise in the entrepót trade.

[8]Principles, Works, pp. 100–01.

[9]Principles of political economy, 2d ed., 1836, pp. 106–07. The above quotation reproduces only part of the relevant material. See also the first edition of the Principles, 1820, pp. 104–5. Cf. also Malthus, The measure of value, 1823, p. 47: “It is evident, therefore, that the values which determine what commodities shall be exported, and what imported, depend ... partly upon the quantity of labor employed in their production, partly upon the ordinary rates of profits in each country, and partly upon the value of money.” Malthus explains that by “value of money” he means the “money price of labor.” (Ibid., p. 46.)

[10]J. R. McCulloch, Principles of political economy, 2d ed., 1830, pp. 355–56 (also in later editions). McCulloch is taking for granted, along Ricardian lines, that the quantity of money remains constant, and that a rise in money wages must consequently be accompanied by a fall in interest rates.

[11]Some leading principles of political economy, 1874, pp. 119–20.

In connection with his discussion of the relation between wage levels and the course of foreign trade, Cairnes (ibid., p. 327, note) pointed out that a general change in the rate of wages in a country, by resulting in relative changes in the money cost of production as between industries in which fixed capital was important and industries in which outlays on wages were important, would affect the course of trade. On the ground that “these are details ... into which it is scarcely necessary to enter in arguing the general question of the effect of wages on foreign trade,” he did not attempt to explain in detail the nature of the changes which would occur. He claimed, however, that a fall in wages “might easily have the effect of checking instead of promoting the exportation of an article if it happened to be one in the production of which fixed capital was largely employed.”

[12]Cf., e.g., Thomas Hopkins, Economical enquiries, 1822, pp. 84–86; Lord Stourton, Three letters ... on the distresses of agriculture, new ed., 1822, pp. 62–64; John Rooke, Free trade in corn, 2d ed., 1835, pp. 22–23; J. S. Eisdell, Trentise on the industry of nations, 1839, I, 343.

E. G. Wakefield cited, in 1833, the following passage from the London Times as representing a prevalent English opinion (England and America, 1833, II, 47–48): All political writers in this country have visited with censure the present policy of the American general governemnt in attempting by high protecting duties to force the establishment, or to encourage the extension, of manufactures in the United States. With the high price for labor that exists in the United States, with their scanty supply of monied capital, with their unlimited range of uncultivated or half improved soil, it was almost a crime against society to divert human industry from the fields and the forests to iron forges and cotton factories.

[13]E.g., Francis Bowen, American political economy, 1870, p. 484; N. G. Pierson, Principles of economics, II (1912), 192–95; Angell, Theory of international prices, 1926, p. 472. Ohlin (op. cit., p. 33) makes acknowledgements to an important contributions (in Swedish) by Hecksher, in 1919.

[14]Protection to young industries, 2d ed., 1884, pp. 7–12; Some aspects of the tariff question, 1915, chap. iii and passim; International trade, 1927, chap. vii.

[15]Especially in his Some aspects of the tariff question, 1915.