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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

I. “Mass of Commodities” and “Sum of Enjoyments”: Ricardo and Malthus

In the comparative-cost approach to the problem of gain from foreign trade, the stress is put on the possibility of minimizing the aggregate real costs at which a given amount of real income can be obtained if those commodities which can be produced at home only at high comparative costs are procured through import, in exchange for exports, instead of being produced at home. In the later development of the theory of international trade, several methods of dealing with the income aspects of foreign trade are introduced, and in the exposition of Marshall and Edgeworth, though the comparative costs are still a factor in the situation,1 they appear in the analysis only implicity through their influence on the reciprocal-demand functions, which, in so far as they are welfare functions, represent “net” income or income-minus-cost quantities.

Ricardo and Malthus, in the course of a discussion of concrete problems of trade policy, offered some indication of the nature of the “welfare” presuppositions of their gain analysis. In Mill, Marshall, and Edgeworth these presuppositions are left unexpressed, as far as their international-trade analysis is concerned, and must be inferred from their other writings. As will perhaps be made evident, it is a question whether Marshall and Edgeworth, notwithstanding their more elaborate techniques of analysis, improved substantially upon what Ricardo and Malthus said, scanty though that was, with respect to the criteria of gain or loss from foreign trade.

Malthus attributed to Ricardo—whether rightly or wrongly is open to argument—the position that the saving in cost under free trade resulting from obtaining the imported commodities in exchange for exports instead of by domestic production not only demonstrated the existence of gain from trade but measured the extent of the gain. To this proposition Malthus objected that the excess in the cost of domestic production of the imported commodities over the cost of obtaining them in exchange for exports provided a grossly exaggerated measure of the gain from trade where the imported commodities could not be produced at home at all or could be produced only at extremely high costs.2

Mr. Ricardo always views foreign trade in the light of means of obtaining cheaper commodities. But this is only looking to one half of its advantages, and I am strongly disposed to think, not the larger half. In our own commerce at least, this part of the trade is comparatively inconsiderable. The great mass of our imports consists of articles as to which there can be no kind of question about their comparative cheapness, as raised abroad or at home. If we could not import from foreign countries our silk, cotton and indigo ... with many other articles peculiar to foreign climates, it is quite certain that we should not have them at all. To estimate the advantage derived from their importation by their cheapness, compared with the quantity of labor and capital which they would have cost if we had attempted to raise them at home, would be perfectly preposterous. In reality no such attempt would have been thought of. If we could by possibility have made fine claret at ten pounds a bottle, few or none would have drunk it: and the actual quantity of labor and capital employed in obtaining these foreign commodities is at present beyond comparison greater than it would have been if we had not imported them.

Malthus held that the gain from trade consisted of “the increased value which results from exchanging what is wanted less for what is wanted more”; foreign trade, “by giving us commodities much better suited to our wants and tastes than those which had been sent away, had decidedly increased the exchangeable value of our possessions, our means of enjoyment, and our wealth.” 3 Malthus, here as elsewhere, meant by “value” or “exchangeable value” not value in terms of money but purchasing power over labor or “labor command.” He reached the conclusion that foreign trade increases the sum of “labor command” in the following fashion: foreign trade, when it results in a new assortment of commodities available for use which is “better suited to the wants of society” than the pre-trade one, increases income in the form of profits without a proportionate decrease in other forms of income, and therefore increases the amount of money available for payment as wages, or the demand for labor; wages do not rise in proportion to the rise in total money income; therefore the new income constitutes a greater sum of “labor command” than the old one.4 Malthus would, therefore, presumably deny that there was gain from foreign trade if money wage rates rose relatively as much as total monetary income, so that there was no increase in “labor command.” To measure gain by the increase in “labor command” without reference to the terms on which labor can be commanded is a fantastic procedure if laborers are recognized as constituting part of the population.

Malthus would have done much better if he had stopped with the exchange of “what is wanted less for what is wanted more” as constituting the content of the gain from foreign trade. He got into this muddle in an attempt to rebut the proposition with which Ricardo's famous chapter on foreign trade opens: “No extension of foreign trade will immediately increase the amount of value in a country.” 5 Malthus regarded this as an absurd proposition, whereas if he had ever succeeded in mastering Ricardo's peculiar use of terms he would have seen that it was a sterile truism. Ricardo's proposition rests upon his use of the quantity-of-labor cost as the measure of value and upon his tacit assumption that foreign trade influences what labor shall produce but does not affect immediately how much labor shall be engaged in production.

Ricardo, however, did not measure gain by changes in “value” as defined by him, and therefore did not deny that foreign trade resulted in gain. After laying down his proposition that foreign trade will not immediately increase the amount of value in a country, Ricardo went on to say that “it will very powerfully contribute to increase the mass of commodities, and therefore, the sum of enjoyments.” 6 What was intended by Ricardo as the main proposition was, at least for our present purposes, of no importance. The incidental comment, on the other hand, was of great importance. It suggests two income tests of the existence, and perhaps also two income measures of the extent, of gain from trade, namely, an increase in the “mass of commodities” and an increase in the “sum of enjoyments.” Ricardo did not expand these suggestions, but in his Notes on Malthus he repeated them: if two regions engage in trade with each other “the advantage ... to both places is not [that] they have any increase of value, but with the same amount of value they are both able to consume and enjoy an increased quantity of commodities,” adding, however, that “if they should have no inclination to indulge themselves in the purchase of an additional quantity, they will have an increased means of making savings from their expenditure.” 7

Both types of test, needless to say, involve in their application serious logical or practical difficulties. The “mass of commodities” is significant only as it is accepted as a measure or index of the “sum of enjoyments” and the “sum of enjoyments” is not itself directly measurable. The use of “mass of commodities” as a measure of gain from trade, or even as an index of the direction of change, would involve in practice the use of an index number of national real income. As in the case of the measurement of real costs, the determination of the proper weights for the quantities of different commodities presents serious, and in strict theory insoluble, problems. There is no evidence that Ricardo gave any thought to these problems. Malthus, however, in defending his own “labor command” test, succeeded in locating the most vulnerable point in the “mass of commodities” test. Where the commodities imported were such as in the absence of foreign trade could not have been produced at home, or could be produced only at prohibitively high costs, Malthus objected, “we might be very much puzzled to say whether we had increased or decreased the quantity of our commodities,” 8 presumably because after trade the country would have more of the imported but less of the native commodities than before trade with no means available of comparing exactly the amount of increase in the one with the amount of decrease in the other.

Malthus could have gone further: even if there were more of every commodity after trade as compared to before trade, the removal of the duties would certainly have resulted in an increase in the quantity of commodities in any physical sense, but there would not necessarily have been an increase in real income or in “sum of enjoyments.” The argument should scarcely call for elaboration. The removal of duties tends to alter the distribution of the national money income unfavorably for the owners of the services entering relatively more heavily into the production of the hitherto protected commodities than into the production of the export commodities. The removal of duties tends also to raise to domestic consumers the prices of the export commodities relative to the prices of the hitherto protected commodities. Suppose that labor enters relatively more heavily into the production of the protected commodities than into the production of the export commodities, and that labor is a heavy consumer of the export commodities but a light consumer of the protected commodities. The removal of the duties, therefore, operates injuriously to labor in two ways: it lowers the relative share of labor in the national money income, and it raises the prices, relative to other commodities, of the things on which labor spends its wages. It is still possible that labor may gain from the removal of the duties, for under the conditions given it is still possible for the buying power of money wages over the things laborers buy to be greater after the removal of the duties than before. Even if labor does lose, other classes will necessarily gain more than labor loses in physical income, if in measuring physical income the quantities of particular commodities are weighted for purposes of summation by their prices under free trade, or their prices under protection, or any intermediate scale of prices, and if the import duties were not merely nominal but were actually restrictive of import of the dutiable commodities.9 But if labor is relatively a low-income class, the removal of import duties might result in a loss of physical income to labor which, weighted by its utility coefficient, might conceivably be greater than the gain in the physical income of the other classes, similarly weighted by its utility coefficient. It is possible, therefore, that even with the usual abstractions from short-run immobilities and rigidities, from monopoly conditions, and from changes in aggregate real cost on the production side, free trade may result in an impairment of psychic income. But the combination of adverse circumstances necessary to produce this result is so formidable as to justify the conclusion that there is ordinarily a strong presumption that free trade—given the usual long-run assumptions—will increase the national real income. Economic analysis can here at best yield only strong presumptions, but this limit in the power of economic analysis extends to the entire field of welfare analysis.

Haberler, on the basis of a combination of a priori and empirical considerations, claims that in the long run the functional distribution of real income is unlikely to be appreciably different under free trade than under protection, and that in so far as it would change with the adoption of free trade the change would more probably be favorable than unfavorable to labor. Free trade, he argues, will result in a rise in the real prices of those factors which are “specific to” the export industries; it will result also in a rise, though a lesser one, in the real prices of non-specific factors; and it will result in a fall in the real prices of those factors which are specific to the protected industries which must reduce their operations or disappear under free trade. Labor is in the long run the least specific of all factors. It will therefore be in the intermediate position, and will gain from the general increase in productivity.10

While Haberler's conclusions may be sound, this reasoning seems inadequate justification for them. Haberler uses “specific” to mean occupational immobility, whether due to technical or to other causes. He compares the mobility of only labor and “material means of production,” which latter is scarcely an elementary factor of production. Natural resources of the agricultural or mining type are no doubt the most specific of the factors, but in the long run it would seem to be free capital and not labor which is the least specific. In any case, it would seem to be not occupational mobility in general, but occupational mobility as between the tariff-sheltered and the unsheltered industries which would be of primary significance for this problem. If labor was used relatively heavily by the protected industries, relatively lightly by the unsheltered industries, and if its marginal productivity decreased slowly in the former and rapidly in the latter as more labor was employed while the other factors were held constant, the removal of tariff protection would lessen the relative share of labor in the national money income. I see no a priori or empirical grounds for holding this to be an improbable case. But even if labor on the average had low occupational mobility and were employed relatively heavily in the protected industries, its real income might still rise with a removal of tariff protection even though its money income and its relative share in the national money income and the national real income all fell, if it was an important consumer of the hitherto protected commodities, and if the prices of these commodities fell sufficiently as a result of free trade to offset the reduction in money wages in the new situation.

The concessions made above to the protectionist case do not qualify the conclusion that free trade—given the usual assumptions—necessarily makes available to the community as a whole a greater physical real income in the form of more of all commodities, and that the state, if it chooses, can, by appropriate supplementary legislation, make certain that the removal of duties shall result in more of every commodity for every class of the community. When the Cobden Treaty was negotiated, Proudhon complained that while it admittedly made cottons cheaper and more abundant in France, it made wine dearer and scarcer, and that the French masses lost more from the latter consequence of the treaty than they gained from the former. It cannot be said with confidence, on a priori grounds alone, that Proudhon was mistaken. But the French government could have brought it about that the Cobden Treaty should not result in a reduction in wine consumption in France—or by any stratum of the French population—by levying special income taxes on the class which consumed cotton goods relatively most heavily and using the proceeds to subsidize the class which consumed wine relatively more heavily, or by levying internal consumption taxes on cottons (at lower rates than the effective amount of the import duties which had been removed) and using the proceeds as a subsidy to domestic wine consumption, or by some other stratagem of this general character, designed to offset an undesired effect of the reduction of duties on the distribution of the national income.

Free trade, therefore, always makes more commodities available, and, unless it results in an impairment of the distribution of real income substantial enough to offset the increase in quantity of goods available, free trade always operates, therefore, to increase the national real income. That the available gain is ordinarily substantial there is abundant reason to believe, but the extent of the gain cannot in practice be measured in any concrete way. These conclusions, which are little more than a paraphrase of some words of Cairnes's,11 are, in my opinion, very nearly as far as the argument can with advantage be carried. The remainder of the chapter is devoted to an examination—as sympathetic as I can make it—of the more elaborate methods of analysis by which J. S. Mill, Marshall, Edgeworth, and others obtained results which were, seemingly at least, more precise and conclusive, with respect to the income gains from trade.

[1]The tendency on the part of Marshall and Edgeworth to allow cost analysis to recede into the background, and to deal with the question of gain or loss from trade primarily in terms of income analysis is in sharp contrast with Allyn Young's contention that the treatment of the problem should be solely in terms of costs: “Here again the study of costs affords the only practicable road to conclusions respecting net gains or losses. Gains come from economies. The economies of international trade are by no means an exact measure of its net benefits. But that net benefits are more or less according as the economies secured are more or less, is a justifiable assumption.” —“Marshall on consumer's surplus in international trade,” Quarterly journal of economics, XXXIX (1924), 150. (Italics in the original.)

[2]Malthus, Principles of political economy, 1st ed., 1820, pp. 461–62. (Italics in the original text.)

[3]Ibid., p. 462.

[4]Cf. ibid., p. 460.

[5]Ricardo, Principles of political economy, 1st ed., 1817, p. 107.

[6]Ibid.

[7]Notes on Malthus [1820], p. 215. Ricardo means presumably that the increased income can be saved and invested instead of being immediately consumed.

[8]Principles, Ist ed., p. 462. Ricardo would not have disputed this. Cf. Principles, Works, 260: “One set of necessaries and conveniences admits of no comparison with another set; value in use cannot be measured by any known standard; it is differently estimated by different persons.”

[9]In a limiting case, where under constant cost conditions the relative prices of all the various commodities would be the same under free trade as their relative costs of production at home, import duties could still be restrictive of import without affecting the amount of the national real income, the distribution of the national money income, or the relative prices of different commodities.

[10]The theory of international trade, 1936, pp. 193–95.

[11]“We know the nature of the gain [from trade]: it consists in extending the range of our satisfactions, and in cheapening the cost at which such as in its absence would not be beyond our reach are obtained; and we know that the amount which it brings to us under each of these categories cannot but be very great; but beyond this indefinite and vague result our data do not enable us to pass.” (Some leading principles of political economy, 1874, p. 421.)