Front Page Titles (by Subject) CHAPTER 15: INTERNATIONAL TRADE - Economics, vol. 2: Modern Economic Problems
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CHAPTER 15: INTERNATIONAL TRADE - Frank A. Fetter, Economics, vol. 2: Modern Economic Problems 
Economics, vol. 2: Modern Economic Problems, 2nd edition, revised (New York: The Century Co., 1923).
Part of: Economics, 2 vols.
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§ 1. Benefits of international trade. § 2. Erroneous views of benefits. § 3. Relatively advantageous industries. § 4. Persistence of differences between nations. § 5. Doctrine of comparative advantages. § 6. Advantages confused with monetary costs. § 7. Equation or international exchange. § 8. Balance of merchandise movements. § 9. Cancelation of foreign indebtedness. § 10. Par of exchange. § 11. International monetary balance and price levels.
§ 1. Benefits of international trade. International trade is carried on by individual traders in any two countries. What motive impels men to trade across the political boundaries of a state? The simple answer is that each trader has something to give and desires to get something in return. Each is seeking to get something that has to him a greater value than the thing he gives, and he believes he can do this in trade with a foreigner better than by trading at home. In any trade, both parties gain, or think they are gaining.1 In international trade there is the same chance for mistake as in domestic trade, but no more. In a single transaction in either domestic or foreign trade one party may be cheated, but the continuance of trade relations is dependent upon continued benefits. The once generally accepted maxim that the gain of one in trade is the loss of another is now generally rejected, but often still it is assumed to be true of international trade. The starting-point for the consideration of this subject is in this proposition: Foreign trade is carried on by individuals, for individual gain, with the same motives and for the same benefits as are found in other trade.
The advantages of international trade are indeed but those of division of labor in general, in the particular case where it happens to cross political boundaries. The great territorial divisions of industry are determined first and mainly by natural differences of climate, soil, and material resources. Thus trade arises easily between North and South, between warm and frigid climates, between new countries and old, between regions sparsely and regions densely populated.2
Territorial divisions of industry are determined, secondly, by social and economic differences such as those with respect to accumulation of wealth, amount of lendable capital, invention, organization and intelligence of the workers, and the grade of civilization.
§ 2. Erroneous views of benefits. Certain erroneous explanations of the advantages of foreign trade may be dismissed with brief mention. It is said to give vent for surplus production and to give a wider market to what would otherwise go to waste. This involves the same fallacy as the “lump of labor notion,” the destruction of machinery, and the praise of waste and luxury.3 If it were true that sale to backward nations were now necessary to give an outlet for products that would otherwise rot in the warehouses, a time would come at length when the world would have an enormous surplus unless neighboring planets could be successively annexed. Again it is said that the great purpose of foreign trade is to keep exports in excess of imports, so that the money of the country may constantly increase in amount. The ideal of such theorists is an impossible condition where the country would constantly sell and never buy.4 In the narrow commercial view of the subject the sole object of foreign trade is to afford a profit to the merchants, regardless of the welfare of the mass of the citizens.
§ 3. Relatively advantageous industries. Foreign trade normally imparts increased efficiency to the productive forces of each country. In most cases it is apparent that labor is more effective and gets a larger product when it is applied in those ways for which the country is best fitted and for which it offers the best and most bountiful materials. When two countries are somewhat differently situated, such as an old country like England and a newer country like the United States in the nineteenth century, the relative advantages of various industries in the two countries are very unlike. The newer country excels in its broad area, its abundant rich lands, its bountiful natural resources of forests and mines. These are the superior opportunities that give the economic motives for settlement and for continued immigration from other lands. Most of the newcomers find it to their advantage to develop the peculiar opportunities of the new land, rather than to go on producing the same things in the same way as they did in the old country.5 Thus they get a larger quantity of products per day’s labor, and are able to gain by trading a part of these for the products of the older country. Thus the characteristic industries of the two countries must differ. Further, when special branches of industry have developed at one place, they make possible the advantages of large production and of high specialization. Without any government supervision, therefore, but simply through the choice of enterprises, each citizen seeking the best occupation and best investment of capital for himself, industries are developed in which each country is either most markedly superior, or least inferior to its neighbors. If either laborers or capitalists in the new country were to turn to the less-favored industries they would be forced to accept a smaller reward than they can earn in the more favored.
§ 4. Persistence of differences between nations. If both men and wealth interchanged between industries and between countries with perfect readiness and without any outlay whatever for transportation, these differences would soon disappear, and perfect equilibrium of advantage would everywhere result. In every country, in every occupation, labor and wealth of given quality and amount would receive the same reward. But the interchange of labor and of products between countries is never without friction.
The laborers, enterprisers, and investors in a naturally rich country are thus in a position of more or less enduring advantage relative to those of older and poorer countries. Differences of the same nature appear as between different parts of the same country, as between the northern and the southern states of the American Union, between the eastern and the western states, and even between neighboring towns in the same state. The differences between two countries, however, are likely to be more marked, the circulation of factors being so active within a country that it is allowable to speak broadly of prevailing national rates of wages, of interest, and of profit. Although, as Adam Smith said, “a man is of all sorts of luggage the most difficult to be transported,” the higher wages in a new country attract constantly from the older lands a portion of their laborers. The higher rate of interest in new countries constantly attracts investments from abroad; yet, despite these forces working toward equalization, the inequality may remain and, through the working of other influences, may even increase in the course of years.
§ 5. Doctrine of comparative advantages. It may be that two countries both possess the necessary technical conditions for making both articles that are to be traded for each other. It may even be that the people in one country would be able to make not only one of the two objects of trade, but both of them, more easily and with less sacrifice and effort than the people in the other. If, for example, American labor can produce two bushels of wheat in a day and English labor but one bushel a day; and American labor can produce just as much iron in a day as English labor—or more—the question always arises: Is it not foolish and wasteful not to produce both the wheat and the iron?
Now, exactly the same case is presented in almost every simple neighborhood trade. The proprietor may be able to keep his books better than does the bookkeeper whom he employs. The merchant may be able to sweep out the store better than the cheap boy does it. The carpenter may be able to raise better vegetables than can the gardener from whom he purchases. Yet the merchant does not turn to sweeping and the carpenter to raising vegetables, because if they did they would have to quit or limit by so much their present better-paying work, and would lose far more than they would gain.
So whenever the people in one country have a greater advantage in one article than in another, relative to another country, the foreigners, like the low-paid man, will be willing to exchange at a ratio that will make it profitable to specialize in the product wherein the greater superiority lies.
As an example, suppose that a day’s labor in country A will secure two bushels of wheat (2x) and two hundred pounds of iron (2y), whereas in B a day’s labor will secure 1x or 2y. Then A’s comparative advantage in producing x becomes a reason for A’s not trying to produce y. Trade can take place (aside from transportation outlay) at any ratio between 2x = 2y (A’s minimum) and 2x = 4y (B’s maximum). Evidently at any rate between these two ratios each party would gain something by the trade, e. g., at 2x=3y A would get 3 instead of 2y by a day’s labor, and B would get 1⅓x instead of 1x for a day’s labor (2x for 1½ day’s labor instead of for two days’). There can be no motive for trade unless the ratio of exchange is such as to enable the producers in each country to get somewhat more goods by specializing than they could get by applying their labor and resources to both kinds of products.
§ 6. Advantages confused with monetary costs. The doctrine of comparative advantages is always a hard doctrine for the popular mind; and particularly for the commercial mind endeavoring to carry on a business that cannot be made to “pay” in the face of foreign competition. It is easy to believe that a country ought not to import goods unless it is at an absolute disadvantage in their production. It is often declared that as our country can produce any kind of goods “as well” as foreign countries (meaning with as few days’ labor), there is a loss on every unit imported. The fundamental principle of trade as applied to such cases shows that not the advantage which one country enjoys over the other as to a single product determines whether it will gain by producing at home, but the comparative advantages enjoyed in the production of the two articles in question.
The difficulty of clear thinking in this matter is increased by the fact that this theory usually has been, and still is, presented under the name of “the doctrine of comparative costs.” The word “costs” is very misleading in this connection, because it is now generally applied to enterpriser’s outlay. It seems best, therefore, to replace it in this phrase by the word “advantages.” Of course, it never can be true that an article can be “profitably” imported when its monetary costs (all things considered, freights, insurance, merchant’s profit, etc.) are higher in the exporting than in the importing country. Indeed, the importation of any article is proof conclusive that the importer thinks that the monetary costs of an article are higher in the importing than in the exporting country.
How does it happen that the monetary costs of any particular goods in one country are higher than those of another country? The answer to this can be made only in the light of the equilibrium theory of prices.6 “Monetary costs” are but the prices reflected to agents from the products which they aid to produce. The relatively short factor in each of the trading countries is priced higher, the relatively long factor is priced lower, than in the other country. For example, agricultural land in England is priced higher (in grains of gold) per acre than equally good land in America, and an ordinary day’s labor in America is priced higher than similar labor in England. The manufacturer in America who is trying to manufacture something in which the labor element is large has to go into the labor market and pay higher wages than his English competitor just because there are other industries that can afford to outbid him for that labor; whereas the English farmer trying to produce wheat finds that he has to pay land rent per acre much higher than his American competitor in North Dakota whose wheat is sold in Liverpool. These differences in relative prices within each country have important effects in the degree of intensiveness of utilization of economic agents, both human and material. Men often speak carelessly as if America were a country of uniformly high prices, compared with Europe, but that is because they are thinking only of the kinds of goods that we import. American (wholesale) prices of the things we export to Europe are lower than European prices; if they were not the things could not profitably be exported. These facts and principles are contrary to much of the popular and political opinion with regard to protective tariffs.
§ 7. Equation of international exchange. Foreign trade, of course, can take place as barter, and in earlier times very commonly did so. But in the existing monetary economy nearly all trades are expressed in terms of monetary prices. It was shown in the last section that both the prices of all the particular objects of international trade and the general levels of prices in any two trading countries come to be pretty definitely interrelated. Changes in the one country at once compel readjustments in the other. To understand in the most general way how this occurs, a knowledge at least of the elemetary principles of foreign exchange is required, and to this we may now turn.
Let us begin with the proposition known as the equation of international exchange, which is sometimes given thus: The valuation (that is, the estimated total price) of the imports of a country must in the long run equal the valuation of the exports. But this proposition (especially the words “imports” and “exports”) must be understood in a much broader sense than that of the movements of merchandise merely. The proposition might better be expressed: the total credits in international trade, created by whatever means, by a nation (including money actually sent abroad) must constantly just equal its total debits (including money imported). Into the balance of accounts between any two nations enter many items: the cash values of the imports and exports of merchandise; freights, insurance premiums, and commissions; the expenses of citizens while traveling abroad; money brought in or taken out by immigrants; the cost of the governmental foreign services (such as the salaries of consuls and of diplomatic representatives); subsidies and war indemnities received from or paid to foreign nations; the investments of foreign capital; and credit items of many kinds on both sides of the account.
The effect of loans upon the equation differs at different periods, according as they are just being made, are continuing, or are being repaid. When foreign capital is first invested in a country, whether it is lent to the government or to individuals or to corporations, either gold must be remitted to the borrowing country or goods be sent. But later the interest payments and the eventual repayment of the principal of the loan act in the opposite direction. Accruing interest must be offset annually by exports from the debtor country, and the repayment of the principal requires that either money or goods be exported equal in value to the original obligations. In popular opinion an excess of exports of merchandise is an index, if not the real cause, of national prosperity; but evidently it is no true index whatever on this point. An excess of exports may at any given moment indicate that the country is rich and is lending abroad, or that it is in debt and is paying interest, or that it is repaying the principal. On the other hand, an excess of imports may indicate either that a country is poor, and is borrowing from abroad, or that it is rich, with many foreign investments, and is receiving the income from them in the form of a regular shipment of goods from the debtors.
The following statistics of the foreign commerce (merchandise imports and exports) of the principal countries of the world are given in significant groupings which call for various explanations. As the war altered all the lines of commerce, these figures are retained as illustrating the principle and the normal conditions better than could recent figures.
Figures are in million dollars ($1,000,000) and are mostly for the year 1908. (Statistical Abstracts, 1908, p. 769.)
§ 8. Balance of merchandise movements. The first group apparently consists of the older, creditor countries which are drawing some of the income of their investments from abroad each year in the form of food and of raw materials of many kinds. The second group includes countries of very diverse conditions, possibly all having some investments abroad; Italy receives large imports in return for the services of many Italians working in foreign countries, and the three Scandinavian countries (especially Norway) carry on a large commerce for other nations which is paid for in these ways. The excess of imports in the third group probably is the result of new investments that were being made in Canada by English and American capitalists, in Turkey especially by Germans, and in China by Americans and Europeans.
The countries in the second column are doubtless on the whole debtors, but in varying degrees. The excess exports of some are insufficient even to pay all the current interest, and they are borrowing still more (possibly the British colonies, Japan, and several South American countries); others have ceased to borrow and are simply paying interest; whereas the United States at least with its excess of exports was at this time both paying interest and getting out of debt. With the outbreak of the war in 1914 the United States began rapidly buying up its foreign-held securities, and became a creditor nation. Its imports must therefore in future more nearly equal if not exceed its exports, the actual outcome being dependent as well on various other items in the balance as on those here considered.
§ 9. Cancelation of foreign indebtedness. In the international business of any two important countries to-day, such as England and America, the number of credit and debit transactions is enormous. If each trader had to attend to the forwarding of the means of payment for his purchases, he would, of course, deduct from the amount of his indebtedness the amount due him from his foreign correspondent, and might from time to time “remit” the balance in the form of a shipment of gold. This simple offsetting and cancelation of debits and credits would greatly limit the amount of gold that would have to be shipped. But still, under such conditions, there must be a very large number of shipments of gold by different individuals, and a large proportion of these shipments would be going in opposite directions at the same time. Now, a merchant in New York called M may have a balance to pay in London to X, and at the same time a merchant in London called Y have a balance to pay in New York to a man called N. If M can buy from N his claim in the form of an order, draft, or bill of exchange, and send it to X, the latter may through his bank collect the sum from Y. In this way a further cancelation of indebtedness would occur.
When all persons having either debits or credits to be paid in New York and in London, respectively, are dealing with the banks in these cities, and the banks and special exchange brokers are constantly buying and selling these bills, a market is created for London exchange in New York (and conversely in London), and a much easier and more nearly complete cancelation of indebtedness results. In effect, all the debits and credits between the two countries are merged into one big ledger balance, and the international shipment of gold bullion finally made is just the amount needed to balance the accounts payable at the time. Industrial indebtedness is represented in various forms: bills of lading for goods shipped, drafts made by the creditor on his debtor for goods shipped or property sold, checks or letters of credit for travelers, bonds and notes public and private. These are the objects dealt in by the bankers who are the agents to carry on the work of exchange.
The balance of foreign exchanges is of essentially the same nature as the domestic cancelation of indebtedness. It is going on constantly between the two merchants in the same town, between two banks in the same town who represent groups of merchants, between men in neighboring towns, and between distant states like New York and California.6 The price of exchange to the individual is reduced by the specializing of the business in the hands of a few dealers, permitting the cancelation of indebtedness or offsetting of exchange, and greatly reducing the amount of bullion to be transported in making the payments. The cost to the bank of providing this exchange for its customers varies as conditions change, but in any case is not great, so that in domestic business when any charge is made it is usually at a fixed rate, and is mainly for the service.
§ 10. Par of exchange. Foreign exchange from America to Europe is, however, in two features different from domestic exchange: (a) the cost of shipment of gold is greater; (b) the monetary units of the two countries usually differ in name, weight, and fineness, and sometimes in materials. We may define foreign exchange as the purchase and sale of the right to receive a given kind and weight of metal or its monetary equivalent in current funds at a specified time and place, or as the funds so purchased. Par of exchange between two countries using the same metal as a standard is the number of units of the standard coin of the one country that contains the same amount of fine metal as the standard coin of the other country. There is no fixed par of exchange between gold-using and silver-using countries; par of exchange between them fluctuates with changes in the comparative values of the two metals. The gold-shipping points for importing or exporting gold are respectively par of exchange plus or minus the cost of moving the actual metal. These points vary with means of transportation and communication. The par of exchange between New York and London being nearly $4.866 and the cost of expressing and insuring a gold pound between New York and London being approximately $.02,7 the shipping point for the export of gold from New York is $4.886 and for the import of gold to New York is $4.846. At these upper and lower limits, there is a motive for shipping gold as a commodity.
When large sales have been made to Europe and credits are accumulating in New York and the importation of gold is imminent or already begun, the claims are bought by bankers in New York at less than par. At such a time one needing to remit a sum to London can buy exchange for less than par, for every such draft remitted reduces London’s indebtedness and, by so much, the need of shipping gold to this country. As a rule, then, accumulating credits here mean a low rate of exchange, accumulating debits a high rate of exchange from this to the foreign country.
These are the merest rudiments of the subject. The many problems arising, such as the adjustment of foreign credits to changing needs, and such as arbitrage (the readjustment of the rates of exchange prevailing among different financial centers), make foreign exchange both a complex science and a difficult art.
§ 11. International monetary balance and price levels. The balance of all accounts for or against a country (including new loans, current interest, and repayments) must thus eventually be settled in money. This cannot fail to effect the general level of prices in both countries, though this is brought about often only in indirect and gradual ways. The flow of money out of a country causes the loan market of a country to tighten (interest and discount rates to rise) in proportion as the reserves of the banks are reduced. Then “general prices” begin to fall.8 When prices fall, imports decline, as the country is not so good a place in which to sell: when prices rise, imports increase, as it is a better place in which to sell. The opposite effect is produced on exports, and thus in a short time the national credits and debits are again brought into equilibrium. A slight movement of money in either direction is enough to influence prices and set in motion forces to counteract a further flow of money. Decade after decade the circulating medium of leading countries changes very slightly in amount, and the fluctuations in its amounts during periods of so-called “favorable balance of trade” and of “unfavorable balance of trade” are only the smallest fraction of the value of goods passing through the ports of the country.
It is therefore absurd to imagine, as is sometimes done, that a country could continually import goods until it was drained of all its money, or that by any possible set of devices it could forever have an excess of exports to be paid for by a continual inflow of gold. Long before either of such movements could go far, the automatic readjustment of international prices would inevitably check it, and secure and retain for each country its due portion of the money.
[1 ]See Vol. I, ch. 5, § 1 and § 7.
[2 ]See Vol. I, ch. 6, § 11, on the origin of markets.
[3 ]See Vol. 1, chs. 36 and 37.
[4 ]Recall ch. 3, in general, on the nature of monetary demand.
[5 ]See Vol. I for numerous statements of the effects of varying quantities of agents upon the economy of utilization; e.g., pp. 138, 163, 164, 213, 228, and chs. 34 and 35 entire.
[6 ]See, e. g., Vol. 1, pp. 71, 162, 213, 227, 399-404, 438.
[6 ]See ch. 7, sec. 8.
[7 ]This varies also with conditions; after the outbreak of the war in 1914 it was for a time as high as $.05 because of high war rates of insurance.
[8 ]The connection between a high rate of interest and falling prices is a dynamic phenomenon of a very temporary nature. In long-time static conditions the general level of prices and the prevailing rate of interest are dependent on entirely different sets of forces. See on the theory of interest, Vol. I, p. 308. In long-time movements of prices, in contrast with brief changes due to foreign trade such as are referred to above, high rates of interest are connected with rising prices, and vice versa. See above, ch. 6, § 12, on fluctuating price levels and the interest rate.