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ECONOMETRIC
VOLUME
33
July, 1965
NUMBER
A SURVEY OF THE THEORY OF INTERNATIONAL TRADE: PART 1, THE CLASSICAL THEORY BY JOHN
S. CHIPMAN*
I must give notice that we are now in the region of the most complicatedquestions which political economy affords; that the subject is one which cannot possibly be made elementary;and that a more continuous effort of attention than has yet been required,will be necessaryto follow the series of deductions.  John Stuart Mill
INTRODUCTION
that "in early life he had thought of studying economics, but had found it too difficult!"' Keynes' own interpretation of the remark was that it was not the logical structure of economic theory that had dissuaded Planck, but rather "the amalgam of logic and intuition and wide knowledge of facts, most of which are not precise, which is required for economic interpretation in its highest form." Keynes cited Planck's remark in connection with his discussion of Marshall's work in the theory of international trade, in the Pure Theory (1879) and in the famous Appendix J to Money, Credit, and Commerce (1923), which had just appearedat that time; cf. Harrod (1951, p. 137). In expressing approval of Marshall's suppression of the Pure Theory from publication, and of his habit of relegating mathematics to appendices, Keynes observed (with an obvious note of disparagement) that "Professor Planck could easily master the whole corpus of mathematical economics in a few days." Even if this had been true in 1923 (which is most doubtful), it would certainly not be true today. To illustrate the point, Brouwer's fixed point theorem (1912) had not yet been proved when Marshall wrote his Pure Theory (1879); yet it is now known that the existence of equilibrium in Marshall's theory (when expanded to
* This is the last in a series of surveyarticleswhich Econometrica is publishingwith the support of the RockefellerFoundation.Because of its length, this articlewill be publishedin three parts. Part 2 on the NeoClassicalTheory is scheduledto appearin the October, 1965 issue, and Part 3 on the Modem Theoryin the January,1966issue. Researchwas facilitatedby a grantto the author of an AuxiliaryResearchAwardby the Social ScienceResearchCouncil, as well as a grantby the National Science Foundation. Grateful acknowledgmentis made to Professor Samuelson for commentson an earlierdraft; he is not, of course, to be held responsiblefor any errorsthat remain. Equallyabsolvedare M.C. Kempand R.W. Jones,whose valuablecriticismsof a laterdraft are greatlyappreciated. 1 J. M. Keynes(1924,p. 333n).(Worksare referred to by authorand year, sometimesby abbreviatedtitle, and are listed alphabetically and chronologicallyat the end of each part of the article.) 477
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JOHN S. CHIPMAN
more than two commodities) cannot be established without it. Uzawa (1962) has shown, in fact, that Brouwer's fixed point theorem and the law of supply and demand are logically equivalent. The present survey will emphasize the mathematical structure of international trade theory as it has developed up to this time. But "mathematical" must not be interpreted in the narrow sense given to the word by Keynes. Symbols must not be confused with substance; as Schumpeter acutely observed (1954, pp. 9545), "the restatement in algebraic form of some result of nonmathematical reasoning does not constitute mathematical economics: a distinctive element enters only when the reasoning itself that produces the result is explicitly mathematical." There are two reasons for this choice of emphasis. One is that the field of international trade is particularly well provided with surveys, especially (although not exclusively) of a nonmathematical kind, and it would be pointless to try to cover ground that others have covered so well. Special mention may be made of the surveys of Edgeworth (1894), Haberler (1936), Viner (1937), Metzler (1948), Haberler (195561), Caves (1960), Mundell (1960), Bhagwati (1963, 1964), and Kemp (1964), as well as the encyclopaedic History by Schumpeter (1954). The second reason is furnished by the opening citation. Difficult problems require adequate methods, and economists have special reason to appreciate the value of capitalintensive ones. The fact that Mill could and did use mathematical reasoning without using mathematical symbols, is a tribute to his genius, and makes his achievement all the more impressive. To try to do the same today would, like swimming the Channel, excite a certain admiration but not much respect. Appropriate mathematical tools are at last becoming available for the task; while they are not a substitute for common sense, they help remove the wasteful doctrinal controversy that has been so characteristic of the subject, paving the way for the supplanting of empirical mysticism by genuine empirical inference. In bringing the history of thought in this field up to date, it seems appropriate not only to report on developments of the last two decades, but also to discuss some of the older writings, which fall into two categories: those which have been neglected and recently been brought to light, and those whose importance may have been overlooked and which can be better appreciated in the light of modern developments. In the first of these categories, I would include the name of Torrens, who discovered the law of comparative advantage, and of whose work we now possess the invaluable study by Robbins (1958). In the second category, I would place John Stuart Mill, as well as his predecessors Say, Ricardo, James Mill, Torrens, Malthus, and Sismondi, whoas has become evident from the publication of Sraffa's monumental edition of Ricardo's Works and Correspondence (19511955)discovered in the course of their lively interchanges the crucial assumptions required in order to prove the existence of competitive equilibrium. The present article deals with the theory of international values. It is divided into three parts, corresponding to the Classical, Neoclassical, and Modern theories.
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479
This division is one of convenience only, corresponding to differences in emphasis. The "classical" approach (by which I mean that of Torrens, Ricardo and Mill), while.oversimplifying things on the production side, has the advantage of bringing out sharply the nature of the problem of international specialization; this early work has come back into prominence owing to the work of McKenzie and others who recognized their relationship to mathematical programming and Koopmans' activity analysis. The "neoclassical" approach (by which I mean that of Marshall, Edgeworth, Haberler, Viner, Lerner, earlyLeontief, and Meade) rests in part on simplifications on both the production and consumption side, as represented by the concepts of opportunity cost and community indifference; the latterwhose status seems ambiguous in the literature, to say the leastis singled out for especial scrutiny. The "modern" approach, by which I understand the school of thought that began with Heckscher and Ohlin, but which did not really come into its own until recently with the work of Lerner and Samuelson, gives the most important role to factor endowment, and represents probably the most complex and impressive theoretical structure that has yet been developed in economic thought. The sequel will be concerned with capital movements, the terms of trade, and the foreign exchanges; trade and economic growth; gains from trade and commercial policy; and methodological issues in econometric studies.
1. THE CLASSICALTHEORY
The main distinguishing feature of international trade singled out by Ricardo (1817, p. 134) was the international immobility of factors of production. Factors were regarded as perfectly mobile within countries and completely immobile among countries, whereas goods were perfectly mobile within and among countries (at zero transport cost). Ricardo rather glossed over the question of the interdependence of industries, treating them as integrated, producing one output and using one primary input (labor). The latter being mobile internally, the unit cost of each good was constant, depending only on the amount of labor required to produce it. Ricardo's exposition of the laws governing trade between two nations was extremely concise, and not entirely free from ambiguity. In his celebrated example of trade in cloth and wine between England and Portugal, he says (1817, p. 135): "England may be so circumstanced, that to produce the cloth may require the labour of 100 men for one year; and if she attempt to make the wine, it might require the labour of 120 men for the same time. England would therefore find it her interest to import wine, and to purchase it by the exportation of cloth." This is a non sequitur, since nothing so far has been said about Portugal; indeed, the argument could be turned around merely by redefining the units of measurement.
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JOHN S. CHIPMAN
The next passage is equally unsatisfactory, except when read in conjunction with the first: "To produce the wine in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for cloth." But Ricardo saves himself in the passages that immediately follow by proceeding with a correct explanation of what was later to be called the law of comparative advantage. Historians of economic doctrine have debated whether priority for the law of comparative advantage should go to Ricardo (1817) or to Torrens (1808, 1815); see Seligman (1903, 1911), Hollander (1910, 1911), Viner (1937, pp. 4417), Schumpeter (1954, pp. 6078), and Robbins (1958, pp. 1835). The debate has centered around the question of (1) whether Torrens stated the principle first, (2) if so, whether correctly, and (3) if so, whether independently of Ricardo. It does not seem to have been recognized that Ricardo's own statement of the law is quite wanting, so much so as to cast some doubt as to whether he truly understood it; at best, his version is carelessly worded. Seligman (1911, p. 449) based his claims for Torrens in part on the following passage from Torrens' earliest publication (1808, p. 53): "Thus, if I wish to know the extent of the advantage which arises to England, from her giving France a hundred pounds, worth of broad cloth, in exchange for a hundredpounds, worth of lace, I take the quantity of lace which England has acquired by this transaction, and compare it with the quantity which she might, at the same expense of labour and capital, have acquired by manufacturing it at home." Hollander (1911, p. 459) objected that this statement "embodies the very error against which Cairnes warned" and proceeded to cite a statement from Cairnes (1874, p. 312) that "when it is said that international trade depends on a difference in the comparative, not in the absolute, cost of producing commodities, the costs compared, it must be carefully noted, are the costs in each country of the commodities which are the subject of exchange, not the different costs of the same commodity in the exchanging countries." In other wordsCairnes seems to be sayingif among four positive quantities, the relation a'/b'<a"/b" holds, this must not be confused with the relation a'/a" <b'/b"; but as any high school student ought to know, the two inequalities are mathematically equivalent (see Viner (1937, pp. 4389), who essentially spotted this same error in Cairnes). Thus Hollander's case against Torrens rested largely on this elementary error in rudimentary mathematics. But even then, he misread Torrens' statement, for what Torrens was comparing was the cost ratio in one country with the international price ratio; this made it possible for Torrens to provide a correct argument for the gains from trade, but the comparison of cost ratios (or rates of transformation) between two countries was lacking. The same kind of comparison was made by Torrens in the External Corn Trade (1815, pp. 2212; 1826, p. 334): "If ... any given portion of our labour and capital can, by working up cloth, obtain from Poland a thousand quarters of wheat, while it
INTERNATIONALTRADE
481
could raise, from our own soil, only nine hundred; then ... we must increase our wealth by being, to this extent, a manufacturing, rather than an agricultural people." Seligman (1911, p. 450), who cited this passage, did not help his case by misquoting it and substituting "their own soil" for "our own soil," and perhaps it was this slip that helped deceive Hollander. Torrens came closer to enunciating the law of comparative advantage in another passage in the External Corn Trade(1815, 1820, pp. 2645; 1826, 1829, pp. 3523), which has been cited by Leser (1881, pp. 823n), Seligman (1903, pp. 3445; 1925, pp. 745), Viner (1937, p. 442), and Robbins (1958, p. 23). The passage in question, like the previous ones, compared the domestic rate of transformation with the international terms of exchange, but added the most important point that this would entail England's neglecting the cultivation of "tracts of her territory, though they should be equal, nay, even though they should be superior, to the lands in Poland ...." This certainly expressed what is usually considered to be the essence of the law of comparative advantage, as Robbins (1958, pp. 223) has pointed out. By way of contrast, Ricardo's Essay on Profits, which was published on the same dayFebruary 24, 1815as Torrens' External Corn Trade (cf. Ricardo's Works, IV, p. 5), contains scarcely any recognition of the principle of comparative advantage. Apart from a rather vague statement (1815, p. 25) to the effect that trade leads to an "increase of the general rate of profits" and to "abundance of commodities," the closest Ricardo came at that time was in the statement (p. 32): "If ... left to ourselves ... we should gradually withdraw our capital from the cultivation of such lands, and import the produce which is at present raised upon them, The capital withdrawn would be employed in the manufacture of such commodities as would be exported in return for the corn. Such a distribution ... would be more advantageous, or it would not be adopted." But there is no very convincing explanation as to why it would be more advantageous, and hence adopted. Torrens' External Corn Trade undoubtedly made an impression on Ricardo, who described the work in a letter to Malthus shortly after its appearance as "on the whole a very able performance" (Works, VI, p. 188). Some years later Torrens' book was described in an article which has been attributed to Ricardo's disciple McCulloch (1819, p. 56) as "one of the most valuable contributions that has of late years been made to the science of political economy" (The attribution of this article to McCulloch will be considered in greater detail in Part 2.) There can be little doubt that Ricardo was influenced by it, whether he was conscious of the indebtedness or not; nevertheless he added a great deal in his own subsequent treatment. The juxtaposition of the two sentencesif not the literal wordingimplied comparison of cost ratios in two countries. And it is only in subsequent editions of Torrens' work that one finds statements such as the following one from the third edition (1826, p. 39): "while Poland can raise corn comparatively cheaper than England, or England prepare cloth comparatively cheaper than Po lndatter...
482
JOHN S. CHIPMAN
will become an exporting, and the former an importing, country." This passagewith a subtle and significant difference of wordinghad already been contained in the first two editions (1815, 1820, p. 38); the word "comparatively" was added in 1826 in both places.2 Furthermore, Ricardo succeeded to a greater extent than Torrens in relating the principle to a larger theoretical system. Thus it would seem fair to say that both Torrens and Ricardo contributed in essential ways to the development of the law of comparative advantage; and that credit for the principal discovery should go to Torrens.3 Even if comparative advantage explains why trade takes place, it does not explain on what terms. Ricardo is widely regarded as having maintained that the equilibrium price ratio would settle "halfway between" the comparative cost ratios.4 This conclusion is usually based on Ricardo's assertion (1817, p. 135): "Thus England would give the produce of the labour of 100 men, for the produce of the labour of 80," implying that the price ratio between cloth and wine would be equal to unity, which is intermediate between the cost ratios of 80/90 and 120/100. But if England should experience a 20 per cent increase in productivity in both industries, and if the two commodities continue to be measured in the same units, then "the produce of the labour of 100 men" which England will supply for the produce of Portugal's 80 will be 20 per cent higher in quantity; thus by Ricardo's own logic the price of wine will rise to 1.2 units of cloth, which corresponds to the
2 The second edition of the Corn Tradeis identicalwith the first except for the addition of a fourth part; the first three parts appearto have been reprintedfrom the same plates. This would explainwhy the changein wordingdid not take place until the thirdedition. Similarly,the passage referredto above, quotedby Leser,Seligman,and Viner,containsa sentence(omittedin Robbins' citation)with a phrase"excessof profits"(Torrens1815,1820,p. 264) which detracts considerably from the worth of the statement;in the thirdedition (1826, p. 353) this was changedfor the better to "excess of produce." 3 It would take us too far into the sociology of knowledgeto attemptto explainwhy it has taken so long for Torrensto gainproperrecognition.The common attributionof the principleto Ricardo evidently derivesits origin, at least in part, in the selfeffacingmodesty of Mill (1844, pp. 17), whose own statementof the law of comparativeadvantageis perhapsthe first completelysatisfactoryone; as Schumpeter (1954,p. 529) pointed out, Mill's own achievementwas "obscuredby filial respect"for Ricardo. James Mill (1826, pp. 118124) certainlyplayed an importantpart in the evolution of the law. J. S. Mill pointed out (1844, p. v) that his Essays had been writtenin 182930, and were publishedin 1844 in responseto the writingsof Torrens.The real difficultyis that Torrens'works are scarceand inaccessible,long out of print, and unavailablein most libraries. Accordingto the recordsof the Libraryof Congressthere are, among the holdings of libraries in the United States, only seven copies of the first edition of the ExternalCornTrade(1815), and six copies of the second (1820). 4 This very concept is questionable;Viner (1937, p. 446n) definedthe midpointin termsof the arithmetic mean, an ambiguousprocedureat best, since differentconclusionswill resultdepending upon whichcost is in the numerator and whichin the denominator.It is mathematically impossible for the reciprocalof the arithmeticmean of two distinct quantitiesto be equal to the arithmetic mean of their reciprocals.This difficultywould have been avoided if Viner had chosen the geometricmean.
INTERNATIONALTRADE
483
relative cost in England. Whether or not this is a correct interpretation of Ricardo, the solution happens to correspond precisely to that which was later obtained by Mill (1852a, p. 158) on the basis of explicit assumptions about demand.
1.2. MILL'S LAW OF INTERNATIONALVALUE
In his remarkable essay, "On the Laws of Interchange between Nations" (1844), Mill set out to find a precise solution to the problem left open by Ricardo. It was implicit in his discussion that an intermediateprice ratio would necessitate complete specialization, entailing a fixed supply of each good; the problem was then whether there would exist a price ratio for which "the demand shall be exactly sufficient to carry off the supply" (p. 9). He recogniized the possibility of "an extreme case" (p. 13) in which demand might be so rigid that no such intermediate price ratio would exist; in that case, the equilibrium price ratio would have to correspond to one of the limiting cost ratios, and there would be partial specialization in the corresponding country.5 Mill's mature thoughts on the theory of international trade are contained in Chapter 18 of the Principles,which Edgeworth (1894) described, with good reason, as the "great chapter." Edgeworth expressed himself differently, however, with regard to the supplementary sections 69 which Mill added in the third (1852a) and subsequent editions. He said (1894, p. 609): "The splendid edifice of theory constructed in the first five sections is not improved by the superstructureof later date which forms the latter part of the chapter. This second story does not carry us much higher." He followed this pun by agreeing with Bastable (1903, p. 29n) that the superstructure was "laborious and confusing." Practically without exception, subsequent writers have joined the monotonous chorus.6 Schumpeter
5Mill had in his exampleassumedthat demandwas rigid in one country, and had then concluded, in the finalparagraphof ?1 of his essay (1844, p. 14) that "in generaltherewill not be this extremeinequalityin the degreein which the demandin the two countriesvarieswith variations in price." This argument,though, is invalid, since the solution at an extreme(limiting)cost ratio wouldresultequallywell (in fact with greaterlikelihood)fromrigidityof demandin both countries. Mill later withdrewthis paragraph(by implication),since it was conspicuouslyomittedwhen the entire section was otherwisequoted in his Principles(1852a, Ch. 18, ?2). Thus Graham (1923) Mill whenhe arguedthat the latterruledout the limitingsolution as "an extreme misrepresented and barelyconceivablecase"; Mill neverused the expression"barelyconceivable,"and theredoes not seem to be any specialreason for believingthat he used the expression"an extremecase" in any sense other than the purelytechnicalone of the extremepoint of an interval.Mill was, after of opinion concerningthe meaning all, the firstto point out the possibility.Evidently,differences of "extremism" alreadyexisted before 1964. 6 Nicholson (1897, p. 302n) spoke of "the confusion of Mill's second statement." Viner (1937, p. 541) commented:"Therehas been generalagreementthat this additionalmaterialwas and unnecessary." Elliott (1950,p. 24) speaksof the "mysterious ... superstructure unsatisfactory which,in spite of the gentletreatmentit has usuallyreceived,seemsto the presentwriterto be very confused."And accordingto Metzler(1950, p. 303n): "In a long and involved argumentintro
484
JOHN S. CHIPMAN
(1954, p. 608n) is almost alone in showing any appreciation and understanding of these supplementary sections. It is time to reverse Edgeworth's judgment: for ?7 of the "great chapter" contains a convincing proof (admittedly for a special case) of the existence of equilibrium; not only that, it does so in terms of what can today be recognized as an ingenious and correct solution of a problem in nonlinear programming. Mill had already asserted the existence of equilibrium in ?4 of his "great chapter" under the heading of the "Equation of International Demand," and expressed it in the words (1852a, p. 149): "The produce of a country exchanges for the produce of other countries, at such values as are required in order that the whole of her exports may exactly pay for the whole of her imports. This law of International Values is but an extension of the more general law of Value, which we called the Equation of Supply and Demand." As we might say today, Mill's law is an extension of Say's law. In ?6 Mill raised the question of uniqueness; this section was criticized by Marshall (1879, pp. 1516), Edgeworth (1894, pp. 61012), and Metz' ler (1950, p. 303n), since Mill suggested that "it is conceivable that the conditions might be equally satisfied by every numerical rate which could be supposed." In Marshallian terms, this would correspond to two countries' offer curves coinciding throughout their length, giving rise to neutral equilibrium, and turning the equation of supply and demand into an identity. Subsequent writers have tended to interpret this as implying that Mill took this possibility seriously; but a much more plausible reading evinces Mill to be simply pointing out that "on the face of it" the equilibrium price ratio might not be determinate, and that uniqueness of equilibrium requires proof.7 This prepares the ground for the demonstration in the subsequent section (?7), which will now be described. Mill sets out (1852a, p. 155) to solve a special case: "As the simplest and most convenient, let us suppose that in both countries any given increase of cheapness produces an exactly proportional increase of consumption: or, in other words, that the value expended in the commodity, the cost incurred for the sake of obtaining it, is always the same, whether that cost affords a greater or a smaller quantity of the commodity." In other words, there is a unit ownelasticity of demand with respect to price, zero crosselasticities and unit income elasticity, as well as a unit elasticity of substitution between any two goods. Such demand functions are known to be integrable, yielding a utility function of the form
duced at the end of the chapteron internationalvalues in the third edition of his Principles,Mill attemptedwithout successto solve the problemarisingfrom neutralequilibrium."Finally, Mundell (1960, p. 73n) states that "John Stuart Mill recognizedthe possibility of multipleequilibria without referenceto stability. . ., but his treatmentwas faulty." 7 Metzler (1950, p. 303n) states that Mill "arguedincorrectlythat such neutral equilibrium would exist if each country had a unitaryelasticity of demand for imports." This is incorrect. The assumptionof unitaryelasticitywas introducedby Mill in ?7 (not in ?6) of his chapter,and on the contrary, Mill used it in that section to prove the uniquenessof equilibrium.
INTERNATIONALTRADE
485
U=xly# where x and y are the quantities of two commodities. Mill chooses the special case a = ,B(i.e., half of expenditure is devoted to each commodity), so without loss of generality we may take U= xy. Let x', x" be the quantities of cloth produced in Germany and England, respectively, and y', y" the quantities of linen; let the corresponding world outputs be x=x'+x", y=y'+y". Let the production transformation sets be given by
(1.1)
 +Y_1;,<, a blb=
X/
yI
all + bll'<,
XII
I,/
and assume a'/b'<a"/b", i.e., that Germany has a comparative advantage in linen. This inequality makes it possible to write (1.1) in the equivalent form8
(1.2) (.)
where a=a'+a", b=b'+b". The problem is to maximize the quasiconcave function U=xy (or equivalently, to maximize the concave positive homogeneous9 function V= U = x+y+) subject to the linear inequalities (1.2). This is a problem in homogeneous programming (Eisenberg (1961))a special case of nonlinear programming (Kuhn and Tucker (1951)). The solution, obtained in all essential respects by Mill (1852a, pp. 1589), is as follows: Given that a'/b' < a"/b", and that utility functions have the form U=xy in each country, both constraints of (1.2) are effective (i.e., the equalities hold) if and only if (1.3) < <
i.e., if and only if the limiting cost ratios contain between them the ratio of England's maximum output a" of cloth (in which she has a comparative advantage)
8 Derivation of (1.2) requires a little manipulation. First, if the inequalities plied respectively by a' and a", and then added, we find that
= 1. Iff is quasiconcave and positive homogeneous of degree r where 0 _ r < 1, then f is concave. The problem of maximizing a quasiconcave function which is positive homogeneous of degree r > 0 is obviously equivalent to the problem of maximizing an appropriate concave function which is positive homogeneous of degree 1 (the new function being the old one
ous in case r
486
JOHN S. CHIPMAN
to Germany's maximum output b' of linen (in which she has a comparative advantage); furthermore this last ratio, a"/b', will be precisely the equilibrium price ratio of linen to cloth. If, instead, a"/b' < a'/b' < a"/b" (i.e., England is "small"), then the equilibrium price ratio will be equal to Germany's cost ratio a'/b', so England will specialize in cloth and Germany will produce both linen and cloth; and if a'/b' < a"/b" < a"/b' (i.e., England is "large"), then the equilibrium price ratio will be equal to England's cost ratio a"/b", hence Germany will specialize in linen and England will produce both linen and cloth. This is Mill's Law of International Value. In its astonishing simplicity, it must stand as one of the great achievements of the human intellect; and yet it has passed practically unnoticed for over a hundred years, if only because it was so advanced for its time.
y
, B2
B,
Om
nA
AO
Al
AZ
FIGuRE1.1
Mill's law is illustrated in Figure 1.1, where the xaxis measures the quantity of cloth, and the yaxis the quantity of linen. Following Mill's illustration, we have for Germany a'= 100 =its maximum output of cloth, and b'= 200 =its maximum output of linen; and for England, a"= 100 and b"= 100 for its maximum outputs of cloth and linen. Germany's production possibility set is OAB (where OA has length a', and OB has length b'). England's production possibility set is shown displaced, at BCOBO (where BCo has length a", and BBo has length b"), its true is the world production possibility origin being at 0 rather than B. Then OAOCOBO set, which is the sum of the other two, and it is obtained geometrically by sliding
TRADE INTERNATIONAL
487
by Lerner (1932);suchsetshave down the edge BA in the mannerdescribed BCOBO been depictedby Whitin(1953,p. 523), McKenzie(1954a,p. 151),and Dorfman, at curvetouchingBOCOAO Samuelson,and Solow (1958,p. 35). The indifference extreme, other At cost the is ratio. slope Germany's is whose to tangent A0C0, Co (showingthe samecompossibilityset is BC2B2 production displaced if England's the worldproductionposparativeadvantagebut a greaterabsoluteadvantage), at C2 curvetouchingB2C2A2 and the indifference sibilityset becomesOA2C2B2, case in cost ratio.In the intermediate is tangentto B2C2,whoseslopeis England's which England'sproductionpossibilityset is given by BC1BI, the indifference curvetouchingB1CIA, at C1is tangentto neitherBIC, nor C1A1.Thebrokenline to all the possible is the locus of equilibriumpoints corresponding OC0C1C2D the samecomparative Englandmighthavewhilemaintaining absoluteadvantages both in the intervalCOC2 only Englandspecializes, in the stretchOCO advantage; only Germanyspecializes. countriesspecialize,and thereafter The meaningof the inequality(1.3) may be broughtout more sharplyafterit is multipliedthroughby b'/a" to obtain a'/a"< 1< b'/b".This yields the following in each countryhave utilityfunctions condition:Giventhat consumers equivalent of the form U=xy, both countriesspecializeif and only if (1.4) at_ a" and b"< b',
ratherthan that is, if and only if eachcountryhas actuallyan absoluteadvantage, in the productionof one of the commodities.This advantage, just a comparative of unit conclusion,which,it mustbe recalled,dependscruciallyon the assumption conflictswith a literalreadingof the classicalstatement elasticitiesof substitution, bothcountries canproduce both commodities, by JamesMill(1826,p. 123):"When it is not greaterabsolute,but greaterrelative,facility,that inducesone of them to
confine [sic] itself to the production of one of the commodities, and to import the
by Ricardo(1817,p. 135)andTorrens(1826,p. 39)also fail other."The statements to bring out the distinction between conditions for trade and conditions for completespecialization. Mill stated his Law of InternationalValue in terms of the cloth previously by Germany(beforetrade),which,owingto the special consumed(andproduced) be half of its maximum natureof the utilityfunction V=y*, would necessarily can make cloth England outputof cloth, or m=a'/2; andin termsof the additional after withdrawing from the productionof linen, which likewise(given the same
xy4) utility function V=
b"/a"
488
JOHNS. CHIPMAN
which is the form in which the inequality was originally stated by Mill (1852a, p.
159).1o
Mill's inequality can be stated in yet another way. Pareto (1909, pp. 50711), without making reference to Mill, questioned Ricardo's assumption that the terms of trade would settle strictly in between the two countries' comparative cost ratios. Pointing out that specialization could lead to a reduction in the world output of one of the commodities, he argued correctly that, without taking account of tastes, one could not justify the assumption that the increased world output of the other commodity would provide sufficient compensation. He went on to argue, less convincingly (pp. 5089), that "in order that Ricardo's conclusion be certainly true," the total output of each good should be larger when there is complete specialization than would be the corresponding equilibrium output (and consumption) that would obtain in the absence of trade. Pareto chose as an illustration the case of two individuals capable of producing bread and beads; if they should trade and specialize, this might lead to a reduction in the total output of bread, and there would be no guarantee that this would be adequately compensated for by an increase in the total output of beads. Let each person devote half of his expenditure to each commodity (as in Mill's case), and let x be the quantity of bread and y the quantity of beads. Before trade, production and consumption of bread and beads would be x' = a'/2 and y' = b'/2 for individual I and x" = a"/2 and y" =b"/2 for individual II; thus the total production and consumption in the absence of trade would be x=(a' +a")/2 and y=(b' +b")/2. Supposing II to have the comparative advantage in bread, so that a"/b">a'/b', then complete specialization would entail x = a" and y = b'; hence Pareto's criterion implies (6) b+ bit a' + a" < (1.6) 2 +2 b' which is equivalent to (1.4). Thus, under Mill's assumptions,Pareto's criterion is equivalent to Mill's, and it is both necessary and sufficient for complete specialization.
Mill's statement of this inequality contains a qualification(1852a, p. 159n) to the effect that "n is always, practicallyspeaking,confinedwithin these limits."At firsthe gave an explanation of how, if n < m, Germanywould produce both linen and cloth, since Englandcould not provide all Germany'srequirementsfor cloth, and "that England thereforewould be able permanentlyto sell her ... cloth at the Germancost of production."This is preciselythe possibility later emphasizedby Graham (1923, 1948), although Grahammade no referencein his writings to this section of Mill's famous chapter. Mill went on, however, to argue that this "would not be the practicalresult,"basinghimselfon the suppositionthattherewouldbe "other commodities" in which Germanyhad a relative advantage,permittingEngland to import them and therefore supply all of Germany'sneeds for cloth. Here Mill changed his premises in the middleof the argument(as Edgeworth(1894, p. 613n)pointed out), so Grahamcould have scoreda valid point againsthim; but he could not have done so without withdrawing his chargethat Mill neverconsideredmore than two commodities.For furtherdiscussionof thesepointssee Viner(1937,p. 449).
10
INTERNATIONALTRADE
489
But Mill's assumptions are very special; the conclusion does not even follow if the utility functions are of the form V= xiy0 where 0<0<1 (unless 0=). This was recognized by Mill, who attempted to analyze more general cases (1852a, Ch. 18, ??89) but whose limited mathematical equipment precluded the derivation of any exact conditions. Pareto stated his conditions as necessary ones, but they are neither necessary nor sufficient in general. That is, even if Pareto's criterion is satisfied, if the elasticity of substitution is small enough it will still be necessary for one country to produce both commodities; and conversely, even if Pareto's criterion is not satisfied, provided the elasticity of substitution is large enough, it may still happen that equilibrium is characterized by complete specialization. Examples of both such cases are readily constructed. Pareto's paradox, that trade with complete specialization might be incompatible with tastes, seems to be at the root of some perplexing arguments presented by Valavanis (1954); but it will be more convenient to discuss these in Part 3 (Section 3.8) of this article. As Ricardo was alleged by Pareto and others to have done (but see Viner (1937, p. 452)), so did Taussig (1927) appear to take it for granted that the equilibrium price ratio (terms of trade) would be strictly in between the comparative cost ratios. In discussing one of the usual examples, he said (p. 24): "At any rates between, both countries would gain from an exchange." But this is not true even under Mill's assumptions. If Mill's inequality is not fulfilled, and if the relative price r of the ygood is strictly in between the comparative cost ratios, so that, for instance, a"/b' < a'/b' < r< a"/b"< a'/b", then trade would necessarily lower the world production of one of the goods (the xgood); and with Millian utility functions, at least one of the countries would be worse off, and possibly both, depending on how the production was distributed. This is Pareto's paradox; it is resolved simply by Mill's law, which states that such a situation as the one just described cannot occur, that is, it cannot be a competitive equilibrium. Taussig's explanation (1927, p. 30),, "The fact that [the Americans] give up some wheat in order to get more linen proves that the rearrangement suits them better," is an argument which assumes what has to be proved, namely that there is an intermediate price ratio for which a competitive equilibrium exists. What Taussig should have said (and possibly meant to say) was that "at any equilibriumrates between, both countries would gain from an exchange"; and there need not be any equilibrium rates strictly in between. Mill's law contains an important corollary, referred to by Edgeworth (1899) as "Mill's paradox," which is also illustrated in Figure 1.1. In Mill's words (1852a, p. 163): "the richest countries, caeteris paribus, gain the least by a given amount of foreign commerce: since, having a greater demand for commodities generally, they are likely to have a greater demand for foreign commodities, and thus modify the terms of interchange to their own disadvantage." In Figure 1.1, what today would be called a "neutral technological change" is shown, for England, by the
490
JOHN S. CHIPMAN
successive production possibility sets BBOCO, BB,Cl, BB2C2,and the corresponding world production possibility sets OBOCOAO, OB,C,A,, 0B2C2A2. England's terms of trade (the ratio of the price of the xgood to that of the ygood) are given by the slope of the indifference curve passing through C0, C1, C2; the terms of trade stay constant along OC0 (at Germany's cost ratio), decline along COC,C2 (the zone of complete specialization), and stay constant thereafter along C2D (at England's cost ratio). It follows that a neutral technological improvement, or general increase in productivity, results in a worsening of the developing country's terms of trade, and this for the simple reason that a market must be found for the increased relative quantity in world markets of the growing country's export goods. Thus "Mill's paradox" is not a paradox at all; rather, it is another name for the Law of Demand. It had already been anticipated by Torrens (1837, pp. 1323) who observed that "if, in the markets of America, the demand for English goods should remain stationary, while the supply of them should be increased, then, in the American markets, a given quantity of English goods would exchange for a less quantity of American produce than before." Torrens then went on to argue that "on these obvious, and universally admitted principles of commerce, we can explain the process by which, in a commercial and manufacturing country, importing raw produce, the increase of commercial and manufacturing capital may lower the wages of the operative class." This formed the basis for his advocacy of a policy of emigration. Mill said that the richest countries gain the least; he did not say that they lose. However, Edgeworth (1894, pp. 4041) took up the question on the basis of Mill's earlier treatment (1852a, Ch. 18, ?5) to argue that an improvement in the export industry might actually make the exporting country worse off. There ensued a controversy in which Nicholson (1897, pp. 3 101 1), Edgeworth (1899), and Bastable (1903, pp. 1857) took part, and which has been discussed by Bhagwati and Johnson (1960). The phenomenon has been emphasized by Bhagwati (1958), who has called it "immiserizing growth." The question of whether a technological "improvement" can actually worsen a country's welfare is a subtle and involved one, which we cannot go into here. Suffice it to say that a worsening of the terms of trade can be expected to be more severe (1) if the improvement is confined largely to the export industry, and (2) if the elasticity of substitution between the two commodities is low, i.e., if demand is inelastic."
11 A voluminousliteratureon these questions has developed in recent years, and will be discussed in the sequel. A relatedphenomenon,referredto by Duncan (1938) as "Marshall'sparadox," has also receivedconsiderableattention over the years; see Marshall(1923, pp. 17780, 3428), Graham (1932, pp. 6002), Viner (1937, pp. 53846), Allen (1952), Kemp (1956), and Bhagwati and Johnson (1960). Marshall'sparadoxconsists in the statementthat an increasein England'sdemand for German goods will result in a greaterworsening of England's terms of trade if England'sreciprocaldemand is elastic (ratherthan inelastic, as just stated above in the text). As Duncan (1938, pp. 35861) pointed out, this conclusionfollows from Marshall'sdefini
INTERNATIONALTRADE
491
In conclusion, there are two quite significant features of Mill's law which are apparent in the light of modern developments. One is that it constitutes a genuine and correct proof of the existence of equilibrium, although of course Mill's mathematical limitations forced him to make very stringent assumptions. But one will not find a rigorous existence proof of any kind again until eighty years later in the work of Wald (193334, 193435). And even McKenzie's existence proof (1954a) retains all the assumptions made by Mill with the exception that the model is extended to include any number of commodities and countries; this remark is not intended in any way to detract from the importance of McKenzie's work (since, after all, the principal mathematical difficulties involved in fixed point theorems arise only in three or more dimensions, and McKenzie's methods are powerful enough to handle much more general cases), but rather to emphasize a feature of Mill's work which went unappreciated by his followers, including economists of such eminence as Edgeworth and Marshall."2 The second feature of Mill's law that is of particularinterest today is the inequality, which establishes conditions for full or partial specialization. Considerations of this kind turn out to be of great importance for the factor price equalization theorem, as will be apparent later on in Part 3 of this article. From geometric considerations it is evident that Mill's conditions can be generalized along the following lines: the likelihood of complete specialization varies directly with (1) the elasticity of substitution between commodities, and (2) the relative equality in absolute advantages among countries. In order to make a case for the prevalance of partial specialization (one of the principal premises of the factor price equalization theorem), if Mill's framework is retained, one must let it rest on either (1) a low elasticity of substitution in consumption, or (2) inequality in absolute advantages, or both. It is natural to ask whether these criteria must in any way be modified or supplemented if one goes outside Mill's (and Graham's) framework. It will be seen presently that both (3) trade in intermediate products and (4) introduction of more factors of production increase the likelihood of incomplete specialization.
tion of a shift in demand as an increasein the amount of exports offeredfor a given amount of imports, whereasthe opposite conclusion would result from Graham's(1932) definition of the shift as an increasein importsdemandedfor a given amount of exports.For the problemof technological change, Graham'sdefinitionis the appropriateone, Marshall'sbeing better suited to applicationsin the field of commercialpolicy; see Bhagwatiand Johnson (1960, pp. 789). 12 In discussing the relevantsection of Mill'sPrinciples, Marshallconcluded(1923,pp. 3545n) that "thereis no problemto be solved at all." But this conclusion followed from an errorin his diagram,which failed to take account of the fact that each country's offer curve would, under Mill's assumptions,start off with a flat segment, and then proceed with a verticalone. This had alreadybeen spelled out by Edgeworthin a sixpagefootnote (1894, pp. 60914n) which, it must be concluded, Marshallhad never botheredto read! Metzler(1950, p. 303n), in the footnote already cited twice (footnotes 6 and 7 above), stated: "Marshallpointed out the error in Mill's earliertreatmentof the subject."But it was Marshallwho was in error, not Mill.
492
JOIN S. CHIPMAN
WHEWELL
There is still a certain amount of mystery surrounding Mill's supplementary sections that warrants some comment. Mill opened the new sections (1852a, Ch. 18, ??69) with the statement: "Thus far had the theory of international values been carried in the first and second editions of this work. But intelligent criticisms, and subsequent further investigations, have shown that the doctrine stated in the preceding pages, though correct as far as it goes, is not yet the complete theory of the subject matter." In the sixth edition (1865, p. 360), after the words "intelligent criticisms," there appears for the first time the explanation: "(chieflythose of my friend Mr. William Thornton)"; but no other changes were added. The following year Thornton (1866) publishedlong after the appearance of the third editionsome rather naive criticisms of the law of supply and demand, to which Mill subsequently replied (1869) in a careful and searching restatement. Thornton had evidently, in private conversation, stimulated Mill into rethinking the basic issues of the existence and uniqueness of equilibrium. None of these discussions was specifically related to international trade, however, and Mill's acknowledgment to Thornton seems like a curious afterthoughta bouquet to a close friend. The only work of that period bearing any relation to Mill's law is that of Whewell (1856). Whewell's memoir was presented to the Cambridge Philosophical Society in 1850, and according to Viner (1937, p. 450n), it was "printed in the same year for private circulation," though it did not appear in the Society's Transactions until 1856. Viner goes on to say: "Since it was primarily a criticism of Mill's doctrines, Mill may have been acquainted with it." It is scarcely conceivable that he was not, for the memoir is devoted entirely to Mill's first essay (1844) and is an honest attempt to translate Mill's argument into mathematical language. Whewell developed (pp. 1302) the concept of "susceptibility" of demand (equal to one minus the elasticity of demand) and addressed himself to the problem of the conditions for complete specialization, given the cost conditions and demand susceptibilities in each country. He also developed (p. 146) the concept of "transferable capital," which was later contained in Mill's new sections (?78) and became the object of criticism on the part of Edgeworth (1894, p. 609), Bastable (1903, p. 29), and Marshall (1923, pp. 3545). Whewell derived an inequality (p. 143) for the characterization of solutions with complete specialization; unfortunately a slip entered his argument, and his formulas are therefore valid only for certain values of the parameters.'3 From what is known concerning Mill and Whewell, the following inference seems plausible: that Mill saw Whewell's memoir and found it of con13 Whewell assumed(1850, p. 143, line 3 of the text) that x < k implies tx < tk, forgetting that this is true only if t > 0. Under Mill's assumptionsof zero susceptibilities,Whewell'sformula would give t = a"la' < 0. Had he possessed an economist's intuition, Whewell might have spotted this error after interpretingthe result; except for this slip, Whewell's treatment seems to be quite valid and even ingenious,and one can only lamentthe fact that, havinggone so far, he fell just short of derivingthe correctconditions.
INTERNATIONALTRADE
493
siderable interest, yet did not trouble himself to go through the algebra, and may even (correctly) have suspected it of being faulty; and that if his suspicions were not enough, his deep antagonism towards Whewell would be sufficient to explain the lack of any specific acknowledgment.'4
1.4.
GRAHAM
After Mill, the issues dealt with above receded to a great extent into the background, owing largely to the erosion of Mill's theory of value with its assumption of constant costs. The methodology of marginal analysis, with its inability to cope with corner solutions, also contributed to this deemphasis. But the modern emphasis on the importance of inequality constraints has led to a revival of interest in the classical problems. Two postMillian developments are especially noteworthy in their foreshadowing of modern ones: one is that of Mangoldt (1863), to be taken up in Section 1.6 below; the other is that of Graham (1923, 1932, 1948), who pursued an iconoclastic course which Haberler (1961, p. 10) has aptly described as "ultraclassical." Graham believed that limiting price ratios were the rule, and intermediate "limbo" price ratios (1948, p. 35) the exception; he claimed with great vehemence that Mill had held the contrary view, a charge which is without foundation.'5 In spite of his protestations, his own work, much more so than that of others, is largely an elaboration of Mill's doctrines, and to some extent even a retrogression from them. It could be said of Graham what Mill already had said of Thornton (1869, p. 513): "If there is a fault to be found with him, it is one that he has in common with all those improvers of political economy by whom new and just views 'have been promulgated as contradictions of the doctrine received as fundamental, instead of being, what they almost always are, developments of them.' " Graham retained Mill's assumption of contant costs, and based his conclusions on numerical examples. In one of these (1948, pp. 7982) he assumed that commodities were consumed in fixed proportions, an assumption which practically guaran14 The Rev. Dr. William Whewell was the leader of the antiutilitarian intuitionist ("moral sense") school of ethics, and his views on these subjectsaroused bitter feelings in Mill; see the latter'sLettresIneditesa AugusteCompte,p. 358. The very year of publicationof the thirdedition Review of his Principles,Mill also published a blisteringattack on Whewellin the Westminster his opinions of Whewell'swork in moralphilosophyin the words (1852b)in whichhe summarized (P. 189): "it can scarcelybe counted as any thing more than one of the thousand waves on the dead sea of commonplace."That Mill neverthelesstook Whewellvery seriouslyis evident from his System of Logic (especiallyBook III), wherehe discussedWhewell'sepistemologicalwritings at great length, and wherehe acknowledgedin the Prefacethat this portion (pp. 185418) of his Logic would not have been written but for Whewell'sHistory of the InductiveSciences.All this with servesmerelyto establishthat it is almost impossibleto believe that Mill was unacquainted Whewell's1850 memoir. 15 In making this assertion,I am glad to invoke the authoritative support of Viner (1937, pp. 4489).
494
JOHN S. CHIPMAN
teed the extreme solution. For the most part he retained Mill's assumption of a unitary elasticity of substitution in consumption, and therefore based his claim, at least in the case of two countries and two commodities, largely on the belief that countries were of unequal size. Graham's views rested heavily on the belief that the terms of trade were empirically stable; this belief was combined with a somewhat unusual view of human nature, according to which demand, although stable with respect to price, was highly volatile and subject to the "shifting winds of desire" (1948, p. 33); he also expressed mortification over the notion of a "naked theory of demand" (p. 37). Thus, on this premise, if limbo prices were the rule, one would observe violent fluctuations in prices, which (he said) one does not; as Metzler pointed out (1950, p. 320), from the same reasoning one would observe, on Graham's premise, violent fluctuations in output. Graham failed to appreciate the importance, pointed out by Cournot (1838, Ch. 4), of the law of large numbers and the consequent stability of aggregate demand; such stability (in the sense of low variance) has been borne out by many econometric studies (e.g., Houthakker (1957)). Of greater interest was Graham's attempt to liberate the theory of international values from the assumption of two countries and two commodities. This had already been begun by Mill (1852a, Ch. 18, ?9) and continued by Mangoldt (1863, pp. 185224), Edgeworth (1894, pp. 6305), and Viner (1937, pp. 45967). The essence of Graham's doctrine lay in the idea of "linked competition" (1932), of which two examples may be mentioned: (1) There may be a third country with relative costs (between two commodities) intermediate between the relative costs of two given countries; in this case the world price ratio may coincide with the intermediate country's cost ratio, hence shifts in world demand will be reflected in reallocation of resources (labor) in the intermediate country, rather than in price movements. (2) If there are three commodities (and two countries), there may be complete specialization in two of the goods (one by each country) and production in both countries of the third good (at equal cost); again adjustments would take place via labor movements between the two industries in each country, rather than via changes in the terms of trade. Graham's analysis suffered from dependence on numerical examples, and from the use of a confusing mathematical notation which apparently derives from Bastable (1903) and which has been perpetuated by some of his followers.'6 Most readers will find Metzler's exposition (1950) more rewarding, to which one may
16 J referto the custom, which goes back at least to Mangoldt(1863), of using a mathematical expressionsuch as "20x = 30y" to mean "20 units of commodity (x) exchangefor 30 units of commodity(y)" (see, e.g., Elliott (1950, p. 23), and Whitin(1953, p. 532)). For such an equation to make any sense, either the symbols x and y must be thought of as coordinatevectors in the commodityspace, and the equalitysign must be thought of as denotingthe relation"is exchanged for" or "hasthe same value as"; or else x and y must be consideredas being the pricesof the respective commodities.
INTERNATIONALTRADE
495
add the analyses of Elliott (1950), Becker (1952), and Whitin (1953), as well as the very thorough developments by McKenzie (1954a, 1954b, 195556). Elliott (1950, p. 23) made a valiant attempt to translate Graham's analysis into Marshallian terms, and displayed offer curves with numerous flat segments; his approach closely followed a manycommodity example considered by Marshall (1923, pp. 3235). Elliott's construction, which is quite ingenious, is closely related to those of Mangoldt and Edgeworth; discussion of it will therefore be resumed in Section 1.6 below. Elliott concluded that numerical examples had prejudiced Graham's conclusions; McKenzie (1954b, pp. 1767) likewise rejected Graham's presumption that "limbo" prices were improbable on a priori grounds.
1.5. MODERN DEVELOPMENTS: MCKENZIE, WHITIN, AND OTHERS
It became apparent soon after the pioneering development of activity analysis and linear programming by Koopmans (195 la) and Dantzig (1951a) that these new methods were particularly appropriatefor the analysis of classical models. In quick succession contributions were made to the literature by Samuelson (1952), Reiter (1953), Whitin (1953), Isard and Peck (1954), McKenzie (1954a, 1954b, 195556), Beckmann (1957), Dorfman, Samuelson, and Solow (1958), and Jones (1961). Whitin (1953) considered the question of limbo prices from a geometrical point of view, taking up models with two or three countries and two or three commodities and adopting the assumption of unitary elasticity of substitution. It is a measure of Graham's influence that Whitin, though echoing Graham's cavils against Mill, was unaware of the fact that Mill had solved the problem for the case of two countries and two commodities almost exactly one hundred years before. In his mathematical appendix, Whitin formulated the problem as one in linear programming, which would correspond to infinite elasticity of substitution in consumption. Schumann and Todt (1957) pointed out that Whitin's algebra did not correspond to his geometry, which would instead call for the use of nonlinear programming (cf. Kuhn and Tucker (1951)). The problem of international values was also taken up by Dorfman, Samuelson, and Solow (1958, pp. 3145), who stated that the equilibrium solution would "almost certainly" be one of complete specialization. Again, this resulted from their use of a linear objective function, implying that both commodities were perfect substitutes. In a significant paper, McKenzie (1954a) took up the MillGraham model in full generality. As has already been indicated, if the inhabitants of each country have utility functions of the Millian form U= XI IX12... xnn(with the same parameters in all countries), the problem of equilibrium international values reduces to the problem of maximizing U subject to the appropriate linear inequalities in the nonnegative xi's, a problem in homogeneous programming. While McKenzie adopted this assumption, his approach is more powerful and admits of much
496
JOHN S. CHIPMAN
weaker assumptions about demand.'7 His method can be roughly described as follows: (1) corresponding to any arbitrary selection of (normalized) commodity prices (which are nonnegative and add up to unity), one can compute (from the demand functions and the zeroprofit conditions of competition) the world demand for each good;"8 (2) the latter determines a ray in the commodity space and a unique intersection with the boundary of the world production possibility set; (3) the latter point on the production surface determines in turn either (a) a unique price vectorif the point is inside an (n  1)dimensional face of the production possibility surface, or (b) a closed convex set of such vectorsif the point is in a face of lower dimension (a vertex being considered to be a 0dimensional face). These three steps define a multivalued mapping from the set of normalized prices into itself; this mapping has values which are closed convex sets, and it is upper semicontinuous (generalizing continuity to multivalued mappings), so the fixed point theorem of Kakutani (1941) applies. There are difficulttechnical points of the proof, such as the proof of continuity and the problem of how to deal with zero prices. McKenzie followed this contribution with two papers (1954b, 195556) on the problem of efficiency in Graham models. His analysis may first of all be taken up from the standpoint of the simple twocountry twocommodity case considered by Mill. Defining u' =x'/a', v' =y'/b', u" =x"/a", v" =y"/b", and recalling that x= x' +x", y=y'+y", the inequalities (1.1) become xa u_a"u" =O, yb'v'b"v'' =0 (1.7) U'+V'+'=1
U" +"V' +6 1 = 1
McKenziestated (1954a, p. 155): "Assumingthe demandfunctions to be continuousfunctions of the prices of final goods, I should conjecturethat elementaryproofs do not exist of this theorem unless the demand functions are drasticallyrestricted."His own demand functions, they imply identical beingof the sameform as Mill's and Graham's,arequitespecial;in particular, and homothetic utility functions in every country, permitting the equilibriumproblem to be 1I of Z translatedinto one in homogeneous programming.Moreover,the specialform U = of constantcosts, gives rise to demandfunctions theutilityfunctions,combinedwiththeassumption with linear segments, as shown by Edgeworth(1894, pp. 61012n) and Elliott (1950, p. 23), and it is this fact that madefor the simplicityof Mill's originaltreatment(1852a,Ch. 18, ?7)and which causedMarshall(1923,p. 355n)to say that "thereis no problemto be solved at all." By exploiting these simple features of the problem, an elementary (and constructive) proof of McKenzie's theoremcan thereforebe obtained after all. 18 Geometrically, this corresponds to determiningthe supporting hyperplane to the world production possibility set, and then the point of maximum utility in this hyperplane; see the familiardiagramsin Viner (1937, p. 521), Leontief (1933, Fig. 4), and Lerner(1934, Fig. 2). It is suggestiveto think of this proof in the following way: Let the "world"be thought of as an aggre(not necessarilyunique)net suppliesand demands gate which, at any fixed prices, has determinate that outsideuniverse;then the proof consistsin establishing for all goods, visavissome imaginary there is at least one set of prices for which these net supplies and demandswill all be zero. This approachshows that the internationaltradeanalogy is helpful even in establishingthe possibility of autarky.
17
INTERNATIONALTRADE
497
where the variables x, y, U',U", V,v", 8', 8" are all nonnegative, 8' and 8" being the levels of the "disposal activities," allowing for the possibility of unemployment. The parameters a', a", b', b" are, of course, strictly positive, and the assumption implied by (1.7) that each country has exactly one unit of labor available is not restrictive (i.e., does not imply that the countries are of equal size or productivity), since labor need not be measured in the same units in the different countries. Thus if country I is larger (or more productive) then country II, a' and b' will be correspondingly higher than a" and b". The system of equations (1.7) may be written in matrix notation as 0 a" 0 1 0 0 F Iu' O a' 0 b" 0 1 00 v' O O b' 1 1 0 0 010 u" = 1 (1.8)
L O 1 1 0 0 0 1 v" Ll1.
x y 8' The model is readily extended to the case of n commodities and m countries, yielding the n + m equations
m
(1.9)
j1
LUi_+_
aijuij+xi=O =l
(i = 1, 2, .. ., n),
(j=l, 2, . .,m),
where all, a12, a21,... take the place of a', a", b', . . . and so on. It is well known (see Dantzig (195la)) that if a feasible solution to (1.9) exists (that is, one with all variables > 0), then a basic feasible solution exists (one with n + m variables _0 and the remainder= 0). It is obvious, furthermore, that a feasible solution exists: e.g., there is always the trivial solution with uij = xi = O and b8= 1. But what is important to establish in the present case is that a nontrivial basic feasible solution exists (one with no unemployment, i.e., with all bj=O), and furthermore that the model shares with the transportation models of Hitchcock and Koopmans (see Koopmans (1949), Koopmans and Reiter (1951), and Dantzig (195lb)) the important property of triangularity, to be described below. Dantzig's algorithm therefore applies, and this is what underlies the graphical technique used by McKenzie (1954b); an exposition and interpretation of Dantzig's algorithm has been presented by Dorfman, Samuelson, and Solow (1958, pp. 11721). The existence of a nontrivial basic feasible solution can be demonstrated by a simple argument. Following McKenzie (1954b), a solution may be called a specializationif each country specializes in exactly one commodity (these need not be distinct); thus there are nmpossible specializations. Any specialization contains m productive activities and produces, say, k_ min (m, n) commodities; if to these
498
JOHN S. CHPMAN
we adjoin the corresponding k consumptionactivities,the resultingsolution is clearly feasible, proving that a nontrivialbasic feasible solution always exists. the basicmatrixcorresponding to this solution,aftersuitablerearrangeMoreover, ment of columns,is alwaysuppertriangular. For example,as one of the possible solutionsof (1.8) we have:
10
a"t0
x
y =
o
0 1 
b'
1
00
VI
U" 1 Lo0 0 1uit_ the triangularity makesit possibleto solve by back substitution, obtainingu"= 1,
v'= 1, y=b'v'=b', and x=a"u"=a"
Not only is it true that everyspecialization is triangular, but futhermore, every nontrivialbasic feasiblesolution can be shown to be representable in triangular form. The argument,while it proceedsin elementarysteps, is intricate,and will not be reproduced here.'9 In orderto analyzethe problemof efficientspecialization, one can choose some arbitrary set of prices,and maximize the value of output; when this is done for all positiveprices, one obtainsthe "efficientfrontier."For example,in the case of three goods and two countries,with quantitiesx, y, z and pricesp, q, r, we must maximizethe linearfunction
f=px+qy+rz
subjectto
[a'
0 a"
0 0
0 b'
b"i
1 0 0 0 0 010
u'
III v'
w'
(1.10)
I
L
O1 1
0 O 0
c"0
1001
1
0
1
0
1
0 00010
1 0000
u
v" x
[Ii
Ll
y
z
6'
i"
19 The proof derivesfrom that of Dantzig (1951b); a good exposition of the method of proof, which lays bare the mathematicaltheory underlyingDantzig's method, will be found in Chapter 6 of Garvin (1960, esp. pp. 8990). The following example will illustratehow the triangularity condition should be interpreted: 0 T I iasn alx 0o b O O I VI u"l = I .
The basis here is not triangular, yet the solution is feasible, in apparent contradiction to what has
INTERNATIONALTRADE
499
x
Y z = O_
000 000
vI 1 _u"
I
_1
_
at
Iu'I
w'I
v"
1 0 1
w"I,
6'
where the variables on the right are set equal to 0. This has the explicit solution
(1.11)
Y z
vI
a" b'I O _
1
a
b' O
1
wI 8 ' v"
w"
1 0
[u"]
6'
indicating that if the variables on the right are set equal to zero then country I will specialize in (y), country II in (x), and that (z) will not be produced. Substituting these values for x, y, z in the objective function f, we obtain (1.12) f=pa" + qb'(qb'pa')u'(qb'rc')w'(pa"qb")v"  (pa"  rc")w" qb'8' pa" b"i For the basis to be optimal, the coefficients of the variables on the right must be > 0, by Dantzig's simplex criterion. Certainly qb' > Oandpa" > Oby assumption, hence 8' = 8" = 0. Now from qb'pa' > 0 and pa"  qb" > 0 we have a'/b' < q/p ? a"/b", that is, country I has a comparative advantage in (y) and country II in (x), just as in Section 1.2 above. In order that the zgood be produced at all, it is necessary that the above solution be nonunique,which entails either qb' rc' = 0 or pa"  rc" = 0. Thus, if (z) is to be produced in I, then w' > 0 and qb'= rc', i.e., the relative price rlq of (z) and (y) must be equal to the corresponding cost ratio b'/c' in country I. Likewise, if (z) is to be produced in II, then w" > 0 and pa" = rc", i.e., the relative price rlp of (z) and (x) must be equal to the corresponding cost ratio a"Ic" in country II. This provides one of the bases for Graham's phenomenon of "linked competition." Whitin (1953, p. 532) supported Graham's contention that "a country may import a commodity in the production of which it possesses a comparative adjust been claimed.But it is degenerate,with v' = 0, and can be replacedby the equivalent(also degenerate)basis 1 0 a,'all x 4)
w i
1
Out 0 nu 1
o o o
[o
0
1
u"'
1
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JOHN S. CHIPMAN
vantage." In our notation, he assumed a'=b' =24, c'= 8, a" = 16, b" = 32, c" = 96, and chose as utility function U= 'ylz. He showed that country I would specialize in (x), and II in (z), and that country I would both produce and import commodity (y) "in the production of which it has a comparative advantage" (p. 533). But this conclusion depends on how one defines the term "comparative advantage." If the expression means that there exists another commodity ((z) in is less than this case) such that, relative to that commodity, I's cost ratio c'/b'= II's cost ratio c"/b" = 3, then in Whitin's example one would have to say that both countries had a comparative advantage in (y) simultaneously, since with respect to (x), II's cost ratio a"/b" ' is less than I's cost ratio a'/b' = 1. On the other hand, if comparative advantage in a commodity is understood to mean that the cost ratio is smaller than that of other countries with respect to every other commodity, then in Whitin's example it could only be said that country I had a comparative advantage in (x), and country II in (z), and that neither country had a comparative advantage in (y). Thus, like many of Graham's extravagant claims, this one must be regarded as a gigantic quibble. On the other hand, one interesting fact is brought out by Whitin's analysis, and that is that if there are more commodities than countries, and if utility functions have the form U= xeyflz (guaranteeing that all commodities will be produced and consumed in positive amounts), then several price ratiosa number corresponding to the excess of the number of commodities over the number of countrieswill necessarily coincide with some country's cost ratios. This can be seen directly from the fact that if the values for x, y, z in (1.11) are substituted in the utility function U= xyz, and the nonlinear terms dropped, we obtain U= a" b' (c' w' + c" w"), showing that the solution with only two commodities cannot be optimal. When the number of countries is greater than or equal to the number of commodities (the case considered by McKenzie in his examples), there is, as McKenzie (1954b, p. 177) pointed out, no particular reason for preferring on a priori grounds an extreme price to a limbo price. In accordance with Mill's law, one has to rely on either (1) a low elasticity of substitution in consumption, or (2) inequality in absolute advantages, in order to obtain Graham's result. However, in the case in which there are more commodities than countries, the situation is this: if one or both of the above conditions holds, we can expect some price ratios to coincide with cost ratios; otherwise, we can expect that the number of commodities produced will be no greater than the number of countries. This is a startling result: under classical assumptions, if absolute advantages are approximately equal and elasticities of substitution relatively high, then there will be a natural tendency for the number of products to be less than or equal to the number of countries. This serves to bring out a point emphasized by Schlesinger (193334) and Wald (193334), namely that it is methodologically unsound to assume in advance that it is known how many commodities will actually be produced. There is a further point that needs to be stressed. In the example considered
INTERNATIONALTRADE
501
above, suppose that at equilibrium prices it is optimal for country I to specialize in (y), and country II in (x); then the coefficientsqb'pa' of u' and pa"  qb" of v" in (1.12) must both be nonnegative, yielding a'/b' < q/p< a"/b". If the third commodity is to be produced, it has already been pointed out that one of the coefficients qb'rc' of w' or pa" rc" of w" must be zero, hence the price r of (z) must be linked to one of the countries' cost ratios, either by r/q = b'/c' or by rlp = a"/c". This does not necessarily imply, however, that both countries will produce (z), as Graham usually assumed. It is interesting to inquire as to the conditions that will lead to this special result of Graham's: the phenomenon of linked competition (1932, p. 581; 1948, p. 69). An interesting necessary condition immediately emerges. In order that (z) be produced in both countries, we must have qb' rc'= 0 andpa"  rc"= 0 in (1.12), i.e., r/q = b'/c' and rlp = a"/c". Taking the ratio of the last two expressions, we obtain q/p = (a"/b')(c'/c"). Now, it would seem a fair application of the principle of insufficient reason to suppose that both countries have exactly the same absolute advantages (for definiteness, identical production methods) in the production of (z), whence c' = c" and q/p = a"/b'. Now substituting this in the inequality a'/b' < q/p? a"/b" obtained above, we obtain simply (1.3). Thus Mill's inequality, which (under Mill's assumptions) is necessary and sufficient for specialization in the case of two commodities, turns out to be a necessary condition for the simultaneous production in both countries of a third commodity. The very circumstances that are necessary for linked competition in the case of three commodities are likely to give rise to limbo prices in the case of two commodities; in arguing for the former and against the latter, Graham was trying to have his cake and eat it. 1.6. CLASSICALTREATMENTS:MANGOLDT, EDGEWORTH,VINER, ELLIOTT,AND
OTHERS
Mangoldt (1863) foreshadowed much of the modern analysis in his book, which is rather a rare item,20 known to most economists only through the exposi20 Walras(1890, p. 320n) drew attention to the fact that FriedrichKleinwachter, editor of the der Volkswirthschaftslehre (1871), took it second (posthumous)edition of Mangoldt's Grundriss (1954,p. upon himselfto omit the diagramsin Sections627 of the text. Accordingto Schumpeter 504), the second edition "leaves out the most originalelement in it, namely, the geometricalapparatusthat Mangoldt devised for the theory of internationalvalues; but Edgeworthbroughtit to light again." Schumpeteralso referred(p. 607) "to the first edition of Mangoldt's Grundriss, which appearedin 1863 and contains the relevant appendixthat the editor of the posthumous lapsed from his usual standardsof second edition of 1871thoughtfit to omit." Here, Schumpeter scholarshipand did not check the originalsources. The second edition omits the diagrams(which have nothing to do with internationalvalues as such), but leaves the appendixintact. Edgeworth (1894, pp. 6306) referredto the supply and demandcurvesin the firstedition, but in his discussion of the appendix of Mangoldt's work, his page referenceswere all to the second edition. to which SchumViner(1932,p. 381n)also reliedon the secondedition.The geometrical apparatus was originalwith Edgeworth,and bearsno relationto Mangoldt's was referring peterpresumably diagrams.The relevantchapterof the original 1863edition, containingthe diagramswhich were
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JOHN S. CHIPMAN
tion and development by Edgeworth (1894) which, in turn, has been further elaborated by Viner (1937). Mangoldt's approach may best be analyzed in terms of the dual of the above. linear programming problem, in which the objective functionfwas to be maximized subject to (1.10), the variables being constrained to be nonnegative. As shown by Dantzig and Orden (1952), this is equivalent to the dual problem of minimizing the objective function21 g=( f r s' s")O
=s'+s
01 01
with respect to the variables pf,q, F, s', s" (which are unconstrained as to sign), subject to the inequalities
O  0b'
1
0 O 0
1 0
1 0
p>p>~O,
>q>O,
s'>O,
sit
>0O,
r>r>O,
where use has been made of the original assumption that the prices p, q, r are nonnegative, whence the variables , q, r, s', s" are, after all, constrained to be nonnegative. If all three commodities are produced (so that the levels of the consumption activities in the primal are positive), then it follows from the duality
removed by Kleinwachter,is now available in English translation(1962). It should perhapsbe finally observedthat neither one of these editions should be confused with anotherposthumous work by Mangoldt entitled simply Volkswirthschaftslehre (1868), which is a rather ponderous treatisedealinglargelywith labor productivity. 21 Dantzig and Ordenstate the dualitytheoremas follows (1952, p. 52). Let A be a givenm X n matrix, b a given m x 1 column vector, and c a given 1 x n row vector. The primalproblemis that of findingan n x 1 vector x > 0 which minimizesf = cx subjectto Ax = b. The dual problem is that of finding a 1 x m vector w (whose components are not restrictedas to sign) that maximizesg = wb subjectto wA ? c. If either problem has a solution, so does the other, and min f = max g. It is just a matter of notation (replacingA, b, c by their negatives)to state the primalin the form: maximizef = cx subjectto Ax = b, x > 0; and its dual in the form: minimize
g = wb subject to wA ? c.
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503
pi_p, q _ q, r > r will theoremof Dantzig and Orden(1952)that the inequalities be replacedby equalities,hencethe bars may be removed.Thens' and s" may be in the two countries,whichwill be strictly interpreted as the resourcevaluations22 positiveas long as the levels 5', (" of the idle activitiesare equalto zero. The first that profitsbe nonrequirements six inequalities of (1.14)expressthe competitive positive on all productiveactivities(see Koopmans(1951a,p. 66)); for any proinequalityin ductive activity carriedout at a positive level, the corresponding (1.14) is replacedby an equalitywhence s' and s" are determinedby s'= max
(pa', gb', rc') and s' =max (pa", gb", rc") (see Beckmann (1957, p. 69)).
Now, Mangoldt(1863,p. 188)postulatedthe existenceof a commodity(say the zgood)that is producedin both countries.This wouldimplyrc'=s' and rc" =s", whences'/c' =s"/c". (If c' = c" this impliess' =s"an exampleof the factorprice equalization theorem.)Let the inequalities (1.14)now be written
(1.15) p s'/a'=p', q < s'/b'=q', r ? s'/c'r', p ? s"/a" =p", q < s"/'b'q", r ? s"/c"Mr",
Thusp', q', etc., arethe costs of wherethe symbol meansequalityby definition. of goods (x), (y), etc., in the respective the "realcosts"being countries, production etc. l/b', l/a', the ratios'/s" is determined; I shallcall this ratio Sincer= r'= r" by assumption, the factortermsof trade, as it is essentiallythe same as Viner's"doublefactoral terms of trade"(1937,p. 561). Then Mangoldt'scriterionstatesthat commodity (x) will be produced in country I or country II according as p' < p" or p' >p",
and similarly for commodity (y). Assuming for definiteness than p' >p" and q' < q", we havep' >p" = p and q" > q'= q, since the price must be equal to the cost
Thepatternof specialiis produced. in the lowcostcountry,wherethe commodity as are all the zation for the other commodities((x) in II, (y) in I) is determined, commodityprices. First,it assumes While Mangoldt'smethodis ingenious,it has two drawbacks. that there is some commoditythat is producedin both countries,and secondly (and more seriously)that it is known in advancewhich one. Edgeworth(1894, pp. 6304) soughtto removethese objections.The firsthe replacedsimplyby the assumptionthat the ratio s'/s" of resourcevaluations(the factor terms of trade) a slidingscalecomprised of the logarithms of costs was given;he then constructed for both countries,the relativepositionsof the two scalesbeingdetermined by the
difference log s'/s" =log s'log s". If, for instance, country I is to produce (y), this
22 We might say "wagerates"here insteadof "resource valuations,"but this could be misleadof the resource(labor)will, accordingto the presentformulaing since the units of measurement tion, in generaldifferbetweencountries.If comparableunits had been used, and the amountsof labor had been 1',1"in the respectivecountriesratherthan 1 in both, then the objectivefunction would have become g = s'l' + s"l", and s', s" could then be interpretedas wage rates.
504
JOHN S. CHIPMAN
can only be so if q'< q"; hence from (1.15), log q'=log s'+log (l/b')? log s"+
log (l/b")=log q", or log (l/b')? log s"log s'+log (1/b").23 (1894,p. 633)that his sliderule fullyrecognized methodleft entirely Edgeworth whichhesaid ofthe factortermsoftrades'/s", openthe questionofthe determination in each country,but also on the law "dependsnot only on the cost of production commodities"; of demandin each countryfor the different thus, "in general no of the relationon the interconclusion... canbe drawnpendingthe determination national marketbetweenthe productivepowers of the two countries,the ratio
which we have designated as [s'/s"]."
It is this gap in the argumentwhich has been nicely filled by Elliott (1950). Quite correctly,Elliottrejectedthe commonlyheld interpretationof Marshall's "bales" as aggregatesof commoditiesconstitutinga given country's exports, and took Marshallat his word (1923, p. 157) when he definedthem instead as "uniformaggregateinvestmentsof her labour (of various qualities)and of her capital."In the presentcase, then, the "bale"is simplythe quantityof labor emtermsof tradearethe factoral of exports,and Marshall's ployedin the production terms of trade s'/s". Elliott proceeded(1950, p. 23) to constructeach country's of a constantproportionof offerfunction,on the Millianassumption Marshallian each country'sincome being devotedto each commodity.While he did not use Edgeworth'slogarithmicscale, his constructioncan be most easily derived by offercurvesarecontinuousbutjagged,being method.24 Theresulting Edgeworth's of infiniteand zero elasticity.A construction made up of segmentsof alternately this kind, as Elliottpointedout, had alreadybeen outlinedby Marshall(1923,pp. 3235). observed (1950,p. 315):"I suspect... In discussing Elliott'sconstruction, Metzler demandtechniquebreaksdown whenthe numberof countries that the reciprocal was cited by Whitin(1953,p. 521) in apparentapexceedstwo." This conjecture proval.Butthereis no reasonwhy this shouldbe so; the individualofferfunctions for eachcountrycan easilybe aggregated to forma globaloffer(or excessdemand) function,as has been shownby Gale (1955,p. 159),or indeedby Metzlerhimself obviousis, of course, (1945,p. 280).Thatthis shouldnot haveseemedimmediately arebales(unitsof the a consequence of the factthatthe objectsbeing"exchanged" in a formal different countries'labor),and such exchangecan only be interpreted and abstractsense; furthermoreand this is what makes the constructionseem somewhatartificialin orderto constructone country'sofferfunction,it is neces23 In orderto facilitatecomparison,we point out that the above symbols s', s" correspondto Edgeworth'so, o', and his symbols a, ', b', etc., correspondto I/a', Il/a", 1/b", etc., in the above notation. Likewise,the ask/ci of Beckmann(1957) correspondsto l/aki in (1.9) above. 24 Readers of Elliott's article are advised to note that he employs Bastable'sconvention, referredto in footnote 16 above, of using the same symbol to designatea commodityand its price; also that there is an unfortunatemisprintafter equation (3) (p. 23) in which A and B have been interchanged.
INTERNATIONALTRADE
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sary to know not only its own production coefficients and utility function, but also the production coefficients (although not the utility functions) of the other countries. The reason for this is simple enough: data in one country are enough to determine how many of its bales it is willing to supply and how many of the various commodities it desires to purchase; the foreign production coefficients will then be needed in order to translate the demand for foreign commodities into the demand for foreign bales. Thus, while Elliott's technique could be validly extended to more general cases, it would probably become quite cumbersome, and no doubt more practical methods could be found for obtaining numerical solutions. Nevertheless, no such method has yet been proposed: the algorithms suggested by McKenzie (1954b) and Dorfman, Samuelson, and Solow (1958, pp. 11721) are suitable only for the computation of efficient(ratherthan equilibrium)solutions; and McKenzie's powerful existence proof (1954a) is, unfortunately, "unconstructive," and therefore of little help in solving practical cases. Viner (1937, pp. 4657) extended Edgeworth's method to several countries as well as several commodities. The extension is quite straightforward: an arbitrary set of values is assigned to the factor prices s', s", s"'; this fixes the relative positions of the Edgeworth scales, from which one can at once read off the minimum cost of each commodity; its price as well as the country (or countries) where it will be produced is thereby determined. The mathematical justification for Viner's procedure is to be found in the dual of the above linear programming problem; both linear programming approaches require an arbitrary selection of pricescommodity prices in the primal and factor prices in the dualand neither procedure by itself provides a systematic method for exploring the entire efficient surface. It was to this latter objective that McKenzie (1954b) addressed himself, with methods based on that of Koopmans (1951a) and Koopmans and Reiter (1951). McKenzie's criticism of "the error of classical ways" (1954b, p. 180) seems to suggest that there might be something invalid about Viner's method, or indeed about those 'of Mangoldt and Edgeworth. In fact this is not so, and the two approaches are not at all as unrelated as has been supposed. Since this has been an area of such great controversy, it will be well to try to set the record straight. McKenzie's principal criticism (1954b, p. 180) is that "the methods of the classical economists are entirely appropriate only to the analysis of trade between two countries," and that "the deficiency of the classical methods . .. is their dependence on bilateral comparison." This criticism has been reiterated by Jones (1961, p. 163), who displayed an example involving three countries and three commodities in a pattern of specialization which he showed was inefficient despite the fact that "each country has a bilateral comparative advantage in the commodity it produces compared with any other country and the commodity that country is assigned" (my italics). This definition of "comparative advantage" is the same as that of Whitin already referred to, and what the example proves is that the relation so defined is not transitive. But who indeed ever claimed that it was?
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JOHN S. CHIPMAN
It is first necessary to identify the "classical economists" who dealt with cases involving more than two commodities and two countries. Mill (1852a, Ch. 18, ?? 4,9) treated the question in general terms, without suggesting specific criteria; the validity of his famous dictum (1852a, pp. 1434): "Trade among any number of countries, and in any number of commodities, must take place on the same essential principles as trade between two countries and in two commodities," must hinge on the meaning of "essential." The case of many commodities (but only two countries) was analyzed by Torrens (1827, pp. 4017), Mangoldt (1863, Appendix II), Edgeworth (1894, pp. 6304), Marshall (1923, Appendix H), and Haberler (1936, pp. 13640); that of three or four commodities and two countries, and of three commodities and three countries, by Bastable (1903, pp. 3640); that of three commodities and two countries, and of two commodities and three countries, by Taussig (1927, Ch. 9 and 10); and finally, that of several commodities and several countries, by Viner (1937, pp. 4627). Ohlin (1927; 1933, pp. 5836) criticized the orthodox doctrine in terms that led Haberler (1936, p. 131) to complain: "Somebody or other is always trying to show that the Law of Comparative Cost is valid only under the simple assumptions upon which it was originally formulated." But it turns out that the only difference of opinion between Ohlin and Haberler is that the former believed he was attacking orthodoxy, whereas the latter considered himself to be defending it. The treatment by Haberler which followed, which is in accordance with Ohlin's, is similar to that of Marshall, and not essentially different from Edgeworth's. Haberler pointed out that it was just a matter of notation to rank the commodities in order of comparative advantage, as a'/a" > b'/b" > c'/c" > . . ., and that demand considerations would determine which intermediate commodities in the ranking would be exported or imported; the important point being that if country I exports a certain commodity, it must also export all the higherranking ones, and if it imports a certain commodity, it must also import all the lowerranking ones. In this sense, "bilateral comparisons" are completely valid in the case in which there are only two countries to compare; this, McKenzie and Jones have not denied. But as Edgeworth (1894, p. 633) and Haberler (1936, p. 137) were careful to point out, and as Ohlin took pains to stress, information on comparative costs alone is not enough to determine where the dividing line will be drawn. Unfortunately, Bastable (1903, p. 36) was not so careful, and appeared to imply that comparative costs would by themselves uniquely determine the pattern of specialization. In analyzing an example of three commodities and three countries, Bastable (1903, p. 39) obtained a correct solution,25 and showed (p. 40) that the pattern of
25 Bastable'ssolution was correctin the sense that he obtained what will be describedbelow as the uniqueefficientassignment,that is, the uniqueefficientspecializationin whicheach country producesa differentcommodity.But he erredin implyingthat this was the only kind of solution possible; in his words: "Frominspectionit is plain that [it is] the most economicalarrangement." There would be severalother "economicalarrangements" in which commoditieswere produced
INTERNATIONAL TRADE
507
specialization could be changed as a result of the introduction of a third country. Nicholson (1897, p. 299) remarked that "when we bring in the fact that any one 'nation' trades not with one another [sic] but with many others, we have to introduce some common measure of values for the world's markets." His use of the word "money" for this common measure seems to have led later writers to question the validity of his analysis, even though he qualified it by the statement that "it may be fully admitted, as in Mill's phraseology, that 'money has little to do in the matter except to furnish a convenient mode of comparing values.' " Taussig (1927) in his examples handled the subject from two standpoints: (1) that of the prices of the various commodities, and (2) that of the wages in the different countries; thus he considered both the primal and the dual of what can now be recognized as a linear programming problem, or indeed a nonlinear programming or equilibrium problem, since the particular solution arrived at would depend on "the play of demand." Taussig's comparisons were all with respect to prices or wages, and were therefore multilateral and not bilateral. His exposition was most lucid, and although he confined himself to numerical examples involving three commodities and two countries (Ch. 9) and two commodities and three countries (Ch. 10), he exhausted all cases. Finally, Viner's treatment was certainly multilateral rather than bilateral, and indeed, the inefficiency of Jones' example can readily be determined by Viner's method. Jones also pointed out (1961, p. 163n) that a solution obtained by McKenzie (1954b, p. 174) was actually inefficient; Jones indicated the correct efficient specializations, and actually all three of them can be quickly read off Viner's scales. In conclusion, therefore, I have not been able to find a single example in the classical literature of the use of bilateral comparison in the analysis of multilateral trade.
RESUMED: JONES 1.7. MODERN DEVELOPMENTS
The record, it is hoped, having been set straight, let us turn to the positive results obtained by McKenzie and Jones. McKenzie (1954b, p. 171) introduced an interesting multiplicative formula which was arrived at independently and in a different way by Jones (1961, p. 165) on the basis of an ingenious use of the HawkinsSimon theorem (1949). Jones considered the case of an equal number of commodities and countries, and sought a method for ascertaining an optimal way of assigning
in more than one country and countriesproducedmore than one commodity.The remainderof the sentencefrom which the above passage is quoted also contains a bad howler. Grahamcould have trippedBastableup on this score, but confinedhimself instead (1948, Ch. IV) to the latter's treatmentof the twocommoditycase. Even here Graham(1948, pp. 667) was more concerned with Bastable'sbad arithmeticthan with his bad economics, and having declaredthat Bastable was "rather slavishlyfollowing Mill'smisguidedlead" (p. 64), the blamewas in any case all shoved onto Mill.
508
JOHN S. CHIPMAN
exactly one country to each commodity and vice versa; he called this an "ii assignment." For convenience I shall instead call such a solution simply an "assignment," reserving the term "specialization" for the broader concept of a solution in which each country produces exactly one commodity, but in which some commodities may be produced in several countries or in none at all. In the notation of equation (1.9) above, where aij is the maximum output of the ith commodity that can be produced in the jth country, suppose there is a numbering of commodities and countries such that the assignment W is defined by xi=aii, i= 1, 2, .. ., n. Let there be another assignment WX in which x=i aij and where j==(i), the function t being a permutation of the integers 1, 2, ..., n (Jones chooses cyclic permutations, but is more efficient than W his analysis can be generalized). Then Jones shows that %![ (in the sense that there is some way for each country i to shift its resources from commodity i to commodity j=t(i) such that the world output of each commodity is increased) if and only if (1.16)
This may be called the Jones inequality; it includes as a special case the inequality (see (1.3) above), which states that if country I has a comparative advantage in commodity (y) over country II with respect to commodity (x) so that b'/a' > b"/a", then the specialization x = a", y = b' is more efficientthan the specialization x = a', y = b" if and only if the product of the outputs is larger in the first case than in the second. Thus, Jones' criterion may be considered as a generalization of the law of comparative advantage. Jones' inequality has a number of interesting implications, not all of which are made explicit by Jones. The first implication is that, since there is a finite number of permutations 2, there is a maximum H1= 1aj,i(i); hence an efficient assignment exists. Jones took this for granted (1961, p. 164), but it is not at all obvious on the face of it; a proof based on Koopmans (1951a, p. 82) had been obtained by Beckmann (1957, p. 68). The second implication is still more remarkable, though also apparentlytaken for grantedby Jones, who spoke of "the" optimal assignment; and that is that an optimal assignment can generally be expected to be unique, since the only exceptions would be those in which Hg=ja ,(j)=117=jaj for 2(i)#i, which can be ruled out on a priori grounds as completely improbable, except for cases such as ai,(i) = aii for all i, in whichin any eventthere would be no trade. Thus, except for degenerate cases, there is a unique efficient assignment. Geometrically, this result states that if the number of commodities is equal to the number of countries, and the countries' production surfaces are not parallel in any direction, then the world production possibility set, which is an ndimensional polyhedron, will have exactly one vertex in the interior of the positive orthant. If the number of countries exceeds the number of commodities, there will be several such vertices (see McKenzie (1954b, p. 174), Whitin (1953, p. 523)); whereas if the
a"b'>a'b"
INTERNATIONALTRADE
509
number of commodities exceeds the number of countries, there will be none (see Whitin (1953, p. 533)). The procedure to be followed in extending (1.16) to the case of unequal numbers of commodities and countries was also indicated by Jones (1961, p. 168).
PRODUCTS 1.8. TRADE IN INTERMEDIATE
In the course of his analysis McKenzie (1954b, p. 177) stumbled across the interesting discovery that the introduction of trade in intermediate products necessitates a fundamental alteration in the classical analysis. It is strange that this had not been noticed before, despite the fact, as McKenzie pointed o.ut(1954b, p. 167), that the classical economists used intermediate products such as "cloth" and "linen" in their examples. Some hints of recognition that intermediate products might cause difficulties are contained in Ohlin's discussion (1933, p. 587), but Ohlin dealt only with the implications of trade in machinery (rather than goodsinprocess) and therefore failed to come to grips with the main problem; or at any rate Ohlin was discussing a somewhat different problem. Reiter (1953) and McKenzie (1954b) both pointed out that trade in intermediate products would enlarge the world productionpossibility set; which should not be too surprising since, if such trade is allowed, all the possibilities previously open are still open, and more possibilities are available. What is more surprising is the effect such trade has on the determination of international values. The principal simplification that is used in the analysis of problems in international trade is the concept of an integrated industry, using up primary factors (which are completely immobile among countries) and producing final commodities (which are perfectly mobile among countries). What is the appropriate simplification in the case of intermediate goods? In the case of some of these, such as electric power and coal, transmission and transport costs may be so high that the assumption that they are infinite may be an appropriate simplification. But in the case of petroleum, copper, cotton, wheat, etc., this is obviously not the case. In the case of a single country, in which there is only one primary factor of production (labor), and in which joint production is excluded, the representation of each industry as an integrated industry, using up only labor and producing only a net output, is justified by Samuelson's substitution theorem (1951). This theorem was sketched by Samuelson within a neoclassical framework, was reformulated by Koopmans (1951b) in terms of his activity analysis model (1951a), generalized by Arrow (1951) and also independently developed by GeorgescuRoegen (1951); an elementary exposition was subsequently presented by Koopmans (1953). What the theorem states, essentially, is that any efficient nonnegative bill of goods (net outputs) can be sustained by only one price constellation (i.e., by one ray of prices (kpl, kp2, . . kp") where k >0); this leads, of course, to a labor theory of value. Given this price constellation, even though many processes of production may be available to each firm or industry, only one such process will actually be used.
,
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Geometrically (cf. Koopmans (1953, p. 104)), there will be for any one country an efficient boundary of the set of net outputs that it could produce (this includes negative net outputs, which of course would have to be matched by corresponding amounts of imports); that part of this boundary which could be achieved under autarky, i.e., that part contained in the positive orthant, will be a flat surface. When trade in intermediate products is allowed, it is no longer necessary that net outputs be positive; countries may import some of their requirements, allowing the corresponding net outputs to be negative. In the absence of international trade, the coordinate vectors which "hold up" the flat surface can be regarded as the fictitious integrated production processes; as soon as trade in intermediate products is allowed, there will be more than one possible price constellation, and it can no longer be known in advance, with respect to a given country, which of its possible production processes each of its industries will use. This was one of the points made by McKenzie (1954b, p. 179). There is only one apparent exception to the above statement (and it is only apparent), and that is the case in which one country is so large that its pricesunderautarky rule the roost under trade; this of course is the Graham solution in which the terms of trade coincide with one of the countries' cost ratios. But even in this case, the Samuelson substitution theorem applies only to that one country, and furthermore we cannot know in advance whether a particular country's costs will dominate international prices. One of the results of trade in intermediate products pointed out by McKenzie (1954b, 195556) was that his algorithm for determining efficient specializations broke down. The reason for this can be appreciated from the following example, illustrated by Figure 1.2. Let the production possibility set of one country be given
y d
FIGURE 1.2
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by the shaded figure OAB, and for the other country by the (displaced) shaded figure BGF. Sliding BGF down BA to ACD, we obtain the world productionpossibility set OACDFB, which intersects the axes at E and H. Now suppose the price ratio is chosen to correspond to the slope of eE (or of dD); then at this price ratio, the first country will produce at A, specializing in the xcommodity and importing the ycommodity, whereas the second country will do the opposite, producing at F (measured from B as origin). Thus world output will be determined at D, which is impossible, since it implies negative net world output of the ycommodity. Thus the world efficiency locus cannot be determined by finding the efficient solutions for each country, at any given price constellation, and then adding them up. The reason for the last result is obvious. Not all nonnegative price constellations can be compatible with equilibrium. To take an extreme case, suppose that in both countries the consumers regard the two commodities as perfect substitutes, so that eE and dD can be considered to be their indifference curves (we are thinking of a commodity that does duty as a consumer good as well as an industrial input, such as gasoline, for instance). Then, contrary to what one might expect, the slope eE cannot represent an equilibrium price ratio, since this would entail a solution at D, as already noted. The feasible part of the world production possibility set is just OEH, and clearly the solution must be the point E; but the only price ratio that will sustain this equilibrium is that represented by the slope FD, which is the same as that of BA. This is a case in which the first country rules the roost, its cost ratios determining the terms of trade, even though both commodities are perfect substitutes. This is an example which Graham would have greatly relished, had he considered it. Undoubtedly the most interesting consequence of the introduction of trade in intermediate products is that which McKenzie (1954b, pp. 1779) and Jones (1961, pp. 1668) have emphasized, namely the possibility of reversal in the pattern of specialization. As McKenzie notes (1954b, p. 179): "Thereis nothing shocking to common sense in these results. A moment's reflection will convince one that Lancashire would be unlikely to produce cotton cloth if the cotton had to be grown in England."
1.9. TRANSPORTCOSTS
"The theory of international trade," Ohlin has said (1933, p. 589), "is nothing but internationale Standortslehre." This is certainly a minority viewpoint (cf. Viner (1937, p. 468)). Location theory emphasizes the continuity of space, whereas international trade theory stresses its discreteness. Transport costs in international trade theory are either zero or infinite; there is nothing in between. So radical an idealization is this that it is a wonder that the theory has any bearing on reality at all. One of the devices used by Ohlin was the concept of "home market goods"
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(1933, p. 142), which Taussig (1927, p. 35) had introduced under the name of "domestic goods"; the concept goes back further still to Marshall (1923, pp. 3545n) and Mill (1852a, Book III, Ch. 18, ?3). These domestic commodities have infinite transport costs, but since they are substitutable in consumption and production with international commodities, an element of continuity is restored, and the resulting theory remains extremely serviceable. Nevertheless, many attempts have been made to introduce transport costs in a more direct manner. Some of these, relevant to the models that we have been analyzing in the previous sections, will now be discussed. One of these is the model introduced by Isard and Peck (1954). These authors acknowledged their indebtedness to Graham for many of their concepts. They considered a model of three equidistant countries, with one scarce factor called a "'productiveunit" (to be interpreted, perhaps, as mostly labor) and various commodities such as coal, iron ore, textiles, and steel, as well as shipping; and of these only steel and textiles were consumed by households, in fixed proportions. The principal object of interest is the shipping, of course, and for each commodity, source, and destination, a "distance input requirement" was defined; if there are n commodities and m countries, there are already nm2 pieces of information required. Isard and Peck found an equilibrium solution to their model, by a tentative method. Their model can actually be set up as one in activity analysis, in which commodities in different regions are considered to be different commodities; the shipping activities, as in the model of Koopmans and Reiter (1951), transform one such commodity into another. While Isard and Peck did not justify their method of solution, it can be shown to be legitimate, being closely related to the solution of the dual linear programming problem; cf. Isard (1956, pp. 20815). This is a case in which an equilibrium problem can be transformed into a maximum problemone in linear programming; the reason for this is that the same Lshaped indifference curves are assumed in each country, hence they can be aggregated, and community (world) indifference curves can be legitimately defined. (The same feature was at the basis of Mill's problem; these questions will be discussed in detail in Part 2.) More recently, Isard and Ostroff (1958, 1960)have greatly generalized this model, and rigorously studied its logical structure, in a treatment closely paralleling that of Arrow and Debreu (1954). The treatment of shipping in these models does not take account of the routing of the moving equipment. In the model of Koopmans (1949) and Koopmans and Reiter (1951) this was shown to be one of the major features of the transportation problem. The movement of empty carryingcapacity must presumably be accounted for in some way; even if such movement can be shown to be empirically insignificant, this could simply be a consequence of the effects of differential transport costs on the location of industry. Thus, once transportation is introduced, it is difficult not to take the whole step into location theory.
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Samuelson (1952) considered the problem of equilibrium in spatially separated markets, in the case of one commodity, with given demand and supply functions in each, and given transport costs from each source to each destination. His model was based on treatments by Cournot (1838, Ch. 10) and Enke (1951) and related to earlier models discussed by Cunynghame (1903, 1904) and Barone (1908). His solution was also characterized by transforming the problem into a maximum problem; since just one commodity was involved, this could be expected on the basis of the considerations mentioned above, and it may be conjectured that his method would not extend easily to more commodities without the addition of special assumptions.
1.10. EMPIRICALEVIDENCE
In a nonexperimental field such as economics, any theory or model is difficult to test, since conditions are not controlled. Before attempting to test a theory, it is wise to form some judgment as to its "robustness," that is, how small an effect small departures from assumptions will have on asserted conclusions. Therefore we cannot hope to make a thorough evaluation of empirical tests of the Millian theory until we have surveyed the entire theoretical field. Nevertheless, it will be appropriate at this stage to make some remarks concerning the impressive empirical work of MacDougall (1951, 1952, 1962), which has been followed up by Stern (1962), Balassa (1963), and others. MacDougall (1951, p. 703) presented a diagram, drawn on a double logarithmic scale, which, in his words (p. 702), "shows the ratio of American to British output per worker in each industrymeasured verticallyand the ratio of American to British exportsmeasured horizontally" for a large number of products in a sample of data collected in the 1930's. Noting that during this period, "American weekly wages in manufacturing were roughly double the British" (p. 697), he drew a dividing line in his chart, showing that commodities above the line had higher costs in Britain, and below the line higher costs in the United States. Of course, this is only a slight adaptation of Edgeworth's logarithmic scale. And if no other countries were involved, what we should expect to find would be complete specialization by the United States on one side of the dividing line, and complete specialization by Britain on the other. Thus the kind of function that would be predicted by pure theory would be a step function. But what MacDougall actually found was that a linear function fitted extremely well. This curious phenomenon bears a striking resemblance to similar phenomena observed in experimental psychology, where pure theory would predict one choice or another, but in practice what is found is a smooth gradation. This relationship held despite the fact that both countries traded more with third countries than with each other. Thus MacDougall was using bilateral
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comparisons in what was really a multilateral situation, as McKenzie and Jones have implied has been the practice. Despite the logical objections that one can make, MacDougall's results seem certainlyin some senseto be a confirmation of the Millian theory. But the theory clearly needs to be stated in more suitable form in order to fit the facts. Universityof Minnesota
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