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An "Austrian" Model of International Trade and Interest Rate Equalization
Author(s): Ronald Findlay

Source: Journal of Political Economy, Vol. 86, No. 6 (Dec., 1978), pp. 989-1007
Published by: University of Chicago Press
Stable URL: http://www.jstor.org/stable/1840394
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An "Austrian" Model of International
Trade and Interest Rate Equalization
Ronald Findlay
ColumbiaUniversity
This paper constructs a model of trade in which an intermediate good is

produced by an "Austrian" point-input-point-output process of variable
duration while the finished good is produced instantaneously by labor
alone. The rate of time preference is a function of the level of stationary
consumption and the two countries differ in the rate at which they
discount the future. It is shown that the less "impatient" country will
export the time-intensive intermediate good and import the finished
good, with both countries incompletely specialized and the rate of
interest and real wage equalized.
The theory of international trade has traditionally tended to ignore the

difficulties associated with the concept of capital in its specification of the
conditions of production in the trading partners. Ricardo's initial model
in the seventh chapter of the Principles was of course based purely on labor
as the sole input in production. Later refinements have extended his
constant-cost case to the more realistic one of increasing cost but continue
to assume a "timeless" structure of production. This is true of the "op-
portunity cost" formulation of Haberler (1936) as well as of the "real
cost" approach of Viner (1937). The treatise of Ohlin (1933), while
containing many interesting insights and asides on various aspects of
capital, is also basically timeless in the more formal parts of its exposition,
based on the Walras-Cassel system of equations.
The standard two-factor, two-good model on which so much of the
trade literature of the last 3 decades has been based usually identifies the
I am grateful to my colleagues Guillermo Calvo, Robert Mundell, and Carlos Rodri-

guez and to an editor and referee of this Journal for valuable comments.
[Journal of Political Economy, 1978, vol. 86, no. 6]
? 1978 by The University of Chicago. 0022-3808/78/8606-0006 $01.44
989
990 JOURNAL OF POLITICAL ECONOMY
factors as labor and land. It is of course possible to follow J. B. Clark,

Ramsey, and Solow in identifying one of the factors with a "quantity of
capital" that can be combined with labor or allocated to either sector in
any desired proportions, and this is what is in fact done in most of the work
on trade and growth. The Cambridge capital controversy has largely
been about the methodological legitimacy of this approach. While I
continue to believe in the usefulness of this Clark-Ramsey-Solow parable,
as Samuelson calls it, my purpose in this paper is to resurrect a more
traditional concept of capital in connection with the theory of international
trade by following Jevons, Bohm-Bawerk, and Wicksell in identifying
capital with the time that elapses between the input of primary factors
into production and the emergence of final output. The classic expositions
of these writers and also Irving Fisher (1930) have made us all familiar
with the examples of the fermentation of wine and the growth of timber
normally used to illustrate this approach. I shall call this the "Austrian"
model because this is the conventional appellation, though its originator
was Jevons and its most rigorous expositor was Wicksell (1934), who
could be described as the best of the Austrian capital theorists in the same
sense as his countryman Jussi Bjoerling used to be called the best "Italian"
tenor of his day.
The Austrian model, particularly in the simple point-input-point-
output version that I will be using, is of course very special. That should
not, however, be regarded as a fatal weakness that makes it uninteresting
to explore further. As the recent treatise by Bliss (1975) and the earlier
pioneering work of Malinvaud (1953) make clear, there are practically no
results of any interest to obtain in the theory of capital under very general
assumptions that do not go much beyond perfectly competitive markets
and the convexity of production and preference sets. The examination of
alternative special models is therefore the only source of "meaningful
theorems" to confront against experience. On the basis of its intellectual
pedigree alone, and the place it has occupied in the evolution of economic
theory, it would seem of some interest to examine international trade in
the light of the Austrian conception of capital, especially since the
existing literature is concerned so exclusively with the Clark-Ramsey-
Solow conception, which is certainly no less special in terms of its assump-
tions. More specifically, this approach will enable us to attack directly the
important question about whether trade in goods alone can equalize the
rate of interest, as distinct from the rentals of particular capital goods.
Furthermore, the Austrian theory of capital continues to be an inspiration
to further theoretical developments, as demonstrated by the works of
Hicks (1973) and von Weizsdcker (1971), so that an examination of its
implications for the theory of international trade would not be solely of
antiquarian interest.
INTEREST RATE EQUALIZATION 99I
Consider an economy in which one sector produces a commodity "wood"

according to an Austrian point-input-point-output process. Labor is
used to plant "trees" only, after which the quantity of wood available
increases as a function of time. but at a diminishing rate. The only use for
wood in the economy is as an input, together with labor, in producing a
final consumer good by an instantaneous process. The total labor input
available for allocation between the two sectors is given and is constant
over time. Physical capital in the economy consists of trees of different
ages, whose value in terms of final product can be calculated once the
wage rate and rate of interest are known. This extension of the familiar
Wicksellian model was made by Metzler (1950), who did not however
provide a detailed formal analysis as we shall do here. The analysis will be
confined to stationary states and comparisons between them.
Suppose that
w = w(t) (1)
is the output of wood per unit of labor input applied at the beginning of
the process, obtainable after time t has elapsed. We impose the conditions
w'(t) > 0, w"(t) < 0 on the production function. Total output of wood
1f under stationary conditions will be 147= wLw,where L, is the amount
of labor in the wood sector. Profit per unit of labor will be w(t)e-Pt -v,
where p is the rate of interest and v is the real wage in terms of wood.
Maximization of this expression with respect to t results in
1 dw
_w dt- = p) (2)
which is the familiar condition for the optimal time t* at which the tree
should be chopped down. We assume constant returns to scale in the wood
sector so that total profit is maximized whenever profit per unit of labor
is. The wage rate and rate of interest are given to the producers under
perfect competition, which also imposes the "zero profit" condition
w(t*)e-Pt* = v. (3)
These relationships are depicted in figure 1, from which it is readily

seen that the real wage v and the optimal "degree of roundaboutness" t*
both vary inversely with the rate of interest p.
The production function for final output is F = F(Lf, W), which is
assumed to have the familiar properties of a neoclassical constant-returns-
to-scale production function with wood and labor being substitutable for
each other in making final output. The output per unit of labor is
f =. f L ff>0,f" <0. (4)
log Wt t* )
log v(t*)
0 t* t
FIG. I
Production in this sector takes place instantaneously and profit maximi-

zation implies the familiar marginal conditions
/W
ff' L = Z (5)
Lf
) = ic, (6)
where i is the price of wood in terms of final output. Equation (5) states
that the marginal product of wood in making final output should be equal
to the price of wood in terms of final output, while (6) says that the mar-
ginal product of labor in making final output should be equal to the real
wage in terms of final output. Dividing (6) by (5), it follows that the mar-
ginal rate of substitution between wood and labor in making final output
is equal to v, the real wage in terms of wood.
INTEREST RATE EQUALIZATION 993
' wood' ,,wood"
0 L L a b o r of
+Lf
FIG. 2
This implies that there is a one-to-one mapping from p to 7r.To see

this, observe that to each value of p there corresponds a t * from the
maximization condition (2) and a v from (3). This determines the mar-
ginal rate of substitution between wood and labor in the final output
sector and consequently the ratio of wood to labor in this sector and thus
7t from (5).
From figure 1 we see that a fall in p increases v, and since v = [f (x)

-f '(x)x]/f '(x) where x = TW/Lfis an increasing function of x, it follows
that x must increase as well when p falls. From (5) and the fact that
if" < 0, we see that 7t falls when x rises. Thus p and X vary together in the
same direction.
Since p determines t* and the wood-labor ratio x in the final product
sector, the output per unit of labor in both sectors is consequently fixed
for each value of p. In order to determine the absolute levels of production
in the two sectors, we use the relation
LW + Lf =L (7)
to construct figure 2, which corresponds to a particular arbitrary value of

p. The horizontal distance 00' is equal to L, with L, measured from 0
and Lf from 0'. The slope of the line Ow corresponds to the output per
unit of labor in the wood sector determined by the given value of p.
Similarly, the slope of the line Of is equal to the wood-labor ratio used in
the final product sector determined by the values of v and 7 corresponding

to the same fixed value of p. An isoquant map for the final product sector
can be constructed, with O' as the origin. Consider the point a where
Ow and Of intersect. The output of wood is equal to the input used in the
final product sector at this point, and Lw and Lf together add up to L.
The total output of final product therefore corresponds to the isoquant
passing through a.
The slope of the final product isoquant at acis equal to v, as established
earlier. This slope must be flatter than Ow, since v is less than w, which is
what the slope of Ow is equal to. The gap between the two depends upon
the magnitude of the given value of p. This shows why the solution
determined by the point a is not inefficient, as it might seem, since it is
possible to travel up Ow to a tangency point with a higher isoquant for
the final product and still satisfy the labor constraint. This solution would
equate the wage in the final output sector to the full undiscounted
product w in the wood sector, instead of v which is equal to the discounted
value wept*. It is only when p is equal to zero and t* equal to the
maximum i that a final output isoquant will be tangential to a ray from
0, steeper than Ow since t is greater than t *. This would be the maximum
possible level of final output, constrained only by technology and the size
of the labor force, and would correspond to a state of capital saturation
where the interest rate is zero.
Under stationary conditions the value of capital per unit of labor in
the wood sector will be the integral of vePtdtfor the interval between zero
and t*, the labor cost plus accumulated interest of planting the trees of
all ages, which is
k= 1=) - (8)
p
The same result would of course be obtained if we calculated the present

discounted value of the wood to be sold from all the trees and made use of
(3). The total value of the stock of trees will be Lk. The number of trees
of maturity t * available at each moment will be proportional to L,. This
shows the fallacy of a tangency solution when the interest rate is positive,
since any increase in L, now will only lead to an increased supply of wood
after a lapse of t*, whereas the loss of final output caused by this re-
allocation of the given labor force will be immediate.
It is intuitively clear that the lower the rate of interest, the greater will
be the stationary flow of final product that the system will produce. This
is because more time will be used in the wood sector, and with the total
supply of labor given, more final output should be obtainable. This can
be established rigorously by the following geometric argument. We know
from figure 1 that a lower p will increase t * and hence w(t *). This means
that the Ow line in figure 2 will become steeper like Ow' as output per
unit of labor in the wood sector has increased. Suppose, for the moment,
that technique in the final stage is unchanged so that the Qf line is un-
changed but is now intersected by Ow' at a point / further to the left,
corresponding to a higher level of final product.
The lower p also implies a higher v, and this must raise the wood-labor
ratio used in the final stage so that Of is replaced by the steeper Of'
which intersects Ow' to the right of /3. At /3 the slope of the final product
isoquant is flatter than Ow so that moving up Ow' implies reaching higher
levels of final output until the slope of the isoquant at T where Ow' and
Of' intersect is equal to the higher v corresponding to the lower p. We
have therefore proved that the lower the rate of interest, the higher will
be the level of final product. All this of course assumes that the volume
and age distribution of the trees which constitute the stock of capital in
the wood sector are adapted to the lower interest rate and the longer
"period of production" that it induces. Figure 1 and equation (8) imply
that the value of capital per worker k in the wood sector will be higher at
the lower interest rate, since k is equal to the area under the compound
interest line connecting v* to w(t *), which must increase when v and t
both increase in response to the fall in p. This result could also be derived
by differentiation of the relevant equations.
Since we are assuming stationary conditions, the entire final output is
equal to consumption. We now have to examine the relationship between
the rate of interest and consumption from the demand side. Irving Fisher
(1930) assumed that the rate of positive time preference varied inversely
with the stationary level of consumption, but his argument has been
criticized severely by Friedman (1969). Here we follow Uzawa (1968) in
postulating, consistently with the rigorous axiomatic investigation of
Koopmans, Diamond, and Williamson (1964), that the rate of positive
time preference increases, at least locally, with the stationary level of
consumption. The consequences of altering this crucial assumption will
be noted briefly later.
Perfect competition equalizes the rate of time preference to the rate of
interest so that we have a positive relation between the rate of interest
and the stationary flow of consumption per capita shown as the curve
CC in figure 3. The inverse relation between the rate of interest and the
per capita level of final output from the supply side that we obtained
earlier is plotted as the curve PP in figure 3. The intersection of the two
curves determines the equilibrium interest rate p* and per capita level of
consumption c*. From p* the corresponding equilibrium values t*, w*,
v*, k*, L*, and r* can all be determined with the system being closed by
the relation
c = c(p) c'(p) > 0. (9)
An increase in "impatience," a rise in the rate of time preference at
each level of stationary consumption, would shift CCto the left in figure 3,
C~~~~~~~
0 C
FIG. 3
resulting in a higher p* and a lower ce'. Greater productivity, as a result

of technological improvement, for example, would shift PP to the right,
raising c* as well as p*.
II
International trade can now be introduced into the model without any
difficulty. We first observe that if there are two separate economies with
the same technology and time-preference functions the equilibrium
values of the rate of interest and relative product prices will be identical,
so that there would be no incentive for trade to arise even if there is a
difference in the size of the labor force, which only influences the scale of
production. In terms of figure 3, identical technology implies the same
PP curve and identical time preference the same CC curve so that p* and
7r must be the same for both countries, hence no trade.
Figure 4 indicates the case in which both countries have the same
technology and therefore the same PP curve but different time-preference
functions or CC curves, CC' for country A and CCb for country B. These
two curves can be combined into a single function CC' for the world as a
whole if CC' and CC' are added after each is multiplied by the fraction of
C
a
C
~~~b
Pa, _ _ _ _ _ _ I
Pb y/--
C
IC I c ll~~I
I I I
I I C I
I l l l I
0 c* c c* c c*
a a w b b
FIG. 4
International trade~~~eqaie reaiv cmoitprcsawelsth
world population in that country. The intersection of CCW and PP

determines the piequilibrium and henceo* for the world economy.
International trade equalizes relative commodity prices as well as the
interest rate and real wage. The common value of p* in the two countries
determines ca*and cb, the levels of stationary consumption, from c~a and
CCb, with c* being the weighted average of the two.
The determination of the quantities produced and consumed of both
goods in each country, and hence of exports and imports, follows from
f (p*) 'Fi + w(p*)- 1 ih L, (10)

[1 - r*Z(p*)]Fi + i*Wi = c*(p*), (11)
where i = a, b, z is the wood input per unit of final product and w(p*)l
and f (p*) -' are the labor input per unit of wood output and final
product, respectively. Since r*, w(p*), f(p*)1, z(p*), and c*(p*) are
all determined at their equilibrium values, (10) and (11) give us a pair of
linear equations for each country to determine Fi and Wi. The levels of
exports and imports follow immediately since the demand levels c*(p*)
and zFj for both goods are also known.
From figure 4 we see that A is the more impatient country, since it
discounts the future more heavily at any stationary level of consumption.
In isolation we have Pa > Pb and ca < Cb, the more impatient country A
having the higher interest rate and lower per capita consumption. Trade
equalizes the interest rate at p* where PP cuts CCW.The posttrade con-

sumption level ca*in A is below the autarchy level ca, since the lower
interest rate moves A down along CCa,whilein B the posttrade consumption
level c* is greater than the autarchy level Cb, since trade raises the interest
rate and B moves up along CCb. The initial difference in consumption
levels is accentuated as a result of trade, since there is a fall in the more
impatient country and a rise in the less impatient one, so that we have
the relation ca*< ca < Cb< Cb.
The consumption level is related to income by
ci* =
-* (V* + p*k*4*), (12)
where A* = L '/Liis the ratio of labor in the wood sector to the total
labor force in each country. Equation (12), which follows from ( 11) with
some substitutions, simply states that per capita consumption is equal to
the real wage rate in terms of final product l*v* plus interest at the rate
on the per capita stock r*k*)4. Since technology is identical in both
countries, international trade in our model equalizes 7r*,p*, v*, and also
t * (the period of production) and hence k* (the value of capital per worker
in the wood sector), since by (8) this depends only on p*, v*, and t*. The
value of capital in terms of final product per head of the entire labor force,
however, is not 7r*k*but 7*k*)4, and it is the i4t that differ, so that c* < c*
implies 4* < 4.
In terms of figure 2, suppose without loss of generality that the given
amount of labor is one unit in each country and the parametrically fixed
value of the rate of interest is equal to p*. Since technology is the same, the
same diagram can then servefor either country. With n* and k* both deter-
mined by p*, the value of capital per capita is proportional to the distance
along the horizontal axis from 0 which is equal to A*, with the output of
wood corresponding to the height of the line Ow for each value of Hi*.
Since ia < ib, it must be that B is further out along the Ow line than A.
For the world economy as a whole, the output of wood must correspond
to the point at which Ow and Of interact, since this is where the world
supply of wood is equal to the world demand for it from the final product
sector. It therefore follows that 2a must be to the left of the intersection and
Ab to the right. The vertical distances between Ow and O'f must be equal
in length, with the excess demand for wood in A being exactly offset by
the excess supply in B. The pattern of specialization is for B to have the
larger stock of trees per capita and a higher proportion of the labor force
in the wood sector, with B exporting wood to A and importing the final
product, though both countries continue to produce both goods. As we
have shown, p and 7rmove in the same direction so that Pa > P* > Pb
implies ala > 7r* > 2tb. International trade makes wood cheaper in A, the
importing country, and more expensive in the exporting country B, as we
would expect.
The fundamental determinant of the pattern of comparative advantage

and international trade is the difference in the degree of impatience or
structure of time preference between the two countries. At any given
interest rate there is a relatively greater supply of "waiting" in B than in
A, which manifests itself in the willingness to hold a larger stock of capital
(in terms of the value at equilibrium interest and wage rates of a set of
trees with a balanced age distribution). This leads to an excess supply of
wood in B which exactly matches the excess demand for that commodity
of the more impatient A. The production of wood requires time to elapse
between input and output, while the final product can be made in-
stantaneously, provided of course that wood is available. In a closed
economy there is no way to produce final output without doing the waiting
necessary for the intermediate input. International trade, however, makes
it possible to separate the two production processes and have the less
impatient country specialize in the more time-intensive intermediate
stage, exporting some wood in exchange for part of the additional final
output that this enables the more impatient country to produce.
The depiction of the gains from trade in our model is a rather subtle
and difficult problem, since, unlike the usual static theory where there is a
fixed endowment of capital, we have to contend with the fact that the
value and the composition of the capital stock are altered by trade. This
makes any direct comparisons between the autarchy and free trade
equilibria impossible. However, we can show that if the interest rate in
each country is at the free trade equilibrium level p* and the values of
the capital stocks per capita in each country are at the levels p*ir*k*)*a
and p*7r*k*)4 associated with this interest rate by virtue of the fact that
p* determines c* and c* from (9), which in turn determine A* and ,b
from (12), then each country is better off with trade than under autarchy,
with the rate of interest and the stocks of capital held constant.
The interest rate p* determines the common values t*, w*, k*, v*, and
7t* for each country and, from (9) and (12), the labor inputs ,*La and
)*Lb into the wood sector, with wood outputs being w*)*La and w*;.*Lb.
In figure 5 the distance 00' measures the combined world output of
wood, which is equal to (W*4*La + w*4 Lb). Labor inputs into the final
output sectors will be (1 - *)La and (1 - )*)Lb. Marginal productivity
curves for wood in the production of final output corresponding to these
fixed labor inputs are drawn for each country, with 0 as the origin for
country A and O' for country B. In the absence of trade, the inputs of
wood into the final output sectors would be W*)*La, equal to OM, in A
and w*,*Lb, equal to O'M, in B. The marginal productivity of wood is
higher in A than in B. Export of MN amount of wood from B to A
equalizes the marginal productivity of wood in both countries at the level
7r*, which also correspondsto the terms of trade. The area of the rectangle
7r*MN measures the export of final product from A to B in payment for
I I
0 M N 0
FIG. 5
wood imports of MN. The gain from trade for A is the upper triangle
below its marginal productivity curve between M and N, while the gain
from trade for B is the lower triangle above its marginal productivity
curve between N and M. International trade thus makes it possible for
each country to have a higher level of stationary consumption at interest
rate p* than if it were in autarchy at the same interest rate. The gain from
trade in this "at the same interest rate" sense is what corresponds to the
ordinary static gains from trade in our model.
We know, however, that trade alters the interest rate in each country,
lowering it in the more impatient country A and raising it in B. This is a
manifestation of the familiar Stolper-Samuelson theorem in the context
of our model with its different technology. Country B exports the more
time-intensive commodity, which is wood, and this lowers the real wage
and raises the rate of interest which is the "price of time," while the
opposite happens in country A, which exports the labor-intensive final
product and experiences a rise in the wage rate and a fall in the rate of
interest. The changes in the rate of interest induce alterations in the supply
of waiting in the same direction. Country B has a higher level of consump-
tion in the free-trade equilibrium with interest rate p* than in isolation at
the lower interest rate Pb'while country A has a lower level of consumption
in free trade at interest rate p* than in isolation at the higher interest
rate Par
INTEREST RATE EQUALIZATION 100I
The fact that c* < ca should not lead to the conclusion that trade
imposes a loss on the more impatient country A. The reason why such an
inference is false is that A can enjoy higher consumption in the process
of going from a stationary state with a higher to one with a lower stock of
capital. This additional consumption during the transition is what
induces the residents of A to reduce their long-run capital stock and the
associated level of consumption. The same situation arises in neoclassical
models of trade and growth studied by Stiglitz (1970), Deardorif (1973),
and others and also in the neo-Ricardian model of Samuelson (1975).
A direct comparison of the costs and benefits of the transition is ex-
tremely difficult to undertake, especially in our model with what amounts
to a continuum of capital goods in the form of the trees of different ages.
Fischer and Frenkel (1974, 1975) conduct a painstaking numerical
simulation using particular functional forms for production and consump-
tion relations to study the analogous problem in a neoclassical context.
III
Since most models of international trade assume that the two goods
traded are both final consumer goods, it is of some interest to see whether
our Austrian model can cover this case as well. Though we shall not
specify such a model in detail for reasons of space, it can be shown that
the extension is quite straightforward. Each of the two final consumer
goods can be given an Austrian point-input-point-output production
function, corresponding to equation (1). Given any interest rate, there is
then an optimum period of production for each good and a corresponding
real wage in terms of that good by the "zero profit" conditions. The
relative prices of the two final goods must then correspond to the ratio of
these real wages, since labor is homogeneous and perfectly mobile. This
relative price is thus a function of the rate of interest alone, independent
of demand conditions, as in the "non-substitution" theorem of Samuelson
(1961). This relative price will be a monotonic function of the rate of
interest if one of the goods always has a longer period of production than
the other at every rate of interest. Figure 6A illustrates this condition and
figure 6B a situation in which it is violated. The reader will note the
analogy to the so-called strong factor-intensity hypothesis in the con-
ventional neoclassical model. The value of capital per unit of labor in our
model will always be higher in the sector with the longer period of produc-
tion. With this assumption the analysis goes through in much the same
way as before. The only modification is that we have to replace consump-
tion per capita of the sole final good with per capita flow of utility from the
consumption of the two final goods in this case. International trade equates
the real wage and the rate of interest, with the less impatient country
exporting the more time-intensive good.
t2ap)
0 Time
FIG. 6A
t2(p)
t1(p)
Time
FIG. 6B
An assumption that has been maintained throughout the paper is that

the rate of time preference is an increasing function of the level of station-
ary consumption (or utility). A more familiar assumption in the literature
is that the rate of time preference is a constant. In this case a difference
between the constant rates of time preference in the two countries must
result in one or both countries being completely specialized, with the one
having the lower constant rate of time preference producing wood, in the
original model, or the more time intensive of the two goods in the alter-
native version discussed in the previous paragraph. The interest rate and
wage rate will obviously not be equalized through trade when at least one
country is completely specialized, just as in the case of the ordinary
neoclassical model.
The rate of time preference decreasing with the level of stationary
consumption presents some real difficulties. In terms of figures 3 and 4 it
means that the CC curve for each country is downward sloping, and since
the PP curve is downward sloping as well, there can obviously be multiple
equilibria in this case. If the CCcurve is steeper than PP at the intersection
point, the rate of return or investment will be less than the rate of time
preference for consumption levels below the equilibrium point. This is
not consistent with stability since the incentive is to decumulate rather
than to increase the level of consumption by accumulation. We may
therefore consider only situations where the CC curve cuts the PP curve
from below at the equilibrium point. As the reader can readily verify by
drawing the appropriate diagram, some extremely paradoxical results
arise in this case. Consumption increases in A, the more impatient country,
and falls in B. Consumption in A is lower than in B in the absence of trade
but is higher than in B in the free-trade equilibrium position. Furthermore,
since A has the higher capital stock under free trade, it must be the
exporter of the more time-intensive good, wood, even though wood is
more expensive in A in the absence of trade. Trade equalizes the rate of
interest and the real wage, but it is the more impatient country A that is
the exporter of the more time-intensive good. These paradoxes essentially
follow from the fact that at the free-trade equilibrium interest rate p* the
more impatient country A must have a higher level of stationary con-
sumption than B to bring both rates of time preference into equality with
the common interest rate p*. Trade always reduces the rate of interest in
the more impatient country A and raises it in B. The consequences of these
interest rate changes for consumption levels, desired capital stocks, and
hence for the pattern of trade depend upon whether the rate of time
preference varies positively or negatively with the level of stationary
consumption.
IV
Having completed the analysis of the Austrian model of trade, we turn in
this final section to the relationship between our work and the relevant
I004 JOURNAL OF POLITICAL ECONOMY
literature. The basic Austrian capital theory has usually been presented
as an aggregative model, and its general equilibrium aspects have not been
explored very much. This is true of pioneers such as Bohm-Bawerk and
Wicksell as well as modern expositors such as Dorfman (1959), Hirshleifer
(1967), and Kuenne (1971). Relative product prices, and their connection
with the rate of interest, have not been prominent in these writings.
Lindahl (1939) and Hansen (1970) have considered what the latter has
called a "Walrasian model with capital a'la Wicksell" in the attempt to
achieve a synthesis between these two important strands of economic
theory. Their work however does not get much beyond counting equations
and unknowns. It is the assumption of labor as the only primary input and
the consequent possibility of exploiting Samuelson's nonsubstitution
theorem that has enabled us to develop an interesting and tractable
special case.
The main contribution that this paper is intended to make is to show
that the Heckscher-Ohlin propositions can be derived independently of
the Clark-Ramsey-Solow view of capital as a homogeneous and malleable
substance that enters the production functions for final goods directly and
of which each country has some fixed endowment per unit of the labor
force. As Kenen (1965) and in particular Metcalfe and Steedman (1973)
have argued convincingly, the Heckscher-Ohlin theory must be viewed
in terms of the long run and the appropriate concept of capital in that
context is of a sum of the value,in terms of some unit of account, of the
various heterogeneous physical objects that constitute physical or "real"
capital in the economy. Any empirical test of the theory, such as the
famous one of Leontief, for example, must be based on an interpretation
of capital as such a value aggregate.
The demonstration in Samuelson (1965) of interest-rate equalization
through trade was based on a model with Clark-Ramsey-Solow capital.
Drawing on the recent literature of the Cambridge capital controversy,
Metcalfe and Steedman produced a numerical example in which all the
usual Heckscher-Ohlin assumptions are satisfied but in which "capital"
is interpreted as a value and not a physical magnitude. In this example
the price ratio of the final consumer goods is not a monotonic function of
the interest rate, and neither is the capital intensity in each sector. They
therefore conclude that all the familiar Heckscher-Ohlin propositions,
which depend crucially on such monotonic relations, must go by the board
once capital is viewed in the appropriate value terms. What we have shown
here, however, is that once the Austrian technological assumptions are
made, the Heckscher-Ohlin results still follow, provided there is no "time-
intensity reversal," which seems to be a natural analogue of the "strong"
factor-intensity assumption that is traditionally made in the trade litera-
ture. How special these Austrian technological assumptions are has been
shown most clearly by Samuelson (1966) himself, but it is worth pointing
out that the basic features of the Heckscher-Ohlin approach Can be

exposited consistently within a framework of assumptions which do not
require capital to be regarded as a lump of putty. A familiar Cambridge
criticism is that neoclassical models are logically circular, since they use a
"quantity of capital" to determine the rate of interest which itself needs
to be known in order to determine the "quantity of capital." What has
been demonstrated here is that the rate of interest and the value of capital
can be determined simultaneously without any circularity whatsoever.
It should also be noted that our statement of the sufficient conditions
for interest-rate equalization is free of the accusation of tautology leveled
against Samuelson by Bliss (1967) and repeated by Metcalfe and Steed-
man, since the nonreversal of time intensities at any interest-rate condition
necessary for the monotonic relation between the interest rate and the
price ratio can be specified independently ex ante, so that the implication
of interest-rate equalization is in principle able to be refuted empirically
and is hence not a tautology. Samuelson (1975), in a long and difficult
paper which would require too much space to comment on adequately
in relation to the analysis given here, also provides cases in which it is
possible to do this. This article gives extensive references to other related
papers in which the time structure of production and the composition of
capital are discussed in relation to international trade, to which we may
add Brecher and Parker (1977), which is also Austrian in inspiration but
makes the severe assumption of a given real wage and rate of interest,
which prevents them from examining most of the issues treated here.
Our version of the Heckscher-Ohlin theory does not assume that
countries are arbitrarily endowed with different amounts of capital per
head, in either quantity or value terms. Instead the differences in the per
capita endowments of capital in the sense of an aggregate of values at
equilibrium prices is shown to follow from differences between nations in
Bohm-Bawerk's "second ground," that is, differences in psychological
propensities as to the relative weight attached to the present and the future.
To the best of our knowledge this paper is the first extended analytical
treatment of this factor as a determinant of the pattern of comparative
advantage and international trade though Stiglitz (1970) considers con-
stant rates of time preference in the frameworkof the Oniki-Uzawa (1965)
model. With a constant discount rate in each country there is either no
trade at all, if these rates are the same, or complete specialization in at
least one country without factor price equalization if they are different.
The variable discount rate which is an increasing function of the stationary
consumption or utility level in our model enables differences in time
preference between nations to be consistent with incomplete specialization
and the equalization of the rate of interest and the real wage.
Finally, we observe that the model enables us to consider a "vertical"
international division of labor, with the less impatient and therefore more
Ioo6 JOURNAL OF POLITICAL ECONOMY
capital-abundant region specializing in the more time-intensive earlier

stages of production while the more impatient one concentrates on the
instantaneous labor-intensive final stage. Helleiner (1973) has shown the
relevance and growing importance of such a trade pattern between the
advanced and less-developed countries. Our Austrian version of the
Heckscher-Ohlin theory enables this phenomenon to be handled in a
natural and easy way. There are obviously a host of qualifications to and
extensions of our analysis that the informed reader might wish to see made,
but further lengthening of the production period of this particular project
is precluded by the author's impatience.
References
Bliss, Christopher J. Review of The Collected Scientific Papers of Paul A. Samuelson,
edited by J. E. Stiglitz. Econ. J. 77 (June 1967): 338-45.
- . Capital Theory and the Distribution of Income. New York: American Elsevier,
1975.
Brecher, Richard A., and Parker, Ian C. "Time Structure of Production and the
Theory of International Trade." J. Internat. Econ. 7 (November 1977): 385-402.
Deardorff, A. V. "The Gains from Trade in and out of Steady State Growth."
Oxford Econ. Papers 25 (July 1973): 174-91.
Dorfman, Robert. "A Graphical Exposition of Bohm-Bawerk's Interest Theory."
Rev. Econ. Studies 26 (February 1959): 153-58.
Fischer, Stanley, and Frenkel, Jacob A. "Interest Rate Equalization and Patterns
of Production, Trade and Consumption in a Two-Country Growth Model."
Econ. Rec. 50 (December 1974): 555-80.
. "Errata." Econ. Rec. 51 (September 1975): 428-29.
Fisher, Irving. The Theory of Interest. New York: Macmillan, 1930.
Friedman, Milton. The Optimum Quantity of Money and Other Essays. Chicago:
Aldine, 1969.
Haberler, Gottfried. The Theory of International Trade. London: Hodge, 1936.
Hansen, B. A Surveyof General Equilibrium Systems. New York: McGraw-Hill, 1970.
Helleiner, G. K. "Manufactured Exports from Less Developed Countries and
Multinational Firms." Econ. J. 83 (March 1973): 21-47.
Hicks, John R. Capital and Time: A Neo-Austrian Theory. Oxford: Clarendon, 1973.
Hirshleifer, Jack. "A Note on the B15hm-Bawerk/Wicksell Theory of Interest."
Rev. Econ. Studies 34 (April 1967): 191-99.
Koopmans, Tjalling C.; Diamond, P. A.; and Williamson, R. E. "Stationary
Utility and Time Perspective." Econometrica 32 (January-April 1964): 82-100.
Kenen, Peter B. "Nature, Capital, and Trade." J.P.E. 73, no. 5 (October 1965):
437-60.
Kuenne, R. E. Eugen von Bdhm-Bawerk. New York: Columbia Univ. Press, 1971.
Lindahl, Erik R. Studies in the Theoryof Money and Capital. London: Allen & Unwin,
1939.
Malinvaud, Edmond. "Capital Accumulation and Efficient Allocation of Re-
sources." Econometrica21 (April 1953): 233-68.
Metcalfe, J. S., and Steedman, I. "Heterogeneous Capital and the Heckscher-
Ohlin-Samuelson Theory of Trade." In Essays in Modern Economics, edited by
Michael Parkin. London: Longman, 1973.
Metzler, Lloyd A. "The Rate of Interest and the Marginal Product of Capital."
J.P.E. 58, no. 4 (August 1950): 289-306.
INTEREST RATE EQUALIZATION I 007
Ohlin, Bertil. Interregional and International Trade. Cambridge, Mass.: Harvard
Univ. Press, 1933.
Oniki, H., and Uzawa, H. "Patterns of Trade and Investment in a Dynamic
Model of International Trade." Rev. Econ.Studies32 (January 1965): 15-38.
Samuelson, Paul A. "A New Theorem on Non-Substitution." In Money,Growth
and Methodology,edited by Hugo Hegeland. Lund: Gleerup, 1961.
. "Equalization by Trade of the Interest Rate Along with the Real Wage."
In Trade, Growth and the Balance of Payments, edited by R. Baldwin et al. Chicago:
Rand McNally, 1965.
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1966): 568-83.
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Intertemporal Efficiency." J. Internat.Econ. 5 (November 1975): 309-63.
Stiglitz, Joseph E. "Factor Price Equalization in a Dynamic Economy." J.P.E.
78, no. 3 (May/June 1970): 456-88.
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Holdings." In Value,CapitalandGrowth,edited byJ. N. Wolfe. Chicago: Aldine,
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An "Austrian" Model of International Trade and Interest Rate Equalization

Author(s): Ronald Findlay

You may need to log in to JSTOR to access the linked references.

This paper constructs a model of trade in which an intermediate good is

The theory of international trade has traditionally tended to ignore the

I am grateful to my colleagues Guillermo Calvo, Robert Mundell, and Carlos Rodri-

factors as labor and land. It is of course possible to follow J. B. Clark,

Consider an economy in which one sector produces a commodity "wood"

These relationships are depicted in figure 1, from which it is readily

f =. f L ff>0,f" <0. (4)

Production in this sector takes place instantaneously and profit maximi-

' wood' ,,wood"

This implies that there is a one-to-one mapping from p to 7r.To see

From figure 1 we see that a fall in p increases v, and since v = [f (x)

to construct figure 2, which corresponds to a particular arbitrary value of

the final product sector determined by the values of v and 7 corresponding

The same result would of course be obtained if we calculated the present

resulting in a higher p* and a lower ce'. Greater productivity, as a result

world population in that country. The intersection of CCW and PP

f (p*) 'Fi + w(p*)- 1 ih L, (10)

equalizes the interest rate at p* where PP cuts CCW.The posttrade con-

The fundamental determinant of the pattern of comparative advantage

An assumption that has been maintained throughout the paper is that

out that the basic features of the Heckscher-Ohlin approach Can be

capital-abundant region specializing in the more time-intensive earlier

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f (p) 'Fi + w(p)- 1 ih L, (10)