. i
UNITEP NA'I'IONS
INSTI'IUTE FOR ECONOMIC
~VELOPMENT AND PLA1TJ.iiiNG .D A KA R
IDEP/ET/VII/ 107 Lecture 1
\pril 1964
c.
D. Caxhey
/f1
INTERNATIONAL ECONOMIC RELA'l'IONS
First Lecture: The Classical· Doctrine of International Trade:
(a) Supply ( b) ·:oemand
A. Basis for a Separate Theoretical Treatment of International Trade The classical economists (from Adam Smith to John Stuart Mill) founded a separate theory of international trade based on what they
observed to be differences in the behaviour of factors of production (land, labour and capital) when employed in the domestic market and when employed in production and trade in the international market. This difference in behaviour, they thoug~t9 consisted in the relative immobility of productive factors in international as distinct from domestic trade. This was broadly true9 but they tended to exaggerate the degree of mobility of such factors on the domestic market 9 for factors are far from being perfectly mobile between the different regions of a country.
Basically9 there is no difference in the principles governing production and trade between the different regions of a country and production and trade between different countries. For the same principles govern in both cases:
(a) production according to factor availabilities and factor priees (b) allocation of the use of productive .factors according to differences in factor costs and product prices9 and according to factor incarnes - that is~
according to supply and demand conditions9 (c) factor mobility or immobility determines also the relative levels of factor priees in different areas9 etc. The difference ,betvreen domestic and international trade is only one of
degree.
Yet there are many other factors9 also of an institutional nature9 which differentiate both types of trade and justify a separate treatment of inter- national trade9 chiefly the following:
( i) Division. of labour wi thin economie theory:_ If only because of the convenie:.1ce and advantages accruing from the application of the principle of division of labour in the treatment of different
aspects of economie theory9 the separate treatment of international
I:DEP/ET/
Lecture ·1 Page 2.
trade would be justified. But the jus tif ica ti on goes beyond thËY' advantages of an intellectual division of labour.
(ii) Political boundaries~ Theexistence of political boundaries and national sovere.ignty makes necessary a separate accounting for the trade that
~ .. . . ~ . .
passes across national frontiers (Not paralleled in domestic trade).
(iii) Political and ideolog~cal differences~ Political and ideological differ- ences betvreen countries have an impact on foreign trade and on the trading relationships between countries. Thus9 there are trade blocs based on ideological differences9 such as the communist trading bloc and the European Common Market, the latter being in part a response of
~'festern Europe to fears of communist economie penetration from the
Soviet Union. Common nationalistic views may also combine with economie necessi t~r to crea te trading areas 9 e. g. 9 the German Zoll vereLYJ. of the 19th century9 the Latin American Free Trade Area and the proposed African Common Market of today (Not paralleled in dornes-tic trade nor recognised by the classical doctrine of international trade).
(iv) Differences in_.}_9-nguage 2 tas tes 9 eus toms 9 habits and tradi tians and in leg?-1 systems.~ These differences betvreen countries do have a restrictive influence on the flow of trade between them9 in a mannar inconceivable for dornes-tic trade (Not paralleled in doniestic trad.e).
(v) Currency Systems: Different currency systems and currency areas, based on different currency units, result in changes in the relative values of the various currency units arising from the flow of trade as well as from differences in foreign exchange policies of different countries or groups of countries (Not paralleled in domestic trade).
(vi) Differences in domestic banking2 credit and fiscal policies ~ncludip~
yariffs2 quotas. restrictions and prohibitions on trade: These differ- ences between countries follow from th8 existence of different currency systems and areas and may be used consciously to interfere with the course and direction of trade (Not paralleled in domestic trade).
(vii) Spatial differences: The existence of space and distances between countries affectstr-ansportation costs and resultsin marked priee
differentiais between the domestic and foreign priee of internationally traded goods (Not so pronounced in <lomestic trade).
..
IDEP/ET/VII/ i 07 Laoture 1
Page
3.
• ( viiij -Differences · in :the kihâ.s· ·and types of goods entering international trade9 ... as distinct from domestic trade: is a direct consequence of tho
existence of transporta ti on costs 9 vrhich makE: sorne goods less able than others to bear the expense of exportation (Not paralleled in domestic trade).
All . these . . . fact~- . . ors . . .. . contribute tovrards making individua. . ~ l countries separate
internationa~ trading units and therefqre give to international trade a distinct theory constituting a separate study in the general body of economie theory.
B.- The Classical Doctrine of International Trade ·
I. The classical doctrine of international trade arose out of the
attempts of the classical school of economists ta find answers to the follbwing
questions~
( 1) Why do es trade take, place. between countries 9 and w·ha t goods do es a country buy and sell in foreign trade?
(2).0n what terms are these goods bought and sol d, that is, what determines the priees at which experts and imports are exchanged in international trade?
(3) How are the gains from foreign trade shared between the partners? · (4) By what mechanism is equilibrium in the balance oftrade. and payments
between countries achieved and maintained?
II. The answers to these questions constitute the classical doctrine of international trade. What were these ansuers?
i . Uhy trade takes place hetvreen na ti ons and in wha t goods (Ricardo and the Law of Comparative Cast Advantage)
Adam Smith: Absolute advantage, with given (uniform) labour and capital oost, that is, constan~ coit.
Using the classical example of the 2-country, 2-oommodity case, let us pursue Adam Smith 1 s line of thought as far as vre could go.
(a) Absolute advantage in a different line of production for either country, that is, different output ratios.
Le0ture
1 ag.:; 4·
Production with given expenditure of labour and capital
(1 week or man-weekl Same range( i) Without Product
of profi- ( Speciali- Wheat (ton)
u . s .
10
U.K.
5
Total 15
tabl e ex- ( zation Cloth (bale)
5
10change ( Ratios: ;; : 1 1 :2
ii)
v h
th Specializa tian. Whea t (ton) (Larger total output Cloth (Bale)20
20 with profitable Ratios:
Range of profitable ex change -vrider than
( i) and (ii)
exchange).
iii) With partial specialization.
(larger total output
with profitable exchange)
20 Hp (US) 2:1 or 1:1/2
1
1 / E = î : 1
1
olt-.~
1 '-/~ange
ofp~ o fi-
\'., ,_, .· _...-.r {abl~ bar-cer
~-. _4:-·-: .• - erm-:
5 _ \ ~\ .. -Rp (UK)1 :2 or
1 -~~~.::. ,,.,,
._., / \ '·\::. '
~',
-· 1/2:10
5
10Figure I
vlhea t (ton) Cloth (bal e)
Ratios:
15
2 1!-
6: Î
vTheat Cloth
(~on) 10((,)
5
(bale) 20(20) 10 Ratios:1:2 (1:3·,~)î :2
15 1 : Î
20 20 1 ; 1
17-~':
n 1-
Î : Î
15 30 1 :2
(b) Absolute advantage in bath lines of production for one country (same or different 6utp~t ratios ).
What happen$ if one country possesses. absolute advantage in
bot~ lines of production?
1 : 1
Breakdor..r.D of 0mi th.' s Theory: No exchange is possible if one
country possesses absolute advantage in both lines of production, since i'~ cannat obtain ei thar commodi ty cheaper by trade than it can by producing it for itself.
Note: Because of assumed immobility of the factors of production (L,L,C) behreen countries in the classical trade theory, compari- sons of cost and output are within not bet1-reen countries. But
• , , •
by standardizing costs, comparisons are possible between countries.
...
IDEP/Nr/VII/107 Lecture 1
Page
5·
:Because of the inability of Smith's theory to explain ·trade between countries, one of which possesses absolute advantage in both
commodities a different explanation must be found for trade between such countries. For otherwise it would be difficult to explain the case of exchange between, say, U.K. and U.S. in regard to cloth and wheat, or between U.K. and Japan in regard to cameras and cloth.
David Ricardo supplied the answer.
David Ricardo: Comparative Cost advantage with given (unifor@) labour and capital (reckoned in terms of labour costs), i.e., constant labour costs.
Production with given expenditure of labour (1 week or man-week)
Product U.S. U.K. Total
Wheat (ton) 12
5 17
Cloth (bale) 20 .10 30
Ratice: 1:1 2/3 1:2 1:1
: n/17
----~---
Wheat (ton) 10
5 15
Cloth (bale) 20 10 3~
Ratice: · h 2 -···- - t·: 2 1 :2
:Because of its comparative advantage in wheât production U.S. will
...
export wheat to U.K., while U.K. will export cloth to U.S. because of its comparative advantage in elath production. In other words, so long as U.S. can get.cloth at any priee cheaper than t:1 2/3 in terms of wheat it will export wheat to U.K., and so long as U.K.
can get wheat at any priee chcaper than 1: 2 it will export elath to U.S.
in terms of cloth Note: The explanation of trade on the basis of comparative oost
advantage breaks down if there is no comparativë but only proportional advantage.
IDEP/ET/
Lecture 1 Page 6.
2. How Priees of internationally traded goods are determined (Mill and the Theory of Reciprocal Demand) ..
Using the familiar Marshall-Edgeworth offer curves (so-called beeause of the authors' application of these curves to the graphical . portrayal of Mill' s Theory) anél home production possibili ty curves
(priee ratios) we can illustrate Mill's answer to Question 2, namely that the limits to possible international exchange ratios, or barter terms of trade, are set by the domestic ex~hange ratios (home
production functions) .established by the relative efficiency of
labour in each country, and that within these.B.ïrifts the actual ratio which will prevail will depend upon the relative strength and elasti- city of each country's demand for the other's product, that is, on their reciprocal
w
i:demand.
. us (
1 0· :5 ) (tf)
1
.Figure IV
UK Offer Curve
w c
UK HPC 6(tons)18 bales US HPC 10(tons)5 bales Offer Curve
--- JK (6: 18') (c)
c
3.
How the gains from trade are shared by any two countries (Mill:Relative intensities and elasticities of demand of any two countries).
Bath countries gain from trade so long as exchange takes place within the limits set by their home production ratios. But that country will gain more whose demand in terms of the other's product is relatively less elastic.
4·
The mechanism by which equilibriurn in trade and balance of payments is achieved (David Hume and the Specie-Flow mechanism of the Inter- national Gold Standard).David Hume provided the answer to Question
4·
The inflow and outflow of gold serves to correct disequilibrium in trade, foreign exchange rates, and balance of payments as follows: Excess imports reduce the supply and increase the demand for foreign exchange:
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I:DEP/ET/VII/107 Lecture 1 ·
Page
7·
(i.e., foreign currencies as means of payments) and thereby raises the market rate of exchange abo~e the official rate. Gold, being cheaper, because having a relatively fixed priee, flows out and causes a contraction in the domestic banks' reserves and volume of credit; this is followed by reduced priees for domestic goods according.to the classical Quantity theory of money by which the priee level is independent of the volume of output which is assumed constant
1 priee level being determined solely by the volume of the money supply. (The Quantity theory, thus propounded, was erroneous). Anyway, wiih lower priees of domestic goods, exports become cheaper and flow out in increasing volume; imports are discouraged because the domestic J?rice level 9 being low9 is unattractive. This shifts the supply ourve of foreign exchange outward tc the right9 and the demand curve for foreign exchange inwards to the left, bath bringing down the market rate of exchange towards or below the official rate. Foreign debtors now find their market rate of exchange higher than the
official rate and gold being cheaper is shipped by them to settle their debts. Once more gold flows in; the domestic money supply is expanded and the level of domestic priees rises, encouraging imports and discouraging exports because of the lower priee level in the other country. Once more an excess of imports develops and the whole process is repeated. over and over again in an unending cycle.
The explanation of the eQuilibrium adjusting mechanism of the movement of gold links together, in one consistent >-reb, domestic priees and production, the flovr of trade, exchange rates, domestic banking and monetary policy, and the balance of payments of a given country. It is a mechanism that is both automatic and self-correcting and implies:
(a) strict adherence to the rules of the game of the International Gold Standard, which requires an expansion of the domestic money supply when gold fl01·rs into a country, and its contrac- tion when gold flows out;
IDEP/ETA I/107 Lecture 1
Page
8.
(b) the utter futility of a policy of gold hoarding since gold flows tend to reverse themselves automatically - a direct shaft at the bullionist branch of the Mercantiliste.
C. Summar t of the Classical Doctrine of International Trade
Assumptions: (1) Perfect competition and perfect mobility of factors and commodities in the domestic market.
(2) Immobility of productive factors, bu~ perfect mobility of commodities, between countries.
(3) For all countries, identical constant labour costs of production, fixed factor proportions and production functions, fixed factor priees - in shor~, relatively elastic supply curves.
(4) Labour theor;y of value (Ricardo) which has now· become
•·
• .
a discredited explanation of commodity priee determination.
(5) No transportation costs between countries.
(6) Two-country, two-commodity case for illustrative purpose;
this was generalized by Mill to include more than t1w countries and commodities without, however, changing the basic analysis.
( 7) Specie-flo>v mechanism for bringing trade and paymonts between any two colintries into eq_uilibrium.
Conclusions and Implications:
(1) There will be complete specialization in p-roJ.uction and ex change•
(2) The volume of proiluction willbe ù.etermined by d.emand of a given volume.
(3) Every domestic article that is produced will enter inter- national trade because there are no transport oost
barriere - in other words, production for the domestic market alone would not exist.
(4) The location of production of a given commoù.ity will be in the country with the greater comparative oost advan- tage.
])efects:
IDEP/ET/VII/107 Le.cture 1
Page 9·
(5) The terms: upon >vhich commodi ties are exchanged between any
two countries will lie within the limits of their home production ratios and bed.etermined by the relative strength of their reciprocal ~emand
(6) ~oth countries will gain by trade but the country with the less intensive demand will gain more
(7) Intercountry trad.e will be brought into stable equilibrium by the operation of the specie-flow mechanism of the inter- national gold standard? which eliminates all balance of payments problems.
( 1) T1.m-commodi ty? two-country model is too restrictive, and Mill1s generalization of this model to cover more than two
countries and commodities does not alter the basic structure of the doctrine.
(2) Assumption of constant costs throughout is too restrictive9
ignoring the c' ases of increasing and decreasing costs.
Hence9 priee is demand determined in the international commodities market, given a relatively elastic supply.
(.3) The result of (2) is to highlight the case of complete specialization in production and trade (a rarity), l eaving out the more usual case of partial specialization based on increasing costs.
(4) To the extent that production is labour-cost determined?
(ignoring demand) and the priees of international commoélities demand-determined (ignoring supply) the doctrine is a
partial doctrine, not a generalized one of production and priee determination by the simultaneous interaction of supply and Llemand forces. If, however, production and priee terms of exchange are taken to be simultaneously determined, as required by general equilibrium analysis instead of in the stage by stage formulation of the classi- cal doctrine, then production9 terms of exchange and division of gains would all be simultaneously determined by comparative
•
IDEP/ET/VI~ 107 Lecture 1
.t'age 1 O.
advantage and reci:procal demand, and the objection to the doctrine raised here would disa:p:pear.
(5) The labour-oost theory of :production is outmoded.
(6) It assumes the restrictive condition of :perfect competi+,ion in the factors and :products markets within countries and ignores transportation costs in trade between countries. Thus, much of the real-world :phenomena of imperfect oarkets for factors and prouucts is abstracted from.
We shall see in our next lecture huw the n1odern doctrine of international trade compares with the classical doctrine.
Dakar,
25
February1964.
•
•,
UNITED NATIONS. IDEP /ET/VII/ 107
Lecture 2 AFRICAN I~TITUTE .FOR ECONOMIC
D~NELOPMENT ANJ) PLAN1HNG
D AKAR
\pril 1964
IN'I1ERNATIONAL ECONO]VIIC RELA'I1IONS
D. Carney
Second Lecture The ~Œodern Theory of International Tra~~-SU"J?J2.!;[_~:p~mand.
I. The modern answers to the four questions asked by the classical economists
a) Why trade takes place ~ Differenc~s in absolute oost~ productive factors and absolute priees o1 commodities.
Supply side : (i) Difference in oost of production reflecting differences in factor a-vailability and factor priees.
Note
Demand Side
(ii) Non-identical oost ratios ( in short Ricardicm comparative cosi; advantage9 but 1vhere cast of production is taken as all costs measured in money ~erms rather than in labour terms ).
(l) All types of cast variations are inc1uded here- constant9 increasing and decreasing9 not mere1y constant oost as in the classical theory.
(2) Differences in factor costs between countries may also reflect shifts ( not merely market changes) in e_;cchange rates9 chang·es in transportation costGp Differences in product priees betr/'Teen nations based on differencls in factor equipment and domestic demand.
b) What commodi ties produced and exchmlged~ those in >Vhich absolute cost differGnces yield comparative money oost advantages
c) How terms of trade deterrnined. and gains from trade shared Reciprocal demand, same answer as Mill' s.
d) Ho;.; equilibrium maintained in balance· o-f trade and. payrnents ~ AEuming paper currency and free exchangè rates9 equilibrum is achieved by shifts in the exchange rate9 whi1e domestic p::-ices remain unchanged.
II. Effect of International Trade on Factor Priceè Given factor immobilitybut product mobility,
IDEP/ET/VII/ 107 Lecture 2
Page 2
(a) Illustrate by swne ) diagrams as for Sectioto)
III folkwing )
no effect on factor priees, under conditions of constant cost-;---
tendency to factor priee equalization, under conditions of increasing cost ;
. . . _( cJ tendeY.lOY to widen factor p:r:ice diffe:œ~tials, of decreasing cost.
under conditio::J3
III. Effect of varying- cost conditions on Production (a)
(b)
Constant costs - Complete Specialization Increasing Costs Partial Specializ
•
ation(c) Deoreasing Costs - Complete Specialization ( historical )
I~. Effect bf Transport Costs on International Trade This is to :
(l) Narrow cost differenties between areas and countries (2) Influence location of industries by encouraging them
to locate in areas with lowest possible factor costs Transport costs play a significant part in location of
(a) raw materials - oriented (b) market -oriented
(c) Neutral or " footloose "
) ) )
industries
V. National Income and Foreign Trade
ThroL-tgh the foreign tra(j_C; mul tiplior .. and acL-elerator, exports are
income-creatin~1 imports income-destroying
Objections to.the Doctrine of the Foreign trade mu],_t:i,.plier : ( l ) Logical conclusion would be that fyr maximum income impact
exports should be increased and imports minimized. This is
the real-goods version of mercantilist doctTine. I~ fact multiplier doctrine is mercantilist as Keynes made clear and, therefore,
very nationalistic, applicable only to indiviclual country cases under con.di tiohs of deficient aggregate demand.
( 2 ) It is anti-international traéle because i t assumes a semi-closecl economy while interna-tional trade assumes an open economy. It therefè>re does.not have a legitimate place in in-ternational economie relations.
( 3 ) It is ;i.mprâctical, as a general rule,- .for all ooUntries.to adopt sirnultaneously a policy of accUffiulating export suT.plu2es with each other in order to increase their national incomes.
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IDEP/ET/VI:!:/ 107 Lecture 2
Page 3
(4) The approprr:iate doctrine of national incarne and foreiGn tl·adG is that which is based on the assumption of an open, not a clos6d economy; namely1 that if in an open economy imports are a key to investment in the economy, then an increase in experts and.
foreign savings may lo1·rer the level of national incarne while an increase in imports especially capital imports and foreign dissaving may increase it.
VI. Defect of Classical and I!oiern Theory of International Trade.
VII. Note
Classical theory integrat0s foreign trade with the general theory of the priee level, modern theory integrat,::Js :tra.de 1-ri th ns,tio::.t~~l
incarne .'or tot al output , and nei ther explici tly integra tes trads
wi th both the general theory of the priee level and the theory of total output. The achievemeni; of Keynes in integr.ating output and general priee level theory has yet to make its impact on the modern theory of international trade.
The modcirn theory of international trade is no more than the
application of modern value theory to the area of foreign trade. As such, the modern doctrine integrates international trade with the work of Eli Heckscher of the University of Stockholm ( tt The Effect of Foreign Trade on the Distribution of Incarne tt, Ekonomick Tids~r..~~f~-~
1919)
and Bertil Ohlin ( Interregional and Inteinational Trad~,Harvard Uni ver si ty Press, Cambridge,
1933 ) .
Ohlin 1 s -vrork appeared at the time when the c..octrines of imperfect competition and monopolistic competition were formulated and disseminated by Joan Robinson andEdwardChamberlin. These doctrines considerably qualified th~ accopted traditional classical doctrine of pure competition, uniform priee and long run equilibrium. It is therefore not surprising that the nodern doctrine of InternationalTrade bears very strongly the marks of tlls revised doctrines of value and priee determination.
Dakar
26
February1964
•
D a
A B
Figure I
Cast differentials with Constant Costs of Production Case of Complete Specialization
A
,
/B
, ])
. b D
b
~----~---~---~---l-.-L~---
M l 0
Figure II
Cast d.ifferentials with Increasing Costs of Production Case of Partial Specialization
-MR ,/
a
A
· !
Fitsuru III
B
])ecreasing Cost : Complete Specialization
.J..,J./J.:J.J. / .J.:JJ../ V.l..l.f 1 V {
Lecture 2 Page
4
'i
• .
··:. ........ ;.,1 ...
\-~ . '~ \ r • . ...
UNITED NATIONS
AFRICAN INSTITUTE FOR ECONOJ'UC DJ:.,V,".LOPMENT AND PLANNING
D A K A R
D. Carney
Il\TTERNA'l'IONAL ECONOMIC RELATIONS (Thir~ and Fourth Lectures )
IDEP/ET/VII/107 Avril 1964
~ Third Lecture Pure Competition1 Monopoly and Monopolistic Competition and .their Effects on International Trade
As indicated in the prcvious leôture the modern theory of international ,trade is no more than an application of modern value theory in the . area of fOr§ign trade. This lecture deals with the various kinds
of market competition and their effeët on foreign trade. It is therefore a convenient >vay by which we can review the elements of value theory as well ~1s an occasion for the application of the
the~ry to foreign tradà problems.
- : - : -
Fourth Lecture g Balance of Trade and Balance of Paymonts Balance cif Payments : Included in this are :
All tr.:wactions 'requiring settlemen.t in the current period (i. e. wi thin a year ) such as imports, experts, shipping services 9 0tc.
and involve short-term capitc.l movoments because the usual means of settlement is bank deposi ts foreign or domastic. How,;3ver for purposes of the balance of paymants all such transactions are entered under
the CURRElff A/C, Debit if payment is to be mad~ and Credit if payment is to be received. The net balance of all such transactions is what is recognized as short-term capital movement and entered under the CAPI 'AL A/C on the appropriate balancing side. It is then regarded as the surplus or deficit in the current account.
Short-term Capital Movements
Short-term C<J.}Ji tal ~·10vernentl in the Balance of PaymEmts aro of two ...
main kinds
(a )Tho se which are ·the net re sul t ( surplus or deficit) of transactions under the current A/c.
(b )Tho se vihich are deliberately undertaken for the ir own sake·
(i) Income-motivated g purchase of foreign short-term
IDEP/ET/VII/107 Lectures 3
&
4 page 2.securities ( treasury bills, commercial bills~ bankers'acceptances ) in order tc earn a higher income return than at horne. (ii) Speculative ~ transactions in foreign currencies
( accumulation of foreign balan-éës -
Y
in anticipation of changes i~ the international---
-·v.<lh~es (_ i _ •. e. _ official exchange rates ) of particular currencies.
(iii) Fear-motivated~transfers of financial assets a·broad for
fear of war, political inst~bility or inflation.
The b·:üance of Paymcmts
DAIG1.R
Shows : l. Current indebtedness and how surplus or deficit is financed.
Does not show
2. Balances uf a period of years tell a revealing story about the charaoter and magnitude of changes in b~lance
of payments and ·its trend.
1. llliether irnprovement or de:. cline due tc c.hange in (a)
(b)
Commercial policy
( e.g - exchange depreciation or rates of oohange
appi-eciation ) is
(c) what to, and -vrith whom,d.:.ficit or surplus/due 2. Balance of over all indebtedness, only net current
changes in bc:lance of indectèdness
3. lfhether ch.?,nge due tc structur1J.ldiS'3'lUilibrium or to ternporary cau~~~ ~~6h ~s a failure in harvest or speculative transfers of funds. i.e. doœ not tell
·why the change took place.
'4.
Says nothing about commercial polioy of the country that may underlie the ~~ficit ~:i_.-~urplus.5.
Does not show whethvr fundamontal diseq_uilibriurn is an aspect of changed debtor-creditor relations of a country i.e. whether going through the four general stages of evolution of its balance of payments and indebtedness.Lecture given in March,
1964
•
•
UNITED NATIONS
AFRIClN INSTITUTE FOR ECONŒ.UC DEVELOPMENT 1\ND PLANNING '
IDEP/ET/VII/107 Avril
1964
D A. k l\. R
INTERNATIONAL ECONŒHC RELATIONS
D. ·carney
Fifth Lecture The Foreign Exchange Market and International Setclements
A. - 1. Ir.st ru:nent s for settling Trade Bills of Exchange ( Gold Standêrd )
Telegraphie Transfers ( modern ) Letters of Credit
)Imports pay for Exports generally )by transfer of claims between )domestic importers
&
exportera )(+gold movements under the Gold ) standard ).) )
2. Avbitrage - to equalize differences in exchange rates
3. Forward Transactions ( Hedging ) to guard against risk of change in value of currency against time of payment ( such forward
tr3nsactions may tend to stabilize or destabilize the market depending on whe"!Wr operators thinktha change.:inthe value of the currency wiil.
or will not reverse itself )
E. Settlement under different systems of exchange rate I. Fixed Exchange Rate ( Gold St2.ndard )
Adjustmnnt by
l. Chanse in level of Priees and Incarne 2. Reversal of Direction of Flow· of Trade II. Fluctuating Exchange Rate
Adjustment by :
l. Change in exchange rate
2. Reversal of flow of funds ( long term)
Note g No change in domestiè priee and income level
3.
Import substitution 4-(+ aroitrage(+ speculative. ~lo~ of funds )
~
short term5.
Exchange depreciation provided èla.sticity of e:xports is .'> ! III. Exchange controlAdjustment by
l. Control over volume of exports
&
imports to force them intobalance ~ (a) licensing of exports(b) Quotas(c) Centralization cf foreing ex.change
IDEP/ET/VII/lü7<
Lecture
5 ·
Page 2 Foreign Exchange Deprecia:f;ion
·-
Steps in wipi-ng 01-it · a -d-eficit through exchange rate depreciation
(l) Depreciation may check imports relatively to Exports thereby.~educing the demand for foreign exchange
( 2) Der;reciation may permit lowering of export 'prîcès· arid if the elasticity of the foreign demand for exports is greater than uni ty ( -::. ·; \ ) for a single deprecia ting country this may- promo te
sales and increase the supply of foreign exchange"
( 3) A wide range of dornes tic goods may flow into the ex~•ort market
(4)
( i.e. export - type goods ) as a resul t of the exuhange d:..:preciation and lovrering of export priees 9 thus ü1creasing the supply of
foreign exchange
. ·•
All thesè re sul ts may follow· in ( l) to ( 3) provided there is no comparative exchance depreciation by anothar country.
Renee conditions for successful use of exchange depreciation to elimiuate a balance of payments deficit are :
:Note
DAKAR
(a) (b)
- / t. for forèÎgn demand for experts
. 1
no diversion of experts from foreign to the higher-priced domestic market
(c) no competitive exchange depreciation .ab.r.oad
( d) the deprecia ting councr;;r' s ex ternal trade should represent a relatively small proportion of total world trade9 otherwise the ~enefits of exchange depreciat ion will-not accru~ as it will be difficult in that case for for foreign
demaï.;d for exports and. for the flo1·r of export-tl)lPe goods to increase in volu."'le to tha &'}:port market
Exchange Equaliz .... tion Fun_de
This is an outgrowth of -the Gold Standard vrhich developed after i ts a'band.onc::-nt ,in the 19301 s. I t vras a fund set up to prevent speculative move::1ents of funds from depressing or raising the external value of the cur!'ency.
Lecture given in March,
1964
UNITED NA.TIONS IDEP/ET/VII/ 10
7
Lecture
6
AFRICA.N INSTITUTE FOR ECONOMIC
DEVELOPMENT ~~D PLANNING April 1964
D A K A. R D. Carney
11-J"TERNATIONA.L ECONOMIC RELATIONS
Sixth Lecture National Incarne and. Foreign Trade
In our first two lectures on the classical and modern theories of international trade two salient facts stand out on the aggregative level:
(1) External trade does not affect volume of domestic output7 only the level of priees. In the classical theory foreign trade is integrated with the general theory of the priee level through the specie-flow mechanism. Output is not affected sinoe the classical theory of the priee level assumes that total output is constant and independent of the priee level. The same volume of output and of business is transacted with more money in circulation as with less, the only effect of priee level changes consists of (i ) changes in the value of money and (ii) income transfers between the various economie groups in society.
In regard to foreign trade the flow of imports and of exports predominates according ·as gold flows into and out of the economy so that 7 given an assumed constant volume of output, the proportion of imports exceeds that of experts in total incarne when priees rise with the inflow of gold7 and vice versa when priees fall with the outflow of gold.
Consequently, the adjustment of total incarne to trade takes the form of an increase in the proportion of imports to total incarne relatively to the proportion of experts when priees rise,and an increase in the proportion of exports to total income relatively to experts when priees fall. A. change in the relative proportions of i mports and experts in total output with the total of output remaining unchanged is the only effect of foreign trade on national incarne.
(2)
•• 1.. ._ ....
ID_EP /ET /VII/ 107 Lecture
6
Page 2
In the mode.. . rn theory foreign trade is integrated withtotaloutput (or
~-; . ; . '. .~
natlo;;_~l· i~come) through the dornestic and foreign trade investment multipliers ;md accelerators; the total effect of which is that -X are Y - cre'lting ~~,Y - destroying. No specifie mention is made of priee level chqngos other than that. these changes are neutral or constant.
I. Cioseci EconoiD,y
J ... ·.
C + I
=
Y=
C + S Iri equilibrium I =s
..
MPC + NPS = 1
Multiplier K = 1/(1
-
~ffPC) 1 /~1PS dY diII. Open Economy
Introduce foreign investment C + Id + If
=
YT.fuere If X - M.
So _that C + Id + X
=
Y + M and Id + X = S + MC + S + M
·· If !d +If= S
=
O, Id= If= 0t.hen X M (as assurned by Hurne's specie-flow doctrine)
.
'
Then. dY
dX
dY
1 /~ =
K (the forèign trade multiplier) dYi ._e.~~-.The change in Y due to a change in X = the reciprocal of the marginal·propensity to import, The sa.me result woU:ld.be got if in the· dornèstio.multiplier Mis substituted for Saving and X for Investmerit,
i\ssuming Id c,onstant at all levels of Y because it is the inde- pendent factor: in the closed system then dX = dS + dM
.. ~ .. -:· ·' . . --... -~-:-----~_:_ ______________ . - . · .
.. :.: . __
arra:--di'vi'di-~g-both---s:Cèfës-·of the equation into dY,·- . , ; . . .
-- -- • •••• owo.-
dy dy... .. ... ---· ... ·-·. ---------
dX dS+dM = K, the multiplier allowing for foreign trade
( =
MPS : MPM) K = 1/ (1 -~aPC+r"PM)
= î/( 1-MPC-MPM)IDEP/ET/VII/107
Leoture6
Page 3
To this extent the value of dC i s reduced9 thereby reducing the V'1.lue of the invostment multiplier whenever imports are received from abroad. Tho multiplier effect of investmcnt on Y is greatest when dM = 0 and therefo:n:v;hen the export surplus is invested abroad.
Thus oxports '1re income-cre1-ting on this anA-lysis and imports income-destroying, the latter becoming one of the le"lkA.ges ·out of consumption in the same w1.y as savings s,nd tA.xes are assumed to be leakages in conventional income analysis.
This é'l,n.'l.lysis is true only of an open econoey which does not depend on foroi~1 imports for domestic investment. For one that so depends the opposite relrüionship is truc. Thon imports become income cre.q,ting, adding to dC instead of dS, and the multiplier, allowing for fo'reign -trq;de;becomës 1/ ( 1....:,MPC$!1?!n» subject ta the qualification that the economy must eventuall;y be A.ble to generA.te · i t.s o1m technology A.nd cA.pitA.l goods industries. Otherwise, it becomes A. passenger on indus- trial ci Vilization.
Not e also th'lt in '111 of the foregoing an'1lysis9 a béisic assumption is that priees are constant and thél.t idle resources exist.
The foreign-Trade Accelerator
.'in acceler.q,tor effect may be added in the foreign trade sector just as in the domestic sector, an incre"lse in export thereby leéiding through in- creases in investment to an import surplus. Kindleberger illustrates this by two different examples g
(;o.) The c<tse -.,There '111 increFl.Se in exports le!=Lds to '1n increase in investment in the export industries g
e. g. ::m incre!'Lse in ll.merican tourist expondi ture in London
(i.e, !1.11 incre1.se in British exports of invisibles) leads to
the construction of more hotels in London for the tourist trade and through this to A. further incre'1.se·in export of invisibles.
1\. ·;· i ..
·
... .
· .. . IDEP/ET/VII/107Lecture 6 Page 4
(b). The c::1se where ::m incre::1se in 'experts leads to new investrnent end output in industries producing for horne consumption.
e.g. q,n increq,se in experts of .groundnuts .in Senegal l eads to· investrnent in processing pl'lnts for the production of groundnut oil for dornestio consurnption.
From this survey the following criticisrns may be made of the cl~ssical
and modern theories of internationa.l tr"lde in respect of the relatioriship between trade and national incarne theory :
( 1) In regqrd to the classica1 theory i t wrongly n,ssurnes th::1t the priee level hqs no effect on the level of incarne or output and thereforefails to integr::1te n8.tion'11 incarne wi th foreign tr"l.de.
Keynes oh::1nged all this in his General Theory of Ernployrnent~
Intèrest q,nd Money Hhere he shows that an integrq,l p"l.rt of the incre::1se in rnonetary dernand i s the increase in priees as >-rell as iri output up to the level of full ernployrnent, w:Pen the cl::1s-·
sical quqntity theory of money becomes effective, an increase in spending leading rnerely to i'Ln inflationary incre.g,se in priees without A.n increqse in output.
( 2) In regi'Lrd to the modern theory i t wrongly q,ssumes th.q,t t·he· mul ti- plier effect of foreign tr'lde on dornestic output oould work with- out a chn,nge in the priee level - and this qfter Keynes bas
written.
Secondly 9 th'lt X are Y -cre!1-ting A-nd M ~ dest~oying v<hile the
opposite could be true in developing countries with open economies.
Both theories qre therefore p.qrti.al, f.ailing to integr.ate foreign trA-de with both the level of priees and the level of incarne. ThiTdly, the implication of the conclusion of the modern theory that X "l.re income-·oreating ; and M incorne-,destroyi:ng, severely n.ationalistio, meroantilistic and contrary to the whole spirit of intern::ttional tr'lde involving mutwù g3.ins o
•
•
IDEP/ET/VII/107 Lecture
6
Pr:tge
5
Fourthly, the conclusion of the thesis th8-t X F~.re income-(crcating ::tnd M income-d.estrcy.ing i.s thq,t i t would P'W 1-ll countries to develop an export surplus "l-nd rninirr.ize imports which is m:=mifestly impossible~
since in order for one country to export -'::mother must irnport. Thus it can only be truc of one country at a timo not for n.ll countries at the sq,me time.
Fifthly, the the sis th at X r:tre income-~c:r.eatj.ngt::: and !VI incarne-• destroyi.ng needs to be reversed for underdeveloped and developing economies with no dornes tic c.q,pi t13.l goods industries 'l.nd no dornes tic technology. The thesis is possible in practic0 for q, single _developed country only in so fq,r as it h13.s home-grown t echnology r:tnd q, domesti~ capital goods industry by means of which domestic substitutes cr:tn be produced for irnports.
UNITED N'l.TIONS
\FRIC llJ INSTITUTE FOR ECONŒHC DEVELOPMENT t!.ND PLIL1WING
IDEP/ET/VII/ 107 Lecture
7
l\.pril 1964
D'-I..KA. R D. Carney
Seventh Lecture
INTERNA.TIONAL ECONŒ!'IC REL \.TI ONS
Rol e of International Trade and Investment in Economie Development Trade versus !\.id
For Developing Countries with an Open Economv
c
+ I yc
+s
c
+Id + If Y, where If ::o X - Mc
+ Id +x
y + Mc
+s
+ MSince for developing countries without dornes tic capital goods industries, X - M may reasonably be regarded as negative (adverse balance of payments of Young Debtor)
T.ve cq,n change the equation to read If M - X
eo that C + Id + M y + x
c
+s
+x
;,fu ore l1 is of the same nature as Id and X of the same nature as
s
Th us gross investment, domestic and foreign~ may be regarded as (Id +
M)
:But not all of M represents C'1pital i mports, sorne representing
consumption goods imports resulting from the international "demonstration effect" as 1•ell as the attempt to diversify the standard of consumption and level of incarne through imports of consumption goods.
M, therefore, consists of two parts, consumption goods and capital goods.
Bence M
=
M + M.c ~
Th us y +x
c
+ M c i.e. yc
+ M c + Id + Y is maximumvrhen dY d.X 0
dC dM
I.e. when
dx
+ ~ dX+ Id + Mi
c
+ s + x M. =c
+s
+x
~
d.Id dM.
dC dS
+ dX + dX ~ 0 d.X + dX + 1
IDEP /ET/VII/ 107 Lecture
7
Page 2
If Id is assumed to be the independant factor in the growth of Y and is const3.Ut, and also equal to
s
in equiÜ briumTh en did
{} -dS -··---··--·-···----··.·
dX dX . ---. ·----- .
dC dM dM.
and c l dC
dX + dX + dX 0 dX +
i.e. dC dX 1
.dM. dM
Renee l 1 c
dX
=
dXdH. dM
whence l is great est wh en c
is least zero
dX dX or
It follovrs that the investment effect of i rr:ports on the volume of y with reg8.rd to exports is gre:1test when the consumption affect of imports is least or zero.
Renee a policy of restriction of consumption imports in favour of investment imports for tbe maximum contribution of imports to investment and income growth in underdeveloped open economi es.
Trade versus aid
y C + Id + (X) - M c + s + (x) - M If X 0 as a result of aid (M)
dy dC + did 0 dC + dS
dM dM dM d~:J dM
i • Go
did dS
dM dM
In other words, income, Y, will be maxirri zed as a relul t of M vrhen M indue es an equal rA.te of grm·rth in I 8.nd
s,
i. e. when the aid (M) l eads to a rR.te of grovrth in th(3. volume of domestiQ . savings equi vA.lent to the ra tG of growth in the volume of domestic investment. In the· simple case of equilibrium when I S this effectively mcans that the aid must lead to an equal .!lmount of Sand of I in.the economy of the recipient country.IDEP/ET/VII/ 107 Lecture
7
Page 3
Whethor this rosult materializes will depend on the nature and composi- tion of M
(1) If M represents food imports which aro sold for counterpart funds
th~t are then invested in development projects of a capital nature this should sn.tisfy th:.=; requirod condition~ but on t-vm further conditions :
(a) the food aid should bo timed md disposed of in a m"lnnor which will not compote 1-ri th or dis courage domostic production
and sale of output of "1 nature simil"lr to the imported food.
Otherwise~ the net offect of tho latter would be correspond- ingly reduced.
(b) It should be pormissible to spend tho counterpart fund.s on capital imports from tho donor country - an important ro-
quirement where the recipient country doe.s not produce capit11-l equipment but bas to depond on imports for this, Othervdse the invostment effect of the aid would not materi"llize. (2) If M represents capital imports the required condition is met
!lutomaticlllly in the simple case rrhore Y is n.t an 8quilibrium level.
It follows from the ti-ro Gxamples, thorefore 9 that "Ln important condition of foreign aid. r epl11cing tr11de 'lnd contributing to the growth of output in an underdeveloped country wi th .g,n open economy i s tl1r1,t such aid should take thG forrn oi ther of investment goods or (directly or indirectly) of funds which are convertible into capi t11l imports from the donor country. In this roSj)GCt ti ed aid would not present r:my obstacle~ unless the type of capit'1-l imports
desir~d c11nnot be suppliod by the donor country but by others, This is astringent condition which is not easy to fulfil in "
world •rhere
(a) "lid is sometimos given for military purposes not for 8conomic development
(b) "Lid often takes tho form of c.onsumer goods inste'ld of C'lpi tal (technical assistance, skilled personnel or capital equipment) required to give oonsiderable stimulus to the economy.
IDEP/ET/VII/ 107 Lecture
7
P;,ge 4
(c) most contem:porary aid i s not permanent ;,nd is afton granted for hleological r'1thGr thq,n economie r:3q,sons. Renee there may be invisible politic~l or other strings attached.
( d) whene' aid takes the form of technicai assist:mce in the form of · knowledge or skilled personnel for é1 c3,pit;,l project there 8-re the possible disadvantages ~
( i) th at the cq:pi tal equiprr,ent will hq,ve to
r.::!
found sub-sequently through regul;,r commercial arrangements to make thG knowledge r.·,atGrially productive. There is thus an unproductive tiGe interv~l
(ii) the technical personnel ·may not work ::ts ~orell in ::1. foreign environment even wi th all the,6:juipment necessary (and worse without it) as in the locq,l home environment . (iii) lack of full use of indigenous personnel may lead to
competition and dis:placement of equally competent indig- enous by foreign personnels or there may be l~'~,ck of
supporting counterpart indigenous personnel to understudy and replace th6 foreign expert.
For all these rer>.sons regul q,r commercial forms of investmont q,re proforq,ble to investment through aid. In particul0.r1 a regular business transqction in- velving trade and investment through tré1de bas the following advantages ~
(a) regular commercial invostment involves capitql imports that bri~g
their own technical assistance with them.
(b) they short-circuit the del.<:cy bGtvreen tochnical ::~.ssistanc8 "thd tho
m~terialization of an investment project.
( c) trade in volves mutual clf'fort and exch'1nge leading to an incre.:1se in the totr>.l of the 1v-orld 1 s ,,real th while aid do es not so incre::~.s0
the total of world's wealth but involving somothing for nothing in a visible materioü sonse9 mGrely redistributes tho sum tot"Ll of oxisting wealth without increasing it.
Howover9 where i t is possible bath IJ.'rade and /\.id could be considered for economie grmv-th provided the condi tiom und er -.rhich aid C3.h maximize growth are met.
IDÈP/ET/VII/ 107 Lecture
7
P:=:tge
5
So far, the argument for trade in preference to ~id has been made on the assumptions that
(a) Trade is possible on mutually profitable terms between developing countries and the rest of the world, especially the industrial countries.
(b) Investment from the industrial countries in the developing countries is possible on a sufficient sc"tl e to enable the latter to hqve a permanent excess of imports over exports such as promotes groT,;th in a young debtor country.
To the·. extent th:::tt these assumptions can be met 9 the foregoing :=:trguments in favour of trade in preferonce to 'l.id, or both combined where possi ble5 :::_re val id.
ifuere, however, the assumptions regarding the profi t::tbili ty of trade ancl the possibility of long-term international investment do not hold or are considerably qualified or restricted it is possible to reach opposite con- clusions supporting \id in preference to Trade.
Thus \-There
(a) Trade of deveioping countries consists of primary export commodities whose long-term priee trends J-re declining and for which world
demqnd i s inelastic resulting in a worsening of the terms of trade of the developing countries (i. e. industri:::tl countries gain more than the developing countries9 even though both may gain);
(b) the intern8.tional flow of private c<:Lpital investment is diminishing or inadequate in f1.ce of the increasing domands of 8. growing nur:1ber of developing counttios9
i t may be th<:Lt Aid is the only way out of the impasse. Or9 age.in9 if the industrial countries cannot exp;:md their demand for the products of primary producers c.tnd the latter cannot restrict s"l.les on world markets to m"lin-tain priees 9 hd m<:Ly be the only al tennti ve rem"'vining. But in this case, tho candi ti ons for maximum use of üd for the promotion of growth v-rould still hold.
UNITED NÀTIONS
FRICAN INSTITUTE FOR ECONOMIC DEVELOPMENT AND PLANNING
t · .. ·( "
IDEP/ET/VII/ 107 Lecturt<3 8
IÎ.pril 1964 DAKAR
INTERKA"TTONAL ECO:NOMIC RELATIONS D. Carney
Eighth Lecture Problems oJ:' International Economie Relations -Commodity Priees and Commodi ty Stabilizo.tion Scheme's
l. Problem of Commodity Priees for Developing Countries
l. Fluctuations in primary commodity priees - agricultural and mineral ( except gold1 ·diamond <:1nd · other preeious nietals )-
Illustration : :....· stàbilizing and d.esta0.ilizing eobwebs.
2. Fluctuating earnings of primary produeers
3. Fluctuating revenues for development projeets to the extent that these depend heavily on earnings from the sale of primary products in world markets.
4. Declining long term trend of priees of primary eommodi ties - Q,ue to (a) Inereasing output of primary commoditiies
(b) Relatively inelastic demand for primary commodities resulting in declining pri~es and earnings ïÜ th inerease in, output. (c) The threat of synthetic products - e.g fibres? metal
substitute~ from technological progress
( d) Declining quanti ties of new materials in content of industrj_al products.
2. Proposed Solutions
(a) Stable and guaranteed prie~ for primary commodities.
e.g, European Common Market arrangements guaranteeing stable priees for primary products; demands by primary producers for similar priee
guarantees from industrial member countries of GATT; former metropolitan guarantees for commodities marketed by colonial marketing boards.
(b) Guaranteed priees and output under international commodity stabilization schemes
e.g.Tin? the most successful1 so far, of international commodity schemes
(c) Temporary compensatory financing by IMF of temporary deficits in balance of payments of primary producing countries due to
the crop failures or decline in world market priees. ·
(d) Commodity sale restriction shhemes by primary producers.
p s p e
D
IDEP/ET/VII/ 107 Lecture 8
P3-ge 2
3.
Bases for evaluating the various proposals for dealing with the commodity problem(a)Their effect on priees under the guarantee scherreaccording as wor]d priees rise or decline
·c~_?f~e~x:-
__
e_if~-~~__
Q~. Q~~;~t~~;__
~::___ _ __ _
(c)Their effect on the general pattern of resource allocation and resuurce use
4.
Limitations of Proposed Solutions - Temporary panaceas, not long-term solutions to the commodity problem or to industrial growth.( a ) Guaranteed priee schemes :
( i)
unnecessary during periods of high w~:œld prioes1 u.nsupportable and therefore of limited or no use during periods ofcontinuous decline in world priees.
-, ,- (ii) stimula te increasedproduction in excess of demand
. _.._. . ._ , . . ... · · · ·---1.,. ...
,~~./.j at a- ~ - ·.. 1
i / 1 ''..._!
-- -- ---,c. ______ _ _ l_
' . i '
1 j- 1 --'---"'---1 ·-
remunerative price9 the guarantors having therefore to subsidize the excess output or operate a buffer storage scheme - either of whioh involves considerable costs which may be insupportable over a long period 9 and one or other Qd Qe Qs of.which is more oxpensive depcnding on demand elastioity
( iii) Impede diversification of resource use or 8hift to new
\
production7 processing or industrial use for the home market.
( iv) As teohnological progress prooeeds ciiid. >ri th i t the introduction of synthetic substitutes the technological gap increases botween advanoed oountries and the primary produoers who have not learnt to prooess or use their produots in oth~r ways.
(b)
Guaranted priees and output(i)Involve fixing of quotas for produoers on the basis of average production for a given past period, penalties for exceeding or falling below quotas, and redistribution of quotas (every six months or so ) of those countries falling below assigned quotas to ·,)ther producers.
