Theories of International Trade Before 1900
Theories of International Trade before 1900
Why do countries exchange goods and services? Before 1900 a variety of reasons were advanced to account for such exchanges. In the Greek and Roman worlds, before the nation-state came into existence, trade was interregional rather than international in scope. Its motivation was simple: It fulfilled the need for commodities that were not available domestically. As Virgil pointed out in The Georgics, Mother Nature spread commodities such as iron, saffron, ivory, incense, and prizewinning race-horses capriciously among different parts of the world, which became known for them. In the Christian era, trade was given a religious dimension by being interpreted as part of a plan of divine providence. Since resources are scattered unevenly throughout the world, the inhabitants of different regions realize the need to trade with each other to make up for resources they do not possess. This leads to a feeling of mutual dependence and solidarity and fosters the cooperation needed to achieve common goals in a universal economy. While some Church Fathers adopted this outlook, others praised self-sufficiency and frowned on trade, since they associated it with greed and luxury and saw it as tending to turn traders and their customers away from God.
International trade became a focus of attention for businessmen and statesmen in the long period of time associated with the emergence of the nation-state and the doctrine of mercantilism, roughly from the sixteenth to the end of the eighteenth centuries. One of the aims of its advocates was for a nation to accumulate bullion or precious metals, which could be achieved by promoting an excess of exports over imports, or what became known as a favorable balance of trade. The accumulated stores of bullion could be used to fight wars to protect the state.
Since the bullion added to the national money supply, another reason for pursuing a favorable balance of trade was to promote internal trade, as expressed in the popular view that "money stimulates trade." International trade was therefore valued for its instrumental role in furthering the power of the state, at home and abroad, and promoting economic development, rather than because it fostered the welfare of consumers by enhancing the variety or reducing the price of commodities. Not only was there was no tendency to promote free trade, but states actively interfered with foreign trade by securing monopoly rights for favored export industries, prohibiting or heavily taxing the imports of finished manufactures, while encouraging the imports of raw materials that could be processed into finished goods, preferably those destined for the export market. Foreign trade, it was argued, took the form of a zero-sum game, that is, of a situation where one country's gain results in another country's loss.
In mercantilist times most economic pamphlets were written by businessmen or writers hired by businessmen. Two of the most influential British writers on economic matters, Josiah Child and Thomas Mun, were wealthy merchants who became directors of the East India Company. Merchants trading on their own account or on the account of a trading company can hardly remain above suspicion when they advocate public policies that affect business practices, including their own (Letwin 1963). At the end of the seventeenth and the beginning of the eighteenth centuries, some writers began to derive public policy implications from economic arguments based on scientific principles, where personal interest and mercenary intent could play no major role.
ANTICIPATORS OF THE FREE TRADE DOCTRINE
In 1691 Sir Dudley North, a British merchant, named trade a "commutation of superfluities," or exchange of surpluses, between the trading parties, and he asserted that people are rich insofar as they exchange the goods they produce for those produced by others, so that precious metals are not the object of transactions. He argued that wealth does not consist of bullion, as the conventional wisdom suggested, and the aim of trade is not to amass it but rather to enhance the welfare of the public.
Another notable British anticipator of the free trade doctrine, Henry Martyn, illustrated numerically in 1701 what Jacob Viner later named the eighteenth-century rule for quantifying the gains from trade, which measure the increase in welfare accruing to a country that engages in international trade. According to this rule, "It pays to import commodities from abroad whenever they can be obtained in exchange for exports at a smaller real cost than their production at home would entail" (Viner 1937, p. 440). This rule was adopted by many subsequent writers, including Adam Smith and David Ricardo.
In his 1758 essay "Of the Jealousy of Trade," the Scottish philosopher David Hume (1711–1776) also advocated free trade and rejected the protectionism favored by the mercantilists. He offered an insight into the rationale for trade, noting that "Nature, by giving a diversity of geniuses, climates, and soils, to different nations, has secured their mutual intercourse and commerce, as long as they all remain industrious and civilized." He pointed out that foreign countries made Britons better off, since "Notwithstanding the advanced state of our manufactures, we daily adopt, in every art, the inventions and improvements of our neighbours." Not only should the prosperity of foreign nations not be feared, but the "emulation among rival nations serves rather to keep industry alive in all of them" (Hume 1758, pp. 78–80).
David Hume's friend Adam Smith (1723–1790) discussed the advantages of foreign trade at much greater length in his pioneering treatise An Inquiry into the Nature and Causes of the Wealth of Nations (1776). It contained a sustained attack on the mercantilist system and the protectionist policies associated with it. It also depicted the rationale for and the benefits resulting from foreign trade, by comparing them to those accruing to individuals who specialize in production and then trade commodities:
It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost more to make than to buy. What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage. (Smith 1776, pp. 456–457).
The "advantage" that Smith refers to is usually labeled absolute advantage and represents the fact that a country can produce a commodity at a lower absolute cost than other countries. It is to be contrasted with David Ricardo's concept of comparative advantage, described below. Smith held a dynamic view of absolute advantage, which is enhanced by lower costs and greater specialization when the opportunity to export creates a more extensive market for a country's output. He thus related the advantages of foreign trade to those associated with the division of labor, the fundamental key to economic growth in the Wealth of Nations. Smith also noted that transoceanic travel was beginning to transform the nature of international trade and to increase its benefits even more by making new commodities available: "The discovery of America, and that of a passage to the East Indies by the Cape of Good Hope, are the two greatest and most important events recorded in the history of mankind" (1776, p. 626).
DAVID RICARDO AND JOHN STUART MILL
Smith's Wealth of Nations marks the beginning of the classical school of political economy that flourished in Britain over the next century. International trade theory, as a specialized field of economic theory, dates from the principle of comparative advantage (or comparative cost) that David Ricardo (1772–1823) enunciated in his Principles of Political Economy and Taxation of 1817. He showed that trade can benefit each of two trading countries A and B even if A's labor force is less efficient than B's in producing all commodities. While foreign trade increases a country's "enjoyments," Ricardo set an even heavier emphasis on another benefit of trade: the increase in the profit rate and in the rate of capital accumulation that result when cheaper wage goods are imported, leading to a fall in money wages. Economists now call this a dynamic benefit of trade, in contrast to the static benefit of the comparative cost example.
John Stuart Mill (1806–1873) inherited Ricardo's mantle and became the foremost British economist of the nineteenth century. In his Principles of Political Economy of 1848, Mill added an important component missing in Ricardo's theory of comparative advantage: the determination of the terms of trade (the price of exports relative to imports) between two countries, as influenced by the reciprocal demand of each for the other's export good.
Mill also explored in greater depth the nature of the gains from trade, going beyond "the direct economical advantage of foreign trade" to describe its "indirect effects, which must be counted as benefits of a high order." Foreign trade "sometimes works a sort of industrial revolution in a country whose resources were previously undeveloped for want of energy and ambition in the people." Like Hume, Mill also stressed the "intellectual and moral" advantages of trade, including the diffusion of technology (Mill 1848, pp. 579–581).
Mill also promoted the infant industry argument for protection, contending that a tariff "continued for a reasonable time, might sometimes be the least inconvenient mode" to establish a new industry in a developing country (p. 922). A similar argument had earlier been made by Alexander Hamilton, the Secretary of the Treasury to George Washington, in the Report on the Subject of Manufactures that he presented to Congress in 1791, and by Friedrich List, commenting on development both in the United States and in his native Germany. It has been used (and abused) as a rationale for protection by statesmen, businessmen, and economists, particularly from less developed countries, for over a century. Mill's insights were developed further in 1879 by Alfred Marshall in The Pure Theory of Foreign Trade. Marshall, who inaugurated the neoclassical school of economics in Britain, illustrated reciprocal demand by means of offer curves, whose intersection determines the terms of trade.
Hume, David. "Of the Jealousy of Trade." 1758. In Writings on Economics, ed. E. Rotwein. Madison: University of Wisconsin Press, 1955.
Irwin, Douglas A. Against the Tide: An Intellectual History of Free Trade. Princeton: Princeton University Press, 1996.
Letwin, William. The Origins of Scientific Economics. Garden City, NY: Doubleday, 1964.
Maneschi, Andrea. Comparative Advantage in International Trade: A Historical Perspective. Cheltenham: Edward Elgar, 1998.
Mill, John Stuart. Principles of Political Economy. 1848. London: Longman, Green, 1920.
Ricardo, David. "On the Principles of Political Economy and Taxation," 1817. In The Works and Correspondence of David Ricardo, ed. P. Sraffa, vol. I. Cambridge: Cambridge University Press, 1951.
Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations, 1776. Oxford: Clarendon Press, 1976.
Viner, Jacob. Studies in the Theory of International Trade, New York: Harper, 1937.