The theoretical basis of a study of international economic relations in
its modern form was formed as a result of a long and difficult process,
full of successes but, nevertheless, with important mistakes.
The early roots are to be found, perhaps, in Antic Greece in the works
of Aristotel, Platon and Xenophon. In general, the antic philosophers
opposed to the big commerce, supporting the idea of a closed domestic
economy. The closed character of the production of a self-supply type,
dominating from the antiquity up to 15th century gave no incentives for
developing any profound and constant studies on international trade. In
these conditions is in no way occasional that the theorists of antiquity
and Middle Ages (scholastics) exaggerated the role of production
(especially agricultural) and pleaded against the “art of making money”,
the chrematistics (after Aristotel).
At the dawn of the Modern Age (16th century) there appeared the first
trials of more systematic analyses of the international economic
relations.
Developed during the period of the downfall of feudalism and the
transition to capitalism, the mercantile theory was the first trial to
explain integrally the principles of international trade in a paradigm
of the analysis of economic reality.
Perhaps, the field of international trade was first closely studied by
men of affaires, in private or governmental employment, as no other
topical area, as a part of an effort to increase the wealth and the
power of the nation, with which these men tended to identify their own
welfare. This body of doctrines, later named by Adam Smith the
“mercantile system” or “mercantilism”, insisted that the acquisition of
wealth, particularly wealth in the form of gold, was of paramount
importance for national policy. Mercantilists took the virtues of gold
almost as an article of faith; consequently, they never undertook to
explain adequately why the pursuit of gold deserved such a high priority
in their economic plans.
The mercantilists held that economic policy should be nationalistic and
aim to secure the wealth and power of the state. This concept was based
on the conviction that national interests are inevitably in conflict –
that one nation can increase its trade only at the expense of other
nations.
Thus the most pervasive and most emphasized doctrine was the importance
of bringing about and maintaining an excess of exports over imports, for
that was the only way for a country without gold and silver mines to
increase its stock of the precious metals. In this way the foreign
trade, after mercantilists, was reduced to the maximum exports of goods
for gold and silver and some exports of raw materials and precious
metals.
The desire for a “favorable” balance of trade was never based by
mercantilist writers on a to see their countries engaged in capital
export, to make investments abroad, as the majority of them were at
least confused as to the difference between money and wealth, and very
often identified these two terms.
The idea was also that the state should provide its citizens with a
monopoly of the resources and trade outlets of its colonies. A typical
illustration of the mercantilist spirit is the famous English Navigation
Act of 1651, which reserved for the home country the right to trade with
the colonies and prohibited the import of goods of non-European origin
unless transported in ships flying the English flag. This law lingered
on until 1849. A similar policy was followed in France.
Thomas Mun
Thomas Mun, as a representative of mercantilist school, was one of the
firsts to deal extensively with the balance of international trade and
the balance of international payments. He first introduced into this
balance such components as the sale of numerous services – freight
earnings, marine insurance payments, travelers’ expenses, and many more
– to foreign countries.
Among other adepts of mercantilist theory we can name also Edward
Misselden, William Petty, and others.
With the emergence of mercantilism in the 16th-17th century, an
extensive body of literature dealing with the international trade
appeared, although we must add immediately that it yielded relatively
few lasting contributions to international trade theory.
Mercantilists’ ideas often were intellectually shallow, and indeed their
trade policy may have been little more than rationalization of the
interests of rising merchant class that wanted wider markets coupled
with protection against competition in the form of imported goods.
Liberalism
A strong reaction against mercantilist attitudes began to take shape
toward the middle of the 18th century. In France, the economists known
as Physiocrats demanded liberty of production and trade. In England,
Adam Smith demonstrated in his The Wealth of Nations (1776) the
advantages of removing trade restrictions. Economists and businessmen
voiced their opposition to excessively high and often prohibitive
customs duties and urged the negotiation of trade agreements with
foreign powers.
This movement was later named liberalism and the very first economists
fighting against the mercantile ideas are regarded to as the
pre-classical liberalists.
Pre-classical Liberalism
18th century is often remarked through the development of the scientific
trend in studying human society. In this way through the association
with such sciences as physics, medicine, astronomy, and others, it was
proved that the society is ridden by the “natural law”. Instead of being
finalistic and normative, as in the Middle Ages, the human sciences
became descriptive and explanatory. One of the first scientists which
tried to follow these concepts are the pre-classical liberalists and
among them such economists as Dudley (Douglas) North, Cantillon, Hume,
Condillac, and others.
Dudley North
North undertook a vigurous attack aimed at ridding the discussion of
foreign trade matters from mercantilist “superstitions”. He has
fittingly been called the first “free trader” in the Smithian sense.
Viewing the whole world rather than a single nation as an economic unit,
he demonstrated that there’s no fundamental difference between foreign
and domestic trade. North also presented a concise formulation of the
automatic and self-regulating mechanism that provides a nation with that
sum of money required for carrying its trade.
Cantillon
Cantillon deflated mercantilist tenets by showing that if a country
continues to sell more than it buys from abroad, money will successively
will flow into it and, as a first consequence, land and labor in the
export-surplus country will become more expensive.
Hume
Hume greatly helped to piece together the theory of self-regulating
international trade, and he went beyond Cantillon in pointing out why a
country could not permanently have a “favorable” or “unfavorable” trade
balance. Specifically, he stated the theory of self-regulating mechanism
with a much greater degree of clarity and incorporated it more
consistently with the remainder of his work than was the case with any
of the earlier or contemporary writers. He included the influence of
exchange-rate fluctuations on commodity trade in the mechanism as an
additional equilibrating factor. Hume considered that the exchange rate
equilibrates the trade balance of the country; this meaning that it
grows, if the trade balance tends to the unfavorable one and in this way
presses the imports, and vice-versa.
Condillac
Condillac applied his utility theory to international trade and
demonstrated that what holds true for exchange between two persons is
largely applicable also to commerce between nations. The inequality of
subjunctive valuations he saw reflected, on a larger scale, in the total
exchange transactions between nations. He decried the foolishness of
establishing trade barriers because it is in the very nature of exchange
that both parties will benefit – what is offered for sale always being
valued less highly than what is acquired in return. If each nation
insisted on selling only, they would all eventually wind up without
foreign trade and deprive themselves of its benefits. Condillac went
beyond his predecessors Hume and Cantillon in showing that even if other
nations continue putting up obstacles to international exchange, it will
be advantageous for a particular country to adhere to free-trade
principles. He concludes, somewhat optimistically, that when trading
enjoys complete and permanent liberty, wealth is bound to spread
everywhere.
Classical Liberalism
Classical liberalistic school gave us three models of international
trade:
the physiocratic model
the absolute advantage theory
the theory of comparative advantage
Physiocratic model
The mercantile policies imposed in the 16th – 17th century, which
proclaimed the accumulation of wealth through trade, in the form of
money capital, had ridden the most of European countries (maybe except
Germany and, in some measure, Britain) into a state of a downfall of
production, especially of agricultural one.
Gradually there appeares the idea that the wealth consists of goods. In
this sense, physiocrats can be considered the pioneers. Supporting that
the wealth is the totality of agricultural goods, physiocrats leave
money the role of a means of exchange only.
In these conditions, the new conception about the international trade
appears. Once the wealth derives from agriculture, it is not created by
trade, therefore the trade must be based only on the exchange of
equivalents, while money are no more than a means of exchange.
The physiocrats oppose to the active (“favourable”) balance, as it
results from the export of wealth (in the form of goods), and the import
of money (which are not wealth). They fight to realise an equilibrated
balance in international trade.
Quesnay
The founder of the Physiocratic School, Quesnay, in all probability
heavily indebted to Cantillon, brought out the fact that the state of
the balance of trade between nations is neither an indicator of the
advantages of foreign commerce nor that of the wealth of nations. But he
was the author of theory which contained the idea that when a country
imports luxury goods, selling the most necessary or most useful
commodities, it prospers, because it means that the people are able to
produce beyond its basic requirements.
The Absolute Advantage Theory
The British school of “classical economics” began in no small measure as
a reaction against the inconsistencies of mercantilist thought. Adam
Smith was the 18th-century founder of this school; his famous work, “The
Wealth of Nations”, is in part an anti-mercantilist tract. In “The
Wealth of Nations”, Smith emphasized the importance of specialization:
in a world where the productive resources are scarce and human wants
cannot be completely satisfied, each nation should specialize in the
production of goods it is particularly well equipped to produce; it
should export part of this production, taking in exchange other goods
that it cannot so easily turn out.
Adam Smith
Adam Smith’s attack was probably the boldest one on the “mercantile
system” which was already tottering both because economic changes had
given some of these doctrines an antiquarian flavor and because the
piecemeal invalidations of these doctrines by the many forerunners of
economic liberalism hardly left it a “leg to stand on”. All the same,
without Smith’s vigurous, forceful, and systematic statement of its
weaknesses, it might have lingered much longer than it did.
On the other hand, Smith was unfortunately not capable of precisely
formulating a general theory of international trade. Apart from his
building up an imposing structure of arguments in favor of freedom from
restrictions on foreign trade activities, his contributions to this
theory are relatively minor, as Smith considered mistaken that a
producer needs an absolute advantage to export its products.
The basic concepts of Smith’s teory of international trade may be
considered the following:
1. The international commerce is close related with the social division
of labor.
2. The international trade after Smith is based apon the freedom of
action and the incentives of economic agents.
3. In international trade the competition is free and perfect (without
monopolies and any governmental restrictions in the form of
protectionist policies).
From these concepts the following indications on international economic
relations result:
1. In the result of labor division it is not necessary and even possible
that every country produce inside all the products it needs. It is
because different states are provided with the factors of production of
different types and quality in different proportions. As the result
every country must specialize in production of that goods, for which the
costs of production are the lowest.
2. Every country imports the goods for which it pays a lower price than
it would cost him in case it produced this product domestically.
3. The difference between the domestic cost of production and the import
price is the absolute advantage obtained through the international
trade, this rule being general for all countries.
4. At the domestic range the state must not interfere in economy, as it
always disturbs economic agents from seeking the most efficient mode to
invest factors of production it posesses.
5. In the international trade must be promoted the policy of free
competition (without monopolies) and a policy of free exchange
(non-discriminating).
Much as Smith was aware of the benifits of free trade and was able to
influence the British economic thought, he was not an unqualified free
trader. He singled out two primary cases which in his view justified the
imposition of barriers on imports for the purpose of encouraging
domestic industry.
First, some particular industries may be necessary for the defense of a
country. From this point of view, the British Navigation Acts, inasmuch
as they promoted the building up of a merchant marine to be used in
peace and war alike, were perfectly sensible.
The second case is an application of the principle that normally
competitive conditions should not be distorted by government
intervention. Consequently, it will be proper to place a burden on
foreign industry if this merely neutralizes the disadvantage under which
domestic industry operates because it is burned with some taxes from
which the foreign producers are exempt. After the imposition of a
“matching” tariff duty, a form of equalizing adjustment no larger
portion of domestic labor and capital would be devoted to the particular
domestic industry of a country than what would naturally go to it. “It
would only hinder any part of what would naturally go to it from being
turned away by the tax, into a less natural direction…” Smith does not
underrate the difficulty arising from the fact that imported commodities
are seldom perfect equivalents of the domestic produced variety.
Adam Smith took up two secondary cases in which he held it to be a
“matter of deliberation” whether or not to follow a laissez-faire
policy.
The first deals with the advisability, pro and con, of imposing a
retaliatory duty designed to bring about the repeal of a duty imposed by
a foreign country. The success of taking such a step, Smith holds, will
always be open to guess; and unless the odds are distinstly in its
favor, the “…transitory inconviniency of paying dearer during a short
time for some sorts of goods” would not be justified.
The second possibility, where the issue is not the imposition of a new
tax but rather the return to free trade from the evils of protection,
centers around the need of preventing a sudden painful shock to a
domestic industry. This will be largely a question of size: only when a
“great multitude of hands” would all at once be deprived of their
ordinary employment and livelihood by the removal of high duties and
prohibitions in some special regard to their welfare in order. Indeed,
Smith feels, it becomes a matter of equity in this case that the return
to exposure to competition from foreigners be undertaken “…slowly,
gradually, and after a very long warning”.
Bounties on exports, that is, government payments to exporters of goods
who could not otherwise effectively compete with their foreign rivals,
were, as we might expect, another device of the “mercantile system”
scorned by Smith. They can only warp the natural allocation of
resources. Since a country cannot force the buying of its exports on
other countries, the next best expedient may be found in one country
paying another for the buying of exports. But doing so, through
bounties, will force a country’s trade in less advantageous channels
than that in which it would go if left alone. Domestic consumers will
be the losers: under conditions of full employment they would pay a
higher price for a smaller portion of the total supply, and in addition
they would have to foot the bill for government payments to exporters.
Such are the highlights of the attack on the absurdities of mercantilist
restrictions, which had flowered too long to suit Smith’s disposition.
The Comparative Advantage Theory
Smith did not expand these ideas at much length; but David Ricardo, the
second great classical economist, developed them into the “principle of
comparative advantage”, a principle still to be found, much as Ricardo
spelled it out, in every textbook on international trade.
The principle of comparative advantage is based on what kind of product
the country can produce best, in comparing not with other countries, but
with the producing of other kinds of goods. In this case the country
doesn’t necessarily need an absolute advantage to specialize in
producing and exporting it.
The major purpose of the theory of comparative advantage is to
illustrate the gains from the international trade. Each country can gain
by specializing in those occupations in which it is relatively
efficient; it should export part of that production and take in exchange
those goods in whose production it is, for whatever reason, at a
comparative disadvantage. The theory of comparative advantage thus
provides a strong argument for free trade – and indeed – for a
laissez-faire attitude with respect to trade.
The supporting argument is simple; specialization and free exchange
among nations yield higher real income for the participants.
The act that a country will enjoy higher real income as a consequence of
the opening up of trade barriers does not mean, of course, that every
family or individual within a country must share in that benifit.
Producer groups affected by import competition obviously will suffer to
at least some degree. Comparative-advantage theorists concede that free
trade would affect the relative income position of such groups, and
perhaps even their absolute income level. But they insist that the
special interests of these groups clashes with the total national
interest, and the most that they are usually willing to concede is the
possible need for a temporary protection against import competition, in
order that the persons affected may have sufficient time to move to
another occupation.
David Ricardo
In his theoretical researches D.Ricardo did not base apon extensive
empirical researches but mainly engaged in abstract reasoning. In
working out his international trade theory, he also founded his
conclusions apon a set of postulates which he considered as first
approximations of the real world. The conclusions he drew, being valid
within the framework of his assumptions only, had of course to be
modified before they could be applied to actual circumstances.
The same is also true for Jean-Stuart Mill, whose studies in
international trade theory completed the framework built by Ricardo. In
spite of many attacks and emandations, the main structure of the
Ricardo-Mill theory of international trade remained basically unimpared
untill well into the 20th century.
He left however, much unfinished business for his successors, since his
statements did not explain how the actual ratios of international
exchange determine international prices.
Ricardo has been attacked on many grounds: his statements of the
doctrine in terms of labor costs only; his assumption of constant cost
of production; and, of course, his artificial assumptions of perfect
factor mobility within a nation as against complete factor immobility
internationally. Many feel that these demerits are minor and are
overshadowed by the fact that his new approach opened up entirely new
vistas for further research, for example, a restatement of the principle
in terms of opportunity costs.
John Stuart Mill
Ricardo’s contribution left unanswered the question of how the actual
ratios at which goods exchange are determined. It was Jean Stuart Mill
who explained the determination of the terms of trade and did so with
great skill. He found that they are dependent on reciprocal demand and
that the equilibrum exchange ratio is the ratio that equalizes the
values of exports and imports for each country in a two-country
two-commodity situation. With the “Equation of International Demand” as
a tool, he proceeded to envisage more complicated situations and explain
what modifications in assumptions their analysis necessitated. His work
helped greatly in clarifying the intricate problems connected with the
theory of international values and strengthened the foundations on which
others could build.
Among the other representatives of classical school we can pick up such
economists as Nassau William, Senior, John Elliot Cairness, the Irish
one Charles Francis Bastable, whose apport in developing theory of
international trade was, perhaps, the boldest, as they tried to modify
the Ricardo-Mill theory in more realistic way.
This change of attitudes led to the signing of a number of agreements
embodying the new ideas, among them the Anglo-French Treaty of 1786,
which ended what had been an economic war between the two countries.
After Adam Smith, the basic tenets of mercantilism were no longer
considered defensible. This did not, however, mean that nations
abandoned all mercantilist policies. Restrictive economic policies were
now justified by the claim that, up to a certain point, the government
should keep foreign merchandise off the domestic market in order to
shelter national production from outside competition. To this end,
customs levies were introduced in increasing number, replacing outright
bans on imports, which became less and less frequent.
In the middle of the 19th century, customs walls effectively sheltered
many national economies from outside competition. The French tariff of
1860, for example, charged extremely high prices on British products: 60
percent on pig iron; 40 to 50 percent on machinery; and 600 to 800
percent on woolen blankets. Transport costs between the two countries
provided further protection.
A triumph for liberal ideas was the Anglo-French trade agreement of
1860, which provided that French protective duties were to be reduced to
a maximum of 25 percent within five years, with free entry of all French
products except wine into Britain. This agreement was followed by other
European trade pacts.
Resurgence of Protectionism
In the period of a whole triumph of the doctrine of classical economic
liberalism, in the first part of 19th century, there appears in Germany
a diametrically contraire (at least apparently) doctrine of economic
protectionism. The brightest representative of this new theory is, no
doubt, Friedrich List (1789-1846), son of a German leatherworker. Not
studying at any university, he made an academic career to become active
in German politics. In 1819, he became leader of the General Association
of Manufacturers & Merchants and the very soul of the movement to
confederate the German states.
Being controversed and pressed in course of his life, list was in no
smaller measure appreciated and valued posthumously. Rare economists had
such a great influence upon the course of economic events as List had,
there are few systems of economic thought which were to such extend
using in practice as the Listian one was.
The economic and political unity that characterized much of Europe in
the first half of 19th century was totally absent from Germany. The
peace treaty that ended Germany’s participation in Napoleonic wars left
that country divided into 39 different states, most of which were
individual monarchies economically and politically isolated from one
another. Such isolation was primarily the result of a complex system of
interstate tariffs that impaired the free and easy exchange of goods. At
the same time, however, no import duties existed. Thus British surplus
products (and those of other countries) found their way into German
markets, where they were offered at extremely low prices.
Under these circumstances the very existence of German manufacturing and
mercantile interests was threatened, and by the 1830, there arose among
the German states a general clamor for economic unity and uniform
tariffs. It was this movement that consumed List’s interests and energy.
In his analysis of national systems of political economy, List applied a
method of inquiry originated by Saint-Simon: the idea that an economy
must pass through successive stages before it reaches a “mature” state.
The historical stages of development detailed by List were:
1. Barbaric
2. Pastoral
3. Agricultural
4. Agricultural-Manufacturing
5. Agricultural-Manufacturing-Commercial
Like Sismondi and Saint-Simon, List was as much interested in transition
between stages of economic development as in the end result. He felt
that passage through the first three stages will be brought about most
speedily by free trade between states and nations, but that economies in
transition between the last two stages required economic protection
until the final stage was reached.
Free trade was warranted once again, however, when the final stage of
development was attained, “in order to guard against retrogression and
indolence by the nation’s manufacturers and merchants”.
By List’s classification and testimony, only Great Britain had attained
the final stage of economic development. While the Continental and
American nations struggled to reach this apogee, however, cheap British
imports were thwarting the development of domestic manufacturing. List
felt that until all nations reached the final stage of development,
international competition could not exist on an equal footing. Thus he
favored protective tariffs for Germany until its greatest national
economic power was attained.
It is important to note that List was not an outright protectionist;
rather, he felt that protection was warranted only at critical stages in
history. His writings are replete with examples borrowed from history
and experience showing that economic protection is the only way for an
emerging nation to establish itself. List felt that the American
experience offered vindication of his views, and he of course found
ready support among United States protectionists, particularly Alexander
Hamilton and Henry Carey.
List’s Criticism of Classical Economics
List strongly opposed the absolutist, cosmopolitian tendencies of the
classical economists. They derived principles, he maintained, which were
then assumed to hold for all nations and all times. By contrast, List’s
theory and methodology were strongly nationalistic and historical. His
theory of stages in economic development, for example, was calculated to
demonstrate the insufficiency of classical economics to recognize and
reflect the variety of conditions existing in different countries and,
most especially, in Germany.
Like Sismondi, List subordinated economics to politics in general. In
his view, it was not enough for the statesmen to know that the free
interchange will increase wealth (as demonstrated by the classical
economists); he must also know the ramifications of such action for his
own country. Thus List argued that free trade that displaces either
population or domestic industry is undesirable. Moreover, List would not
sacrifice the future for the present. He maintained that the crucial
economic magnitude in economic development is not wealth (as measured by
exchange values) but productive power. In his own words, ” The power of
producing wealth is…infinitely more important than the wealth itself”.
Thus economic resources must be safeguarded so that their future
existence and development are assured. This view constitutes further
justification for List’s protectionist arguments; it also lies at the
root of the popular “infant-industry” argument in support of protective
tariffs.
For List, the ultimate goal of economic activity should be national
development and the accretion of economic power. In this, he (as Marx
was to do later) perceived industry as more than the mere result of
labor and capital. Rather, he conceived industry as a social force that
itself creates and improves capital and labor. In addition to effecting
present production, industry gives an impetus and a direction to future
production. Therefore, List recommended the introduction of industry
into underdeveloped countries even at the expense of temporary loss.
List’s originality in economic theory and method consisted in his
systematic use of historical comparison as a means of demonstrating the
validity of economic propositions and in his introduction of new and
useful points of view in contradistinction to the economic orthodoxy of
classical liberalism. In stretching the dynamic fabric of classical
economic growth by representing economic development as a succession of
historical stages, he provided a methodological rallying point for the
economists of the German historical school. Thus List may appropriately
be considered the forerunner of that school.
This reaction in favor of protection spread throughout the Western World
in the latter part of the 19th century. Germany adopted a systematically
protectionist policy and was soon followed by most other nations.
Shortly after 1860, during the Civil War, the United States raised its
duties sharply; the McKinley Tariff Act of 1890 was ultraprotectionist.
England was the only country to remain faithful to the principles of
free trade.
But the protectionism of the last quarter of the 19th century was mild
by comparison with the mercantilist policies that had been common in the
17th century and were to be revived between the two World wars.
Extensive economic liberty prevailed by 1913. Quantitative restrictions
were unheard of, and customs duties were low and stable. Currencies were
freely convertible into gold, which in effect was common international
money. Balance-of-payments problems were few. People who wished to
settle and work
in a country could go where they wished with few restrictions; they
could open businesses, enter trade, or export capital freely. Equal
opportunity to compete was the general rule, the sole exception being
the existence of limited customs preferences between certain countries,
most usually between a home country and its colonies. Trade was freer
throughout the Western World in 1913 than it was in Europe in 1970.
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