Qualms On Foreign Trade

"7.5. The idea that the opening of foreign trade bears a close resemblance to technical progress, in that in both cases additional processes of production are made available to the economy, is clearly expressed in Ricardo's Principles in the chapter 'On Foreign Trade'... Ricardo in fact compares the extension of trade to improvements in machinery, and, taking the real wage rate as given, investigates whether trade or improved machinery will have an impact on the general rate of profit. He concludes that if 'by the extension of foreign trade, or by improvements in machinery, the food and necessaries of the labourer can be brought to market at a reduced price, profits will rise,' whereas 'if the commodities obtained at a cheaper rate... be exclusively the commodities consumed by the rich, no alteration will take place in the rate of profits'...

7.6. In recent years the pure theory of trade has been reformulated, using a 'classical' approach to the theory of value and distribution and paying special attention to the fact that capital consists of produced means of production. A start was made by Parrinello (1970), followed by several contributions by Steedman, Metcalfe and Steedman, and Mainwaring... It was shown that several of the traditional trade theorems, derived within the Heckscher-Ohlin-Samuelson model, do not carry over to a framework with a positive rate of profit (interest) and produced inputs (capital goods). (As is well known, the Heckscher-Ohlin-Samuelson model of international trade assumes two countries producing the same two commodities by means of the same constant returns to scale technology, using the same two primary inputs, each of which is taken to be homogeneous across countries.) With a positive rate of interest that is uniform across countries some, though not all, of the standard theorems are undermined (including the 'factor price equalization theorem'), while with different rates of interest in different countries all standard theorems except the Rybczynski theorem turn out to be untenable. The 'gains' from trade for the single small open economy need not be positive. When in the Heckscher-Ohlin-Samuelson theory one of the two primary factors (land) is replaced by a factor called 'capital', the 'quantity' of which is represented in terms of a given total value of capital, then the theory is deprived of its logical coherence..." -- Heinz D. Kurz and Neri Salvadori, Theory of Production: A Long-Period Analysis, Cambridge University Press, 1995.

P.S. Some mainstream economists have recently expressed doubts about the empirical ability of the theory of comparative advantage and its use as a basis for policy. One can add Paul Krugman to the doubters.

Hoisted From Comments: Query On Foreign Trade

A reader asks:

"This is an unrelated discussion, but I was hoping that maybe you (or someone else reading this forum) could help me with a question that may also be of interest to you.

How does a standard neo-Walrasian CGE (computational general equilibrium) model predict economic losses from trade liberalisation?

I understand the logic behind the two goods and country case where welfare gains can be made through the elimination of trade barriers if there exists a comparative advantage (assuming the standard assumptions of perfect competition, constant returns to scale etc.), but how does the logic work with more than two countries and goods?

Is the answer simply that those countries which do not have a comparative advantage (in any or critical goods), experience welfare losses, because they are now importing more (due to lower prices abroad) and exporting less (trade is being diverted to other countries)?

Most (if not all) countries when getting the CGE treatment with full liberalisation scenarios, seem to make welfare gains. Is this because most countries have at least some comparative advantage in some goods, and the theory neglects any adjustment and transaction costs?

Some background on this question: I'm not an economist by trade, but rather study development studies, for which I'm writing a Master's Thesis. My strategy has been to use the Lakatosian methodological framework for studying the hardcore assumptions behind general equilibrium analysis. This has led me to study for example Keen's work, and Fabio Petri's (on the capital controversies) among others. Since I'm not concentrating on heuristics (and I'm not particularly mathematically inclined), I'm not familiar with all the implications of the standar neo-Walrasian theory (e.g. Arrow-Debreu) that the criticism, quite rightly it seems, is able to destroy by attacking its inconsistent or absurdly narrowed assumptions. To the standard unacquainted reader (for example my supervisor) it is however perhaps not only enough to attack the assumptions, but also be able to reduce the theory via its implications. I'm thinking that for a conclusion, I could write up a kind of characterisation of what the theory implies in the narrow sense and a wish list of what problems a perfect economic theory would be able to cover and account for as a contrast (perhaps a distant dream, but why not?)

Any ideas on the above would be appreciated.."

I don't know much about CGE models. I understand that commodities can be indexed in the Arrow-Debreu model on space, and this provides a theory of foreign trade. In the Arrow-Debreu model, the initial endowments of all commodities are taken as given data. This makes it a very short run theory. I was under the impression that the traditional argument about comparative advantage takes place in the Heckscher Ohlin Samuelson (HOS) model, which is a long run model.

Given the presence of produced capital goods and a positive interest rate, many supposed theorems in the HOS model are simply incorrect. In particular, trade according to the pattern of comparative advantage can move a country's Production Possibilities Frontier inward. Ian Steedman is a good author to read here. Perhaps your university library has a copy of the New Palgrave, and Steedman wrote the entry on "Foreign Trade". (I talked to Keen about these ideas before the publication of his book. He said that if he writes another edition, he might put in a chapter on foreign trade.)

I don't think comparative advantage explains the pattern of trade. A theory based on the Keynesian multiplier is another possibility. Literature here includes Luigi Pasinetti's Structural Economic Dynamics: A Theory of the Economic Consequences of Human Learning (Cambridge, 1993). Paul Davidson has proposed some reforms of the international monetary system. I have not read Ha-Joon Chang, neither his Bad Samaritans nor his Kicking Away the Ladder.

Two PDFs that I have downloaded from somewhere or other in the past year and have never got around to reading might be of interest. I am talking about Roberto Mangabeira Unger's Free Trade Reimagined and Robert Driskill's "Deconstructing the Argument for Free Trade".

Another body of literature that I have never explored is new trade theory, as presented by Paul Krugman. Given that comparative advantage fails to justify free trade, I don't see the point of that theory. As I understand it, new trade theory asserts incorrectly that comparative advantage would provide this justification if it were not for increasing returns or oligopoly or something. According to Barkley Rosser (in a 1996 book review in the Journal of Economic Behavior and Organization), Krugman claims more originality for his presentation than can be justified.

Anger Can Be Power

What I'm reading:

"The colonial world is a world cut in two. The dividing line, the frontiers are shown by barracks and police stations. In the colonies it is the policeman and the soldier who are the official, instituted go-betweens, the spokesmen of the settler and his rule of oppression. In capitalist societies the educational system, whether lay or clerical, the structure of moral reflexes handed down from father to son, the exemplary honesty of workers who are given a medal after fifty years of good and loyal service, and the affection which springs from harmonious relations and good behavior - all these aesthetic expressions of respect for the established order serve to create around the exploited person an atmosphere of submission and of inhibition which lightens the task of policing considerably. In the capitalist countries a multitude of moral teachers, counselors and 'bewilderers' seperate the exploited from those in power. In the colonial countries, on the contrary, the policeman and the soldier, by their immediate presence and their frequent and direct action maintain contact with the native and advise him by means of rifle butts and napalm not to budge. It is obvious here that the agents of government speak the language of pure force. The intermediary does not lighten the oppression, nor seek to hide the domination; he shows them up and puts them into practice with the clear conscience of an upholder of the peace; yet he is the bringer of violence into the home and into the mind of the native." -- Frantz Fanon, The Wretched of the Earth (1963).

Wages, Employment Not Determined By Supply And Demand

1.0 Introduction
One theme of this blog is that the introductory textbook model of the labor market is incorrect. Two recent papers make this point from the perspective of institutional economics.

2.0 The Impossibility of a Perfectly Competitive Labour Market
The abstract of the first paper under consideration states:

Using the institutional theory of transaction costs, I demonstrate that the assumptions of the competitive labour market model are internally contradictory and lead to the conclusion that on purely theoretical grounds a perfectly competitive labour market is a logical impossibility. By extension, the familiar diagram of wage determination by supply and demand is also a logical impossibility and the neoclassical labour demand curve is not a well-defined construct. The reason is that the perfectly competitive market model presumes zero transaction costs and with zero transaction costs all labour is hired as independent contractors, implying that multi-person firms, the employment relationship and labour market disappear. With positive transaction costs, on the other hand, employment contracts are incomplete and the labour supply curve to the firm is upward sloping, again causing the labour demand curve to be ill-defined. As a result, theory suggests that wage rates are always and everywhere an amalgam of an administered and bargained price. -- Bruce E. Kaufman (2007). "The Impossibility of a Perfectly Competitive Labour Market", Cambridge Journal of Economics, V. 31: 775-787

Kaufman states that, "Institutional, post-Keynesian, radical and other heterodox economists have for many years expressed scepticism about the theoretical and empirical validity of the competitive model of labour markets." He cites the following literature:

• C. Kerr (1950). "Labour Markets: Their Character and Consequences", American Economic Review, V. 40 (May): 278-291
• G. Hodgson (1988). Economics and Institutions: A Manifesto for a Modern Institutional Economics, Philadelphia: University of Pennsylvania Press.
• D. Vickers (1996). "The Market: The Tyranny of a Theoretical Construct", in Employment, Economic Growth, and the Tyranny of the Market, (ed. by P. Aretis), Brookfield: Edward Elgar
• W. Streeck (2005). "The Sociology of Labour Markets and Trade Unions", in The Handbook of Economic Sociology (ed. by N. Smelser and R. Swedberg), 2nd edition, New York: Russel Sage
• S. Fleetwood (2006). "Rethinking Labour Markets: A Critical-Realist-Socioeconomic Perspective, Capital & Class, V. 107 (Summer): 59-89

As far as I can tell, none of these papers are about the Cambridge Capital Controversy, which is the basis of my favorite critique of the introductory textbook model of labor markets.

3.0 Professor Lester and the Neoclassicals
The abstract of the second paper follows:

"This article revisits what is remembered as the 'Marginalist Controversy' in light of its immediate context and object: the substantial late 1940s increase in the federal minimum wage. Richard Lester's critique of 'marginalist theory,' and its implication that the minimum wage would be detrimental to labor was founded upon empirical studies and surveys that supported an Institutionalist conception of the business firm, the labor market, and economic policy. His disputants, Fritz Machlup and George Stigler, countered his points on the basis of what they took to be 'economic theory'. By any measure, including those of their own intellectual allies, Machlup and Stigler faired poorly. Interestingly, they are collectively remembered as having been triumphant in this debate. The essay suggests that what triumphed was not their arguments but rather the Neoclassical school of economics that Stigler represented." -- Robert E. Prasch (2007). "Professor Lester and the Neoclassicals: The 'Marginalist Controversy' and the Postwar Academic Debate Over Minimum Wage Legislation: 1945-1950", Journal of Economic Issues, V. 41, N. 3 (September): 809-826."

I had not known that the context of the debate about full cost pricing included minimum wage policies. Prasch makes the point that neoclassicals often misrepresent their position as a defense of economic theory, instead of as of a specific theory. In addition to drawing on a specific school of thought, Institutionalist economics, Lester had survey data supporting his position that the typical firm does not operate in a region of increasing marginal cost. It is this sort of data, which has been repeatedly replicated, that Milton Friedman argued, in his famous paper on positive economics, should be ignored.

History Is A Nightmare From Which I Am Trying To Awake

Last year I bought my 12-year-old niece a novel. My sister-in-law says that as far as books goes, my niece likes memoirs and history, like The Diary of Anne Frank. I ended up buying my niece something other than a book. But I wonder what would be a good book to buy my niece.

I presented this to the salesperson at Barnes and Noble as, "Suggest a book like the Diary... about a girl growing up in troubled circumstances. She suggested Smashed: Story of a Drunken Girlhood. This does not seem a good answer to me. I haven't read Zailckas' book. From a review, I know she went to Syracuse University, and, for some reason, I think she may be a product of the Syracuse creative writing program. I have a vague impression that that program is quite good. The authors I associate with it write well about drunkenness and drugs.

I could always loan my niece a book from my collection. Perhaps my niece would like Eric Hobsbawm's The Age of Extremes: A History of the World, 1914-1991. I find the Russian names in Hope Against Hope confusing, even with the translator's or editor's appendix. Likewise, I think Antonio Gramsci's Letters from Prison is not understandable without quite a bit of knowledge of the historical setting. I seem to have mislaid my copy of Biko. I just bought The Mascot: Unraveling the Mystery of My Jewish Father's Nazi Boyhood and will not lend that away until I have read it.

I've loaned my copy of A Long Way Gone: Memoirs of a Boy Soldier to a young friend of mine. This was his choice in a selection I thought of after he told me about a somewhat autistic kid in his class: "He's even better at math than I am." I think I talked him out of The Curious Incident of the Dog in the Night Time by trying to explain the concept of a unreliable narrator. I don't seem to be able to sell Life As We Know It: A Father, A Family, And An Exceptional Child, including to my sister, who has children and a degree from University of Illinois at Urbana-Champaign.

A salesperson at Borders suggested Zlata's Diary: A Child's Life in Wartime Sarajevo. A librarian in Rome, NY, suggested Four Girls From Berlin: A Ture Story of a Friendship That Defied the Holocause and two novels: The Devil's Arithmetic and The Diary of Pelly D. Come to think of it, isn't the Speilberg film, The Empire of the Sun, based on a memoir?

Does anybody have any comments on any of the above books or any further suggestions?

Jeopardy!

The answer for 42-across in today's New York Times crossword puzzle is "Larry Summers". What do you think the clue should be? Will Shortz, the puzzle editor and an institution, is content with "Former president of Harvard". I think being former secretary of the treasury is more impressive, myself.

Rich Man Wanna Be King, And A King Ain't Satisfied 'Til He Rules Everything

I have a series of posts on the distribution of income, the distribution of wealth, income mobility, and related matters. I don't know Lane Kenworthy's work, but his blog, "Consider the Evidence", looks interesting. He describes himself as "a social scientist who studies causes and consequences of poverty, inequality, employment, mobility, economic growth, and social policy. [He] focus[es] mainly on the United States and other affluent countries."

More To Read

Apparently, Andrew Trigg has written a book Marxian Reproduction Schema: Money and Aggregate Demand in a Capitalist Economy (Routledge, 2006) on the topics of my post. He relates Marx's schemes for simple and expanded reproduction to Keynes' theory of effective demand, Kalecki's idea that capitalists "get what they spend", input-output analysis, and post-war growth models. At least a chapter discusses money and finance in this approach, including circuitist models. In my exposition, I put aside the labor theory of value. Trigg, on the other hand, discusses the transformation problem and whether or not a tendency exists for the rate of profit to decline.

I don't know if I'll purchase this book. Mike Beggs should be interested in it.

It's Never Enough Until Your Heart Stops Beating

Aaron Swartz quotes a paper by Louis Pascal posing a thought experiment. I wonder if many find this argument emotionally unsatisfying. It doesn't feel that one causes the starvation of others just by consuming one's income. And, although giving to charity may help a few, nothing is systematically changed.

But perhaps this is all self-justification. Aaron's argument reminds me of some of Blaise Pascal's mockery of the Jesuits. It is hard to approach how Pascal says they made morality all too easy to live up to:

"I mentioned, at the close of my last letter, that my good friend, the Jesuit, had promised to show me how the casuists reconcile the contrarieties between their opinions and the decisions of the popes, the councils, and the Scriptures. This promise he fulfilled at our last interview, of which I shall now give you an account.

'One of the methods,' resumed the monk, 'in which we reconcile these apparent contradictions, is by the interpretation of some phrase...'

'Take another instance: It is said in the Gospel, "Give alms of your superfluity." Several casuists, however, have contrived to discharge the wealthiest from the obligation of alms-giving. This may appear another paradox, but the matter is easily put to rights by giving such an interpretation to the word superfluity that it will seldom or never happen that any one is troubled with such an article. This feat has been accomplished by the learned Vasquez, in his Treatise on Alms, c. 4: "What men of the world lay up to improve their circumstances, or those of their relatives cannot be termed superfluity; and accordingly, such a thing as superfluity is seldom to be found among men of the world, not even excepting kings." Diana, too, who generally founds on our fathers, having quoted these words of Vasquez, justly concludes, "that as to the question whether the rich are bound to give alms of their superfluity, even though the affirmative were true, it will seldom or never happen to be obligatory in practice."'" -- Blaise Pascal, "Letter VI", Provincial Letters (trans. by Thomas M'Crie

(Letter XII is also on topic.)

One can react in various ways to the raw need that prevails so much throughout the world. I don't think I am very charitable, but you would think otherwise based on the organizations that feel it is worth their while to send me solicitations. A friend of mine adopted several children and founded his own charity. I never asked him his motivation.

Simple and Expanded Reproduction

1.0 Introduction
This post presents a model in which a capitalist economy smoothly reproduces itself. The purpose of such a model is not to predict that capitalist economies will converge to some such path as illustrated in the model. Rather, the model provides a basis for the analysis of where things can go wrong.

This sort of model has a long history. My exposition is close to Marx (1956), with the difference that Marx sets out the conditions of simple and expanded production in terms of labor values, not in terms of prices of production. Rosa Luxemburg (1951) and Michal Kalecki (1969) used Marx's department break-down to develop a Keynes-like model of the long run and the short run. Shigeto Tsuru (1942) apparently exposed this model to english-speaking academics when few were looking at Marx's analysis. Joan Robinson (1962) drew on these ideas, among others, in her models of metallic ages. Goodwin's generalization (1949) of Keynes to a multisectorial model and Pasinetti's (1981, 1993) analyses of vertically integrated sectors also seem to me to bear family resemblances to this model. Doubtless, my references could be extended in many directions.

Table 1: Definition of Variables

Variable	Definition
	The person-years of labor hired per unit output (e.g., ton steel) in the first sector.
	The person-years of labor hired per unit output (e.g., bushel corn) in the second sector.
	The capital goods used up per unit output in the first (steel-producing) sector.
	The capital goods used up per unit output in the second (corn-producing) sector.
	The price of unit output in the first sector.
	The price of unit output in the second sector.
	The rate of profits.
	The savings rate out of profits.
	The wage, that is, the price of hiring a person-year.
	The number of units (tons steel) produced in the first sector.
	The number of units (bushels corn) produced in the second sector.

2.0 Two Departments
This model considers a capitalist economy with no government and no foreign trade. The outputs of this economy are grouped into two great departments. In the first department, capitalists direct workers to produce means of production (also known as capital goods) with the means of production in that department. In the second department, the workers are directed to produce means of consumption (also known as consumption goods) with the means of production in that department.

For ease of exposition, I make certain additional simplifying assumptions. The workers consume all of their wages. Only the capitalists save, and they save only in the case of expanded reproduction. All capital is circulating capital. That is, there is no fixed capital, such as long-lived machinery. In other words, all capital goods are totally used up each year in producing the yearly output. No technological innovations are introduced.

I think introducing technological innovations and fixed capital makes the possibility of smooth reproduction more incredible. A govenrment can be introduced as a third department, or perhaps by dividing government output among the two departments shown. Foreign trade introduces the possibility of correcting imbalances in domestic demand from outside the domestic economy. But then one could recast the model as of the world economy.

3.0 Prices
A necessary condition for smooth reproduction of a competitive capitalist economy is that the same rate of profit be made in all departments. Otherwise, some capitalists are finding that the expectations on which investments were made are being unfulfilled. They would want to have contracted some departments and expanded others. I also impose the condition that spot prices remain stationary. Equations 1 and 2 express these conditions:

(1)

(2)

I suppose one could put time indices on the prices in Equations 1 and 2, thereby defining a dynamic system for prices. Suppose distribution and the ratios of physical quantity flows remain unchanged year after year. Then the steady-state prices expressed in Equations 1 and 2 (without time indices) would be a limit point of the dynamic process so defined. It is this caveat, I think, that allows me to ignore that constant prices are, perhaps, not a necessary condition for smooth reproduction.

Table 2: Values of Outputs By Department and Distribution

Department	Capital	Wages	Profits
Capital Goods
Consumption Commodities

4.0 In Balance
4.1 Simple Reproduction
The economy is in simple reproduction when it is replicated on the same scale year after year. A necessary condition for an economy in simple reproduction is that the production of capital goods each year be equal to the capital goods used up each year. In the model shown here, the value of the capital goods used up each year must equal the value of the output of the first department:

(3)

Equation 3 can be simplified:

(4)

Equation 4 is easily summarized in words. It states that the value of capital goods demanded from the second department matches the demand for consumption goods from the first department. In a sense, Equation 4 is a generalization of Keynes' idea of effective demand. The condition that all workers looking for a job are able to find one at the going wage is a separate condition, not stated here. In a sense, this model generalizes Keynes' theory, in some sense, to the long-run.

An alternate method of deriving Equation 4 is available. Start from the equation of the value of total demand for consumption goods and the value of the output of the department producing consumption goods. This condition, when simplified, also yields Equation 4.

4.2 Expanded Reproduction
The economy experiences expanded reproduction when it consistently expands each year. In this case, the demand for capital goods from the second department includes the savings of the capitalists receiving profits from that department. Likewise, the demand for consumption goods from the first department excludes the savings of the capitalists in that department. Observing these qualifications, it is easy to mathematically express the condition that the demand for capital goods from the second department match the demand for consumption goods from the first department:

(5)

Or:

(6)

Focus on the left-hand side of Equation 6. Is it apparent that the rate of growth in expanded reproduction in this model is the product of the capitalists' saving propensity and the rate of profit? In other words, the rate of profit along a warranted growth path is the quotient of the rate of growth and the saving propensity of the capitalists. So this model points to a Post Keynesian theory of distribution.

5.0 Conclusion
In the model, capitalists independently decide on what department to enter, and how much to produce in that department. A collective result of those decisions is the total output of each department. For those decisions to be validated, the value of consumer goods demanded by workers and capitalists in the department producing capital goods must match the value of capital goods demanded by the capitalists in the department producing consumption goods.

The model is silent on how such an equality can come about. Supply and demand seems like an inadequate answer to me.

References

• Richard M. Goodwin (1949). "The Multiplier as Matrix", Economic Journal, V. 59, N. 236 (Dec.): 537-555
• M. Kalecki (1969). Theory of Economic Dynamics: An Essay on Cyclical and Long-Run Changes in Capitalist Economy, Second Edition, Augustus M. Kelly
• Rosa Luxemburg (1951). The Accumulation of Capital (Trans. by Agnes Schwarzschild), Yale University Press
• Karl Marx (1956). Capital, Volume 2, Progress Publishers
• Luigi L. Pasinetti (1981). Structural Change and Economic Growth: A Theoretical Essay on the Dynamics of the Wealth of Nations, Cambridge University Press
• Luigi L. Pasinetti (1993). Structural Economic Dynamics: A Theory of the Economic Consequences of Human Learning, Cambridge University Press
• Joan Robinson (1962). Essays in the Theory of Economic Growth, Macmillan
• Shigeto Tsuru (1942). "On Reproduction Schemes", Appendix A in Paul Sweezy's The Theory of Capitalist Development, Monthly Review Press [This reference I haven't read]

Judge Friedman's Advice To Pinochet Yourself

Naomi Klein makes available Milton Friedman's 21 April 1975 letter to mass murderer Augusto Pinochet.

Microeconomics Required By Implementation Of Federal Law

President Bush's Executive Order 13422, dated 18 January 2007, further amends President Clinton's EO 12866, of 4 October 1993. These EOs are part of a family of EOs. This family defines a process for performing and reviewing cost-benefit analyses before any Federal agency promulgates any new regulations. As I understand it, President Reagan set up the Office of Information and Regulatory Affairs (OIRA), within the Office of Management and Budget (OMB), to review and approve these analyses. Here's an excerpt from the amended EO:

Section 1. Statement of Regulatory Philosophy and Principles.

(b) The Principles of Regulation.

(1) Each agency shall identify in writing the specific market failure (such as externalities, market power, lack of information) or other specific problem that it intends to address (including, where applicable, the failures of public institutions) that warrant new agency action, as well as assess the significance of that problem, to enable assessment of whether any new regulation is warranted.