Foreign Trade In Capital And Consumer Goods

Figure 1: Specialization In A Single Country

1.0 Introduction

This post considers how the firms in a small open economy will specialize, given prices on international markets and the domestic rate of profits. The example would only be interesting as part of a larger argument, which I have not yet worked out.

2.0 Technology

Consider a small, open economy which has a flow-input, point-output technology for producing two consumption goods, corn and linen. Corn is manufactured from inputs of direct labor and steel. Steel and linen are each manufactured from inputs of direct, unassisted labor. Table 1 shows an input-output table for the technology. The technology is thus specified by three coefficients of production, (l_{1, C, n}, l_{2, C, n}, and l_{1, L, n}).

Table 1: Example Technology

Input	Industry
	Steel	Corn	Linen
Labor	l2, C, n Person-Yrs	l1, C, n Person-Yrs	l1, L, n Person-Yrs
Steel	0	1 Ton	0
Linen	0	0	0
Corn	0	0	0
Output	1 Ton	1 Bushel	1 Square-Yd

Comparative advantage when the rates of profits is zero in each country is determined by relative ratios of labor embodied in each commodity. The labor value of steel is:

v_{S, n} = l_{2, C, n}

The labor value of corn is the sum of the labor embodied in steel used in producing corn and the direct labor used in producing corn:

v_{C, n} = l_{1, C, n} + l_{2, C, n}

The labor value of linen is:

v_{L, n} = l_{1, L, n}

For a technology in which dated labor inputs extend for a larger number of time periods, finding labor values can require the calculation of sums with a greater number of terms.

3.0 Autarky

In this section, I assume foreign trade is not possible for the country being analyzed.

Let p_{C, n}, p_{L, n}, and p_{S, n} be the domestic prices of corn, linen, and steel when no foreign trade is possible. Let w_n be the wage paid for a person-year of labor, and let r_n be the rate of profits. Assume labor is advanced and wages are paid out of the surplus at the end of the year.

Under these assumptions, prices, with labor-commanded as the numeraire, are:

p_{S, n}/w_n = l_{2, C, n} = v_{S, n}

p_{C, n}/w_n = v_{C, n} + l_{2, C, n} r_n

p_{L, n}/w_n = l_{1, L, n} = v_{L, n}

4.0 Trade in Consumer Goods

Now suppose foreign trade is possible in consumer goods, but not in capital goods. In terms of the example, the firm can trade in corn and linen, but not in steel. Let P_C and P_L be international prices of corn and linen, respectively.

Two patterns of complete specialization are possible. Suppose the firms in the country want to produce linen (and the required steel), but not corn. Linen is sold on international markets, and corn is purchased. For firms to be unwilling to produce corn, the cost of producing a unit of corn, at the going rate of profits, must exceed the given international price:

[l_{2, C, n}( 1 + r_n) + l_{1, C, n}] w_n > P_C

In a steady state, the cost of producing linen must be equal to its price:

l_{1, L, n} w_n = P_L

Solving for the wage and substituting, one obtains the following inequality.

P_L/P_C > l_{1, L, n}/(v_{C, n} + l_{2, C, n} r_n)

Or:

P_L/P_C > p_{L, n}/p_{C, n}

For domestic firms to want to specialize in producing corn, the above inequality is reversed. In words, the country specializes in producing those goods whose international prices exceed autarkic prices.

5.0 Trade in Capital and Consumer Goods

In this section, I assume that the country can trade steel on international markets, as well as corn and linen.

Suppose the country specializes in producing linen. The following inequalities and equalities must be satisfied in a steady state:

l_{2, C, n} w_n > P_S

P_S ( 1 + r_n) + l_{1, C, n} w_n > P_C

l_{1, L, n} w_n = P_L

Following my usual practice of solving for wages and substituting, I obtain two inequalities:

P_L > (l_{1, L, n}/l_{2, C, n}) P_S

P_L > (l_{1, L, n}/l_{1, C, n})[P_C - P_S ( 1 + r_n)]

When the country specializes in corn, the system of inequalities and equalities is modified in a way that I hope is obvious. As above, two conditions characterize prices on international markets. The same is true for when the country specializes in the production of steel. For the country to specialize in linen, it is necessary but not sufficient that the country would have specialized in linen in trade in steel were impossible. This is not so for specialization in corn. For some combinations of international prices, the country will specialize in corn even when the country would not have so specialized when trade in capital goods was not possible. Likewise, a set of prices exists in which the country specializes in steel when the country would have specialized in corn without the possibility of trade in steel.

6.0 Conclusion

Figure 1, at the head of this post summarizes the analysis. The upward-sloping line extending from the origin divides regions of specialization under the assumption that foreign markets exist for consumer goods, but not for capital goods. When the international prices of corn and linen are in the region above this line, the country specializes in producing linen. When they are in the region below this line, the country specializes in producing corn.

With the possibility of international trade in steel, additional regions appear. If prices of linen and corn are low enough, for a given price of steel, they fall in the rectangle at the lower left in the figure. The country specializes in steel. All of each year's output of steel is sold in foreign trade, and linen and corn are bought with the revenues thereby obtained. A wedge appears in the upper right. If prices are in this region, the country does not specialize in producing linen. It becomes more cost-effective to produce corn, with inputs of steel purchased on international markets.

Can A Nazi Be Rational?

Hilary Putnam has long argued that facts and values, or ends and means, cannot be neatly separated. In 1981 he proposed a thought experiment, I assume not to be of contemporary political relevance:

What troubled us earlier was that we did not see how to argue that the hypothetical 'perfectly rational Nazi' had irrational ends. Perhaps the problem is this: that we identified too simply the question of the rationality of the Nazi (as someone who has a world view or views) with the rationality of the Nazi's ends. If there is no end 'in' the Nazi to which we can appeal, then it does seem odd to diagnose the situation by saying 'Karl has irrational goals.' Even if this is part of what we conclude in the end, surely the first thing we to say is that Karl has monstrous goals, not that he has irrational ones.

But the question to look at, if we are going to discuss Karl's rationality at all, is the irrationality of his beliefs and arguments, not his goals.

Suppose, first, that Karl claims Nazi goals are morally right and good (as Nazis, if fact if not in philosophers' examples, generally did). Then, in fact, he will talk rubbish. He will assert all kinds of false 'factual' propositions, e.g., that the democracies are run by a 'Jewish conspiracy'; and he will advance propositions (e.g. that, if one is an 'Aryan', one has a duty to subjugate non-Aryan races to the 'master race') for which he has no good arguments. The notion of a 'good argument' I am appealing to is internal to ordinary moral discourse; but that is the appropriate notion, if the Nazi tries to justify himself within ordinary moral discourse.

Suppose, on the other hand, that the Nazi repudiates ordinary moral notions altogether... I argued that a culture which repudiated ordinary moral notions, or substituted notions derived from a different ideology and moral outlook for them, would lose the ability to describe ordinary interpersonal relations, social events and political events adequately and perspicuously by our present lights. Of course, if the different ideology and moral outlook are superior to our present moral system then this substitution may be good and wise; but if the different ideology and moral outlook are bad, especially if they are warped and monstrous, then the result will be simply an inadequate, unperspicuous, repulsive representation of interpersonal and social facts. Of course, 'inadequate, unperspicuous, repulsive' reflect value judgments; but I have argued that the choice of a conceptual scheme necessarily reflects value judgments, and the choice of a conceptual scheme is what cognitive rationality is all about.

Even if the individual Nazi does not lose the ability to use our present moral descriptive vocabulary, even if he retains the old notions somewhere in head (as some scholars, perhaps, still are familiar with and able to use the medieval notion of 'chivalry'), still these (our present moral descriptive notions such as 'considerate', 'compassionate', 'just', 'fair') will not be notions that he employs in living his life: they will not really figure in his construction of the world.

Again, I wish to emphasize that I am not saying that what is bad about being a Nazi is that it leads one to have warped and irrational beliefs. What is bad about being a Nazi is what it leads you to do. The Nazi is evil and he also has an irrational view of the world. These two facts about the Nazi are connected and interrelated; but that does not mean the Nazi is evil primarily because he has an irrational view of the world in the sense that the irrationality of his world view constitutes the evil. Nevertheless, there is a sense in which we may speak of goals being rational or irrational here, it seems to me: goals which are such that, if one accepts them and pursues them one will be either be led to offer crazy and false arguments for them (if one accepts the task of justifying them within our normal conceptual scheme), or else one will be led to adopt an alternative scheme for representing ordinary moral-descriptive facts (e.g. that someone is compassionate) which is irrational, have a right to be called 'irrational goals'. There is a connection, after all, between employing a rational conceptual scheme in describing and perceiving morally relevant facts and having certain general types of goals as opposed to others.

Hilary Putnam (1981). , Cambridge University Press, pp. 211-214.

But this a thought experiment that takes an obvious consensus for granted. Fascism is bad.

Neo-Ricardianism: A Marxist Insult

Today is the 200th birthday of Karl Marx.

My favorite school of thought in economics is sometimes called Neo-Ricardianism, instead of Sraffianism. As I understand it, the label "Neo-Ricardianism" was invented in 1974, as an insult, by Bob Rowthorn. Basically, he claimed to more closely follow Marx, and claimed that the Neo-Ricardians were, like neoclassicals, bourgeois economists. Other Marxist economists at the time offered arguments along the same lines. Franklin Roosevelt III, for example, did not use the label "Neo-Ricardian", but rather described Sraffians as in the grip of commodity fetishism.

(This Roosevelt is the grandson of FDR, the United States president. According to Wikipedia, he is a Du Pont on his mother's side, and therefore a descendant of the famous physiocrat. I've also recently read one in the series of Elliot Roosevelt's mystery novels, in which his mother Eleanor is the detective.)

One aspect of the Marxist argument against Sraffians harkens back to J. S. Mill. The claim is that, in Mill, production is taken as a matter of natural law, while distribution is a matter of social laws that can be freely changed, if we collectively decide so, perhaps through government. According to Marxists, production and distribution cannot be separated like that. You can see why this might be described as commodity fetishism, in which social relations are taken as natural relations.

This argument also provides a context for understanding some chapters in Steedman (1977). Sraffa, for some purposes - e.g., internal criticism of neoclassical economics - takes quantity relations as given, while considering what prices would be if some distributive variable were at a different level. But, Steedman argues, that, in principle, one can relax what is taken as given. The length of the working day or the intensity with which laborers work might be varied in the analysis. This is not just a matter of, say, increasing all inputs in a production process by some proportion. You would want to consider how fuel, oil, or other elements of working capital vary with output, how output varies with concrete production processes, and whether or not these variations have an impact of the efficiency on machinery of various ages. I suppose I ought to also mention Steedman's polemics, especially his labeling of some anti-Sraffa Marxists as "obscurantists".

Of course, many arguments have been developed on both sides over the nearly half-century since these charges and counter-charges were first offered. Does Sraffa provide a constructive alternative, as well as an internal criticism of neoclassical economics? Do Sraffian interpretations of classical economics hold up as history? How do issues of money enter? Is Sraffian economics confined to logical - not historical - time? How do market prices relate to prices of production? And what does this all have to do with Marx?

Another famous adoption of "Neo-Ricardism" as an insulting label for Sraffianism comes shortly later from Frank Hahn, who was no Marxist.

References

• Frank Hahn (1982). The Neo-Ricardians, Cambridge Journal of Economics, V. 6, iss. 4: 353-374.
• Frank Roosevelt (1975). Cambridge economics as commodity fetishism. Review of Radical Political Economics, V. 7, no. 4. (Reprinted in Growth, Profits, and Property: Essays in the revival of political economy, (ed. by E. J. Nell) Cambridge University Press, 1980.)
• Bob Rowthorn (1974). Neo-Classicism, Neo-Ricardianism, and Marxism. New Left Review
• Ian Steedman (1981, first edition 1977). Marx After Sraffa, Verso.

How Has Economics Failed?

The Financial Times is having a debate about whether economics has failed. The first interchange is here, with some followups here. (I happen to have two tabs about neoliberalism open at the moment as well.)

Mainstream economics is a failure in so many dimensions that its failure cannot be characterized shortly in any comprehensive way. For example, I am not going to discuss funding sources and economics role as a system justification. Even so, you might find this post long and wandering.

As you can see, I do not take the claim to be that non-mainstream, heterodox economics has failed. In the comment section, for one FT page, Percy Pavilion writes, "So Marshall, Keynes, Kahn, Kaldor and Harcourt failed did they?" I think any opinion on whether Keynes, Kahn, Kaldor, and Harcourt were failures to be irrelevant to the topic. Was it Joan Robinson, commenting on the claim that it is all in Marshall, said something like, "The problem is that the opposite is also in Marshall, too"?

Anyways, I want to focus on the failure of economic theory. I think any well-trained economist in some field knows how to tweak assumptions to get any results that they want. Start with a model of perfect competition. Add an information asymmetry, a transaction cost, a search cost, sticky prices and a Calvo fairy, some monopoly or monopsony, whatever. Then you can argue that some policy will lead back to efficient markets. Or, if so inclined, that government failure prevents any some implementation.

Given this openness to such tweaks in mainstream economics, why is Sraffian economics or some other variety of heterodox economics not more widely accepted? Most of the time, when I or others put forward a model with Sraffa effects, we are not arguing about the implications of an imperfection. Rather, the argument is that the model of perfect competition does not work the way that mainstream economists teach. And this is usually in an open model with no way to resolve class interests in some utopian world. To understand such models, it is helpful to have some understanding of the history of political economy and alternative theories of value and distribution. As Mariana Mazzucato notes at the FT, mainstream economists are trained to be ignorant of such topics.

What to make of empirical research? Some of it, say, on malarial nets, is by researchers striving to be useful. One can raise questions about external validity and whether atheoretical research is possible or desirable. But this is a different direction from my comments above.

But how does the theory relate to the supposed empirical turn? Are textbooks updated to state that some theories (e.g., skills-biased technical change) have been rejected by the evidence? Can you point to an introductory textbook that includes a section on behavioral economics and empirical evidence? (I expect "Yes" to be an answer to this question.) But how many experiments decide between contrasting theories? It is my feeling that the ability to tweak a theory includes an ability to maintain it as consistent with any empirical evidence that shows up. And much empirical work takes a particular approach for granted, without testing it. I like reading Marshall Steinbaum, but will cite him as somebody that does not realize how many effects he takes as a consequence of monopsony might be consistent with Sraffian price theory, before adding in failures of competition.

I am unsure how to take a lot of applied research. I do not think tariffs on steel and aluminum should be imposed on the whim of an ignoramus. I suppose one can use Leontief matrices to trace through the effects of such tariffs on the automotive industry, aluminum cans and the beverage industry, etc. And I suppose that one can apply game theory after the fact to rationalize, say, the Chinese reaction. But can one say beforehand whether soy bean farmers in the mid west or Boeing executives trying to sell Dreamliners should have more to worry about? And is not the question of the long term effects of undermining the World Trade Organization more a qualitative question for historians that data-driven economists? I want to take analysis of the possible effects of the exhaustion of North Sea oil reserves on sustainable social spending in Norway as useful. But I suspect that if I look carefully, I will find theoretical errors embedded in many of the equations in supposedly applied research.

I am amused that Maurice Obstfeld shows up in the FT interchanges, when I have just demonstrated the failure of what Krugman and Obstfeld teach in one edition of their textbook on international trade. I am aware that the boundary between mainstream and non-mainstream economic theory is not necessarily well-defined. Nevertheless, I do not expect most mainstream economists to be able to conduct a reasonable conversation about the topics in this post. At the FT, Diane Coyle, Tony Yates, and Tim Harford exemplify my expectation. And much of what I am saying is old hat. You can see some of what I am saying as echoing Christian Arnsperger and Yanis Varoufakis. Or even Robert Solow.