International Supply and Demand
( Originally Published Early 1900's )
THE operations of international supply and demand are governed by the same general principles with those which govern home supply and demand. The differences between the productive capacities of different countries are of the same general nature as between different iron or coal mines. There are, however, certain modifications in the application of these principles of which the following is the one chiefly to be considered. In domestic trade and manufacture laborers can pass from one establishment to another, and capital can pass from one employment to another, with comparative freedom. The various machine-shops and railways compete with each other in the price they offer for goods and the wages they offer to their employés. We may thus imagine a certain level or equilibrium between the different employments in a country. Any disturbance of this equilibrium will very soon be corrected. Thus each country, considered separately, will enjoy this equilibrium within its own limits.
But it does not follow that the equilibrium will hold between different countries. There is no competition between a farm-hand in China and one in the United States, and therefore no tendency to an equality of wages between them.
Let us now suppose a number of countries in each of which an industrial organization of its own has grown up, but which have never had any communication with each other. To make this supposed case merge as nearly as possible into the real one, we shall suppose that these different countries all use the same kind of money; which money, for simplicity, we may call gold. Then there will be in each country a certain scale of prices for all the commodities it produces; and this scale will be determined in each case by the laws of equilibrium between supply and demand which have already been laid down. Suppose now that some two of these countries discover each other, and that free communication is opened up between them. Of course absolutely free communication is not practicable, because labor is required to transport goods across the ocean or other intervening region. For the sake of simplicity, however, we may first suppose transportation to cost nothing. To begin with an extreme case, let it be found that the prices in gold of all commodities in one country are higher than in the other. The country of higher prices will then begin by making all its purchases from the cheaper country, paying for them in gold. The result will be a scarcity of gold in the one country and a plenty in the other. This will result in a fall of prices in the one and a rise in the other, until the two scales are brought into approximation.
Of course the general inequality of prices which we have just supposed is something which never exists under our present arrangements; because, as a matter of fact, communication between countries has always been more or less free, and thus no general inequality between the scale of prices in different countries has ever had a chance to exist. In other words, the equilibrium to which, in the state of things which we have sup-posed, the prices would ultimately attain is that to which they really do approximate, so far at least as concerns those goods which pass between the two countries.
The question now is where the excess of purchases by the dearer country would stop. We suppose that everybody in each country buys where he can get his goods the cheapest. So long as this mode of buying results in a greater value of goods being conveyed from A to B than is conveyed in the reverse direction, so long will gold to pay for them continue to flow out of B into A, and so long will prices continue to fall in B and to rise in A. This rise and fall will stop as soon as equal values are transported in each direction between the two countries.
Relative Advantages of Different Countries in Production. If, when an equilibrium is reached, the price of each individual commodity is the same in the two countries, all trade between them will cease, because there will be no inducement to transport goods from one to the other. The prices will be equal unless one country has a relative advantage over the other in the production of special commodities. An example of what is meant by relative advantage is this : If in each country the cost of producing ten yards of cotton is the same as that of producing one bushel of wheat, then, no matter what that cost is, neither country will have any advantage in the relative production of wheat and cotton. It may cost twice as much to produce both the wheat and the cotton in one country that it does in the other, but in this case the advantage is an absolute and not a relative one. If it costs just twice as much labor to produce each separate commodity in one country that it did in the other, there would be no relative advantage between any two commodities, and therefore, in the case supposed, no trade between the countries. Wages of all kinds would be twice as high in the more favored country, but this would not lead to any trade or competition. There would be, indeed, an inducement to emigrate from the less favored country to the other, which tendency would, however, execute itself with comparative slowness, owing to the indisposition on the part of men to change their country. We have therefore, in our present discussion, nothing to do with the general advantage of one country over another in production, but only with its relative advantage in producing one commodity rather than another.
From what has been said we see that this relative advantage would, in the case of free trade between the two countries, be indicated not only by the relative prices of different commodities, but by their actual prices. If wheat is cheaper in America than in England, it shows that we have a relative advantage in producing wheat over producing the common run of commodities which are transported between the two countries ; while if iron is cheaper in England, it shows that England has a relative advantage in the production of iron. But this fact gives us no clue to the rate of wages in the two countries, which may differ to any extent without impairing the equilibrium of prices. The exchanges between the two countries show that America has a relative advantage over England in the production of bread-stuffs, pork, cattle, cotton, leather, tobacco, and some dairy pro-ducts. England has a relative advantage in the production of spool-thread, woollen goods, and a great variety of manufactures of small articles in common household and family use. The result is a continual flow of the former in one direction over the ocean, and of the latter in the other direction.
Balance of Trade by Foreign Exchange. In a former chapter it was shown how international trade is balanced by the use of foreign exchange on the part of bankers (II. 95). If the value of our imports from England exceeds that of our exports to that country, there will be, as already shown, a demand in the New York market for exchange on London in excess of the supply. In accordance with the common law of supply and demand, the New York bankers will then raise the price of exchange on London. The question now arises to what limit the price may rise. The answer is that the limit is determined by the fact that the New York debtor has always the privilege of making payment by sending coin across the Atlantic. If then the premium charged by the bank is in excess of the cost of freight and insurance, coin or bullion will be exported. The ratio between the amounts of metal in the English pound and the American gold dollar are such that the bullion value of the former is $4.86 65. It is found by experience that when the New York bankers charge a higher price than $4.90 for exchange on London our merchants begin to export bullion. Perhaps at a rate one cent above this, all payments would be made in bullion and no foreign exchange would be bought. The gold will flow out in payment until the fall in prices consequent upon the outflow stimulates the exportation of other commodities than gold, and then the balance will be restored.
Suppose, on the other hand, that our exports are in excess of our imports. Then the merchants in New York who possess credits in London will exceed those who owe debts there. Thus the supply of foreign exchange by the former will exceed the demands of the latter, and the bankers will find exchange on London accumulating on their hands. In accordance with the law of supply and demand, they will lower the price in order to stimulate demand and discourage the supply. The limit will, however, be reached on the same principle as in the opposite case. Whenever the price offered by the banker falls so low that it will pay the New York creditor better to ask his London debtor to send coin across the Atlantic than it will to sell the debt, then coin will begin to come. This limit of price ranges from $4.83 to $4.84. If the excess of imports continues, the inflow of coin will result in an increased volume of currency on this side of the Atlantic, which will lead to a rise in prices and thus stimulate importations from abroad.
Of course the flow of gold from England will tend to make prices low there and thus stimulate exports to America. Thus the foreign exchanges both of gold and commodities always tend towards an equilibrium which, however, is continually being disturbed through the action of changing economic causes in each country. For a few weeks or months there will be an excess of imports, followed by a corresponding demand for foreign exchange or for gold to send abroad, while at other times the state of things is the opposite.
The one condition which is always to be fulfilled to produce equilibrium is that equal values shall pass in the two directions. It does not follow either that equal weights or equal numbers of different kinds of commodities shall pass. One country may have a great advantage in the production of a single commodity and no more. If wheat is the commodity which we can produce to the greatest relative advantage, and if the quantity which we can produce is sufficient to buy our whole supply of those foreign commodities in the production of which other nations have a relative advantage, then we should export nothing but wheat. The people of Switzerland, by a system of training extending through many generations, have acquired a great advantage in the manufacture of watches. The result is that little except watches is exported from that country in exchange for many kinds of products imported.
Tax and Cost of Transportation. In the preceding discussion we have supposed transportation to cost nothing, and trade to be perfectly free. We have now to inquire how our conclusions must be modified when we allow for the cost of transportation and for the duties which have to be paid on imports. As a result of this cause the relative prices of commodities will always be higher in the country to which they are exported, and as a consequence equal values according to the scale of prices in each country cannot pass. If, for example, the imports into New York should equal the exports in value, then it is certain that those imports are worth less when they leave England than when they are landed in New York. And because the exports are worth more when they reach England,' it follows that, as measured in England, the value of the imports would be in excess. How then is the equilibrium to be defined?
To answer this question, let us suppose that both exports and imports are carried in foreign ships to and from the port of New York. Then in order that the accounts of the New York merchants with other foreign correspondents may be accurately balanced, it is necessary that the value of the goods as received from the ship shall equal the value of those ex-ported, at the price paid in New York by the London purchaser of the exports. Let us call this equal quantity P. Then when this value P of exports reaches London it will be valued at a higher price, the addition being represented by all the cost of transportation, insurance, and interest on capital. If this cost be D, the value delivered in London will be P + D. If the cost of sending the goods back from London in payment be H, then it is only necessary to send the value P — H from London in order to make the value P in New York. Thus as measured in London the value of the imports will exceed that of the exports by D + H. This quantity D + H will represent the total cost to the English shipper of carrying the goods in both directions, including all profits upon the transaction. If the cost of transportation were entirely incurred by the New York dealers, the result would be that to balance the account the exports and imports should be equal as valued in England, while the imports would be in excess as valued in New York. It is therefore practically impossible to strike a mathematically exact balance in the case. In theory, however, the balance is obtained by subtracting from the price of the imports the sums paid by the importer for the cost of transportation, and adding to the cost of exports whatever he pays towards transporting them. Modifying the sides of the account in this way, the exports and imports should balance on both sides, provided no gold is to be transported in either direction.
We thus reach a very simple theorem concerning the balance of foreign trade. Since the excess of imports into each country must be paid for in coin, it follows that if we include the value of the coin or bullion paid with that of the exports, and if we include coin and bullion among the imports, then the sum total of imports and exports must in the long-run balance each other. This qualification "in the long-run" is important, because there is no necessity that the balance should be struck every day or every month, or even every year. A nation may go on for some time increasing its debts abroad simply by the home merchants deferring payment. Thus there is always a fluctuating mass of indebtedness from the merchants of one country to those of another which may sometimes go on increasing for years. As a general rule, however, this indebtedness does not increase indefinitely, but is being paid off from time to time. If it has grown in one year, it probably will diminish in the year following.
Of course the supply and demand for foreign exchange corresponds to the payment of indebtedness on the two sides, and not to its being incurred. That is to say, a New York importer does not demand foreign exchange when he becomes indebted to his London correspondent, but when he has to pay that indebtedness.
Although the preceding theory is exact when we make all due modifications in its application, yet the student must be warned against supposing that any official statement of the total values of imports and exports will accurately represent the theory. The precise value of goods is always indefinite, and becomes necessarily greater with every step the goods take towards their destination. A bale of cotton is worth more on hoard a ship in Charleston harbor than it was on the wharf. And a bale of broadcloth, when brought to New York, is worth more after being landed on the wharf than while it was in the ship. The prices of goods also fluctuate from day to day, and it would be impossible to formulate any system which would be exact from an economical point of view, without an examination of every merchant's ledger to find what all his imports actually cost him in every way. For this reason statistical tables of the values of imports and exports are not to be regarded as mathematically exact, but only as rude approximations to the actual values.
In the case of gold and silver bullion, however, the numbers may be regarded as sufficiently exact for all practical purposes, and they afford the best test of the actual balance of trade. If during a series of years we find that more gold is exported from any country than is imported, we may conclude that there is a corresponding excess to the home value of imports of other goods, and vice versa. But even in this case the completeness of the tables is always open to challenge. Coin and bullion may be imported by passengers arriving from abroad without being reported to the authorities, and the principles of economics may settle the question of the balance of trade better than statistics.
Total Balance of Trade with all Countries. Hitherto we have considered interchange between two countries only. But it does not at all follow that the value of our imports from any one country must equal that of the goods which we return to it. During the year 1883-4, for example, our imports from Brazil were 50 millions of dollars, while our exports to Brazil were only 9 millions. Our trade with France, Austria, and the East Indies and many other countries shows an excess of the same kind. On the other hand, our imports from Great Britain were 163 millions, and our exports to that country were 386 millions. This, however, forms no exception to the rule when we extend the latter to include sums total. Our total imports from all countries were valued at 668 millions, and our total exports at 740 millions. This difference is partly to be attributed to the defects of the official system of valuation, partly to the indebtedness incurred by foreigners to our merchants, and partly to the profits gained by the latter through the ex-change. The inequalities in the relations of the different countries are accounted for by England paying Brazil and France for what they export from those countries, and charging it against the value of what she receives from us. The case is exactly the same as between individuals. If A purchases from B, B from C, and C from A, and the values are equal, the commodities are paid for by simply cancelling the accounts without any money passing between the parties. The operation is, in principle, identical with the balancing of bank indebtedness at a clearing-house.
Theories and Nomenclature of the Balance of Trade. When it is found that the total value of the goods imported into a country exceeds the total value of those which it ex-ports in exchange, the balance of trade is said to be against that country. This form of expression may surprise the young economist, since it implies that a nation is more favorably situated the greater the value of the goods which it sends abroad and the less the value which it receives in payment.
It is a relic of the old "mercantile system" of two centuries ago, and is based on two principles then in vogue.
The first of these principles was that a nation was rich in proportion to the amount of gold and silver which it possessed. Accordingly, the policy of the leading mercantile countries was shaped by a constant effort to get as much of these metals as possible into the country, and to prevent them from leaving it. Since, as just shown, the metals would be received in payment for any excess of exports over imports, it was considered that an excess of exports encouraged the importation of money, while the opposite state of things implied its exportation.
The second principle was that a nation was impoverished in proportion to the amount of labor expended on any imported product by the foreign producer. For example, when it was found that a product which only cost an English manufacturer one day's labor could be sold in Portugal for two or three days' labor of a Portuguese, it was held that the exchange was disadvantageous to England. This principle combined its force with the other in leading governments to look unfavorably on an excess in the value of their imports.
At the present time the expression "favorable balance of trade" implies to those who use it an increasing indebtedness from foreign countries. It is not a good thing to be in debt, but it is supposed to be a good thing to have others indebted to us. Statesmen like to see our exports exceed our imports, because that seems to imply either that our indebtedness is being paid off, or that foreigners are running in debt to us. Since, however, this indebtedness is not public, but private, the parties can be safely left to take care of it for themselves.
In the long-run the relation of the export to the import of the precious metals to and from any country must depend on whether that country is a large producer of them. A considerable part of the annual gold-supply of the world comes from California and Australia. These countries may therefore in the long-run be supposed to export more gold than they import, because the supply tends to diffuse itself over the world in proportion to the needs of different countries.
Advantages of International Trade. The advantages of international trade are that the people of each country have a larger field from which to supply their wants than they would have were they to depend entirely upon their own resources. If all countries were alike in their productive capacities, no international trade would arise. The inequalities which give rise to trade are both natural and artificial. In trade, countries share these advantages with each other. For example, it is found that there are certain kinds of foreign wool which when mixed with American wool will make a far better cloth than the latter will make alone. By importing this wool we make our own more valuable. It is also found in metallurgy that there are certain foreign ores the addition of which to our own greatly facilitates the process of manufacture. Our metallurgists therefore seek for these foreign commodities. Nearly all the platinum of the world is found in or around the Ural Mountains. If it could not be exported, no other nation than Russia would have the use of it.
The principle is the same in the case of artificial powers or products. Our inventors have by peculiar skill and application brought the sewing-machine to great perfection. With-out foreign trade the advantage of the skill that they have acquired in making these instruments would be enjoyed only by ourselves. But by exporting these machines other nations share these benefits with us. Our cotton helps to clothe the whole world, and our breadstuffs to feed large portions of it. In return for this we get the benefit of any peculiar skill that may be acquired by the inhabitants of any other countries. The products of Chinese and Japanese art are found in many of our houses. The skill acquired by the English manufacturer of cloth is available to clothe us. The mere fact that a country is less rich in natural wealth than another may make its services available. No civilized country is so poor that it cannot in some way assist us in supplying our wants. As the poorest classes among us can perform menial services for us more advantageously than we can perform them for ourselves, so the inhabitants of countries less fortunately situated than our own are ready to supply us with many commodities more cheaply than we can afford to make them for ourselves. As some people are so wealthy as to command nearly everything they want without irksome labor, so we might imagine a country so rich in natural wealth as to have most of its wants requiring disagreeable labor supplied by its neighbors. In a word, the social organism does not comprise the people of one country alone, but of the whole civilized world, who are all engaged in supplying each other's wants.