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 statement 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 politique economique ig 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 Listien 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 justified 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 displace 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 ultra-protectionist. 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.