Masters of International Trade

The Nobel Prize in Economics for 1977 was awarded to Bertil Ohlin and James Meade for their works on various aspects of international trade and cross-border capital movements. As the Nobel Prize website informs us, Ohlin developed a theory of modern international trade wherein he detailed factors that determine the pattern of international trade and the effects of trade on allocation of resources and income distribution. Ohlin's theory is detailed in his work 'Interregional and International Trade', which first came out in 1933. Meade's work included 'stabilisation' policies in open economies and can be found in his work 'The Theory of International Economic Policy', first published in 1951. Stabilisation policies are essentially those that are necessary to maintain external balance and internal balance i.e. balance in the domestic economy and international trade.

However, the importance of Ohlin's and Meade's works came to be realised only in the 1960s and the 1970s, when international trade became a tool for economic development for many developing countries in Asia (in particular, the 'gang of four' namely Hong Kong, Singapore, Taiwan and South Korea began using international trade as a tool of development). As the Nobel website notes:

The breadth and importance of Ohlin's and Meade's contributions have, however, not become obvious until the sixties and seventies, in conjunction with the growing internationalisation of the economic systems. It has become increasingly clear that problems related to the allocation of resources, business cycles, and the distribution of income are very much international problems. This means that foreign trade, international price fluctuations, the international allocation of economic activities and the transfer of resources, as well as the international payments system have become dominant factors in economic analysis and economic policy.

In this article, we will review the works of Ohlin and Meade and see how they are still important for economic and trade policy.

The Works of Bertil Ohlin

Ohlin completed his undergraduate studies at the University of Lund in Sweden in Mathematics, Statistics and Economics in 1917. He got his M.Sc. in 1919 from the Stockholm School of Economics and got another Masters in 1923 from Harvard University. He returned to the University of Stockholm and completed his Ph.D. in 1924. He joined University of Copenhagen as a Professor in 1925. In 1930, Ohlin moved to Stockholm School of Economics, where he succeeded Heckscher as Professor in Economics.

As noted above, his well-known work 'Interregional and International Trade' was published in 1933. In this work, Ohlin built on Heckscher's earlier work and proposed his theory of international trade. There is an interesting anecdote that Ohlin shares in his Nobel speech. At the suggestion of Cassel, who was Ohlin's colleague in Stockholm, he sent a brief version of his thesis to Professor Edgeworth, who was then the co-editor with Keynes for the 'Economic Journal'. It presented equation systems as a basis of an analysis of the causes and effects of international trade. When asked for his opinion, Keynes wrote on a piece of paper which followed the manuscript via Edgeworth back to me: "This amounts to nothing and should be refused. J.M. Keynes."

We may recall that before Ohlin proposed his work, the dominant paradigm in international trade was David Ricardo's theory of comparative advantage. As we know, Ricardo had modified the absolute advantage theory of Adam Smith. According to the absolute advantage theory, two trading partners can benefit from trade if they produce their respective goods at lower costs than their trading partner and then exchange them. Ricardo, on the other hand, argued that even if a country did not have absolute advantage in producing goods, it could still gain from trade because of comparative advantage. This essentially means that even if a country is less efficient than its trading partner in producing both goods (assuming that there are two countries and two goods), it could produce that good, in which it is relatively more efficient and exchange it for the other good. Ohlin went beyond Ricardo's theory and introduced factors of production in the model. Ohlin's work became the basis of the famous Heckscher-Ohlin model.

The Heckscher-Ohlin model is basically built on Ricardo's theory of comparative advantage and states that nations export products which use their cheap and abundant factors of production and import products that consume scarce factors. Hence, factors of production like capital and labour determine a nation's comparative advantage. To elaborate, in capital-abundant countries, wage rates tend to be high; therefore, labour-intensive products are more costly to produce internally. In contrast, capital-intensive products are less costly to produce internally. Countries with large amounts of capital will therefore export capital-intensive products and import labour-intensive products with the revenues earned from the exports. Labour-abundant countries will do the reverse. This also allows countries to specialise.

It may be recalled that Leontief had questioned the Heckscher-Ohlin model citing the example of the US. Even though the US is capital-abundant, it exported labour-intensive products and imported capital-intensive products.

The factor price equalisation theorem was a by-product of the Heckscher-Ohlin model. This theorem tells us that foreign trade tends to equalise the prices of the factors of production in different countries. In other words, trade in goods and services tends to have the same effects on the prices of the factors of production as if the factors themselves could move freely between countries. In this sense, trade in goods and services is a substitute for international mobility of the factors of production. Another inference from Ohlin's theory is that a tariff on a labour-intensive good affects the distribution of income in favour of labour in the importing country, while a tariff on a capital-intensive commodity results in an income redistribution in favour of the owner of capital.

Ohlin also had a political life. He became leader of the Liberal Party in 1944 and remained the party leader till 1967. From 1946 until his resignation from the leadership, the Liberal Party was the leading opposition party.

The Works of James Meade

Meade studied at the undergraduate level at Malvern College and at Oriel College, Oxford, where he earned first class honours in 1928. In 1930-31, he spent a postgraduate year at Trinity College, Cambridge, where he became involved in discussions of Keynes' 'Treatise on Money' that led to the development of Keynes's 'General Theory of Employment, Interest, and Money' (1936). He was the leading economist in the Labour Government (1946-47) and held chairs at the London School of Economics (1947-57) and at Cambridge (1957-68). He resigned as Professor in Cambridge because of differences with the faculty and became a senior research fellow at Christ's College,

Cambridge. He retired from here in 1974 and thereafter brought out four volumes on the domestic aspects of economic theory and policy namely: 'The Stationary Economy', 'The Growing Economy', 'The Controlled Economy', and 'The Just Economy'.

Meade is also known for his model of economic growth. According to the model, based on certain assumptions such as perfect competition and no government intervention, the output of an economy depends not only on the availability of factors of production but also technological progress.

However, Meade's best known work is on balance of payments and how various economic policies can be used to achieve a balance in the domestic economy and the external sector. This work is in the two volumes of his 'Theory of International Economic Policy', which is must-read for all trade theory students. In this work, Meade makes economic and trade policy prescriptions. In the first volume, 'The Balance of Payments', Meade reiterated Jan Tinbergen's point that each policy objective needs a single tool. According to Meade, full employment can be achieved by fiscal policy and balance of payments equilibrium by monetary policy. Meade also showed how, and in what circumstances, a country may simultaneously achieve balance, both in the domestic economy and its international payments (which he called internal and external balance). In other words, a country can resolve the conflict between full employment and balance of payments through a combination of several policy instruments. In the second volume, 'Trade and Welfare', he examines conditions under which trade makes a country better off. He later extended this work to institutional arrangements relevant for international trade such as customs unions, monetary unions and free trade areas. He also provided new ways of measuring the level of protection, and analysed the possibilities of comparing non-optimum situations with each other – which later came to be known as "the second best problem".

Meade also analysed the effect of interest rates and monetary policy on balance of payments. He also looked at the role of exchange rates in stabilisation policy.

Ohlin, Meade and applications in Public Policy

Ohlin made important policy suggestions and his work has continued relevance to public policy. We may recall that the Heckscher-Ohlin theory of comparative advantage was produced as an alternative to the Ricardian model and replaced the labour theory of value. It also incorporated the neo-classical price mechanism into international trade theory.

The H-O model has implications for the pattern of trade. As we saw above, the model suggests all-round benefits from international trade when each country puts the most effort into exporting products which intensively use domestically abundant resources. All countries benefit when they import the products intensive in resources they naturally lack. A corollary of this is that a nation does not have to rely solely on internal markets, and therefore, can take advantage of global elastic demand.

We also saw that the H-O model does not depend on total amounts of capital or labour, but on the ratio of the factors of production available. It is assumed that capital and labour are not available in the same proportion in the two countries. As a result of this, small countries can trade with large countries by specialising in production of products that use the factors which are more available than its trading partner. This leads to specialisation, which leads to gains from trade and welfare gains. The greater the difference between the two countries, the greater the gain from specialisation.

As noted above, Meade's major work on international trade is in the two volumes of his 'Theory of International Economic Policy', which is compulsory reading for all trade theory students. In this work, Meade makes economic and trade policy prescriptions. Meade suggested that although the ideal would be to eliminate all trade barriers, if for some reason this was not feasible, then some protectionism could improve the nation's economic well-being. This is also referred to as Meade's theory of second-best problem.

Meade's other public policy prescription was to minimise government intervention and in Friedman's mould, he also suggested that government regulation distorted efficient allocation of resources and led to an inferior outcome.

In response to the challenges of job losses in face of technological advancement, a question that we are confronted with even today in the face of Artificial Intelligence, Meade suggested that there should be lower wages and a high return on the machinery. This would mean a revolution in ownership and distribution of income, as our economy would no longer rely on wage rates as the main instrument to distribute wealth.

In respect of government budget-making, Meade suggested that the government needed to have a long period of considerable budget surplus, raised through taxes, to gradually build up national assets. These should be used to create dividends to be paid to workers to supplement their income. In effect, he suggested, one could design a society in which the wage rate is rather low but people's income isn't because they receive a social dividend and partial benefit from the profits that have been made on machine productivity.

Conclusion

The H-O model was a breakthrough in international trade theory because it connected comparative advantage with a country's availability of factors of production, and how these might change through time. The model has been challenged on the grounds of unrealistic assumptions (no unemployment, no place for firms or enterprises, identical countries except for difference in resource endowments,

identical production function etc). As a result, the model could not explain trade between developed countries and developing countries. Even so, it is still a useful framework to understand international trade. There are of course, alternative theories of international trade such as New Trade Theory, (which analyses individual enterprises and plants-in an international competitive situation), gravity model (trade flows are predicted by the size of trading partners and geographical distance between them) and Ricardo-Sraffa theory (which includes not only labour as a factor of production but also the intermediates and raw materials).

Meade's work on balance of payments and conclusion about internal and external equilibrium remains relevant even today. According to him, the macroeconomic system was an interconnected complex of internal and external equilibrium, with both existing concurrently. Internal equilibrium meant concurrent full employment and price stability (he did not view these two variables as two separate entities) and external equilibrium means balance of payments equilibrium. Meade was also concerned about two important issues of his time — unemployment and the war. Meade's efforts in this regard led him to write about the

partnership between labourers and capitalists that ensured their mutual welfare. In the real world, however, such a system does not yet exist. Meade's model of economic growth , which was basically a neoclassical model of steady state growth, was also criticised as too simplistic. From the early 1930s to his death in 1995, James Meade studied macroeconomics, including production, distribution, money, tax and benefits, the welfare state, and the economy's international dimensions. All through, he consistently pursued themes which were Keynesian in spirit — stimulate demand to reduce unemployment and the market as the efficient way to produce and distribute goods and services; the reduction of economic inequality; and later, the importance of individual freedom.

All in all, Ohlin and Meade made lasting contributions to international trade theory. Even though there are competing theories, their work remains relevant to public policy.

The writer is an IAS officer, working as Principal Resident Commissioner, Government of West Bengal. Views expressed are personal