Knowledge that Transforms

E CONOMIC theory can be regarded as consisting of a number of models designed to explain economic phenomena and to yield predictions for the future. Any choice among alternative models should be based on their explanatory valuea model (or hypothesis) can be regarded as superior to another if it better explains actual phenomena and it is more helpful in predicting future events. theory of international trade abounds in theoretical models, some of them complementary, others conflicting. Alternative approaches towards explaining the causes of international specialization are followed, for example, by classical economists on the one hand, and by Heckscher and Ohlin on the other. While the hypothesis advanced by the former presupposes the existence of inter-country differences in production functions, the latter assume identical production functions and qualitatively identical factors of production in the trading countries and attribute international specialization to differences in factor endowments. empirical testing of the Heckscher-Ohlin hypothesis by Leontief led to inconclusive results, and the interpretations and explanations given to the Leontief paradox have demonstrated that the assumptions of this model require modification.' In the present paper, we will not attempt to test the Heckscher-Ohlin hypothesis, but will rather inquire into the validity of the classical model. According to the original formulation of the classical theory, comparative advantage based on relative productivity differentials determines international specialization. It has subsequently been realized that inter-country differences in the wage structure and in the capital-labor ratios of various industries may compensate for productivity differentials; a country possessing a relative productivity advantage in a particular industry may still import the commodity in question if it paid relatively higher wages and/or had higher capital costs per unit of output in that industry.2 Still, the defenders of classical theory among others, Taussig expressed the opinion that the latter factors are not sufficiently important to warrant significant changes in the trade pattern as determined by relative differences in productivity.3 Let us adopt the following notation: C= unit cost A = labor input per unit of output W wage rate T ratio of capital plus labor costs to labor costs Subscripts I and II refer to country I and country II, respectively. Capital letters refer to commodity X, small letters to commodity Y. modified classical hypothesis can now be written: If A, a, < , (I) All all it is likely also that CI CI , , (2) CIw CIl when the latter exDress'ion is equivalent to * This paper was prepared during the tenure of a research grant from the Economic Growth Center at Yale University in the summer of ig6i. author wishes to express his appreciation to Marnie Mueller who has cheerfully borne the burden of data collecting and computations and also made helpful comments on an earlier version of the paper. Further thanks are due to Michael Lovell for valuable suggestions and criticism. 1 W. W. Leontief, Domestic Production and Foreign Trade: American Capital Position Re-examined, Economia Internazionale, (February 1954), 9-38; Proportions and the Structure of American Trade: Further Theoretical and Empirical Analysis, this REVIEW, XXXVIII (November I956), 386-407. Also, P. T. Ellsworth, The Structure of American Foreign Trade: A New View Examined, this REVIEW, XXXVI (August I954), 279-285; Stefan Valavanis-Vail, Leontief's Scarce Factor Paradox, Journal of Political Economy, LXII (December I954), 523-528; N. S. Buchanan, Lines on the Leontief Paradox, Economia Internazionale (November I955), 79I-794; and the discussion in the supplement to the February I958 issue of this REVIEW, by Stefan Valavanis-Vail, Romney Robinson, G. A. Elliott, Beatrice Vaccara, and W. W. Leontief, III-I22. 2 For references, see Jacob Viner, Studies in the Theory of International Trade (New York, I937), 493-5I2. 'F. W. Taussig, International Trade (New York, I927), 43-68.

MECHANISM Si commodity, with each market in turn described by (a) supply conditions, (b) demand conditions, and (c) clearing of market or equilibrium conditions, of which one is redundant (Wairas' law).The main advantage of the general equilibrium framework is that it insures a systematic and, at least initially, symmetrical treatment of all markets.'For the commodity market, the demand conditions are described by equations (i) to (i); the supply conditions by (4b) and the clearing conditions by (7).In the labor market the supply is given by ( 6), to be reviewed more closely below; the demand by ( 5); and market clearing by (8).The remaining two markets are described under the next heading, 2.2. Explicit treatment of the bond market and

PpT HE subject assigned for this session covers too broad an area to be given even fairly cursory treatment in single paper. Accordingly, we have chosen to concentrate on the part of it that relates to in fluctuations. We shall still further narrow the scope of the paper by interpreting monetary factors to mean the role of the stock of money and of changes in the stock thereby casting the market as one of the supporting players rather than star performer and by interpreting economic fluctuations to mean business cycles, or even more exactly, the reference cycles studied and chronicled by the National Bureau. The topic so interpreted has been rather out of fashion for the past few decades. Before the Great Depression, it was widely accepted that the business cycle was phenomenon, a dance of the dollar, as Irving Fisher graphically described it in the title of famous article.' Different versions of theories of the business cycle abounded, though some of these were really theories misnamed, since they gave little role to changes in the money stock except as an incident in the alteration of credit conditions; and there was nothing like agreement on the details of any one theory. Yet it is probably true that most economists gave the money stock and changes in it an important, if not central, role in whatever particular theory of the cycle they were inclined to accept. That emphasis was greatly strengthened by the course of events in the twenties. The high degree of stability then achieved was widely regarded as consequence of the effectiveness of the policies followed by the only recently created Federal Reserve System and hence as evidence that were indeed central factor in the cycle. The Great Depression radically changed attitudes. The failure of the Federal Reserve System to stem the depression was widely interpreted-wrongly as we have elsewhere argued 2 and elaborate below to mean that were not critical, that real were the key to fluctuations. Investment which had always had prominent place in business cycle theories received new emphasis as result of the Keynesian revolution, so much so that Paul Samuelson, in the best selling textbook in the country, could assert confidently, All modern economists are agreed that the important factor in causing income and employment to fluctuate is investment. 3 Investment was the motive force, its effects spread through time and amplified by the multiplier, and itself partly or largely result of the accelerator. Money, if it entered at all, played purely passive role. Recently, revival of interest in money has been sparked less by concern with business cycles than with concern about inflation. Easy money policies were accompanied by inflation; and inflation was nowhere stemmed without more or less deliberate limitation of growth of the money stock. But once interest was aroused, it naturally extended to the cycle as well as to inflation. In the United States, indeed, there has been something of repetition of the I920's. A high degree of stability has been accompanied by large measure of talk about an active policy, and the authorities have often been given credit for playing an important role in promoting stability. As the experience of the twenties suggests, this fair-weather source of support for the importance of money is weak reed. Examining the present state of our understanding about the role of money in the business cycle, we shall first present some facts that seem reasonably well established about the cyclical behavior of money and related

Journal Article Hire-Purchase Equilibria: Some Transition Theorems Get access F. R. Oliver F. R. Oliver Exeter Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 30, Issue 2, June 1963, Pages 131–140, https://doi.org/10.2307/2295811 Published: 01 June 1963

Journal Article A Stochastic Income Model Using Optimal Inventory Rules Get access Daniel Orr Daniel Orr Chicago Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 30, Issue 2, June 1963, Pages 84–92, https://doi.org/10.2307/2295805 Published: 01 June 1963

Journal Article The Adjustment of Savings to Investment in a Growing Economy Get access J. E. Meade J. E. Meade Cambridge Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 30, Issue 3, October 1963, Pages 151–166, https://doi.org/10.2307/2296315 Published: 01 October 1963

Journal Article Business Saving and Normal Income Get access Tony Lancaster Tony Lancaster Cambridge Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 30, Issue 3, October 1963, Pages 203–216, https://doi.org/10.2307/2296321 Published: 01 October 1963

Journal Article A Measure of Capital Get access Graham Pyatt Graham Pyatt Cambridge Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 30, Issue 3, October 1963, Pages 195–202, https://doi.org/10.2307/2296320 Published: 01 October 1963

Journal Article Scarcity of Specific Resources as a Limit to Output Get access Ashok Guha Ashok Guha Cambridge, Mass. Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 30, Issue 1, February 1963, Pages 37–42, https://doi.org/10.2307/2296029 Published: 01 February 1963