Knowledge that Transforms

HE quantity of money in economic modT els traditionally has been assumed (by Keynes, as well as others) to be an exogenously determined variable controlled uniquely by the monetary authorities. Traditional theory argues that, in a fractional reserve system, money supply is a constant multiple of the reserve bank's monetary liabilities which are controlled via the conventional instruments open market operations, changes in the required reserves ratio, and variations in the discount rate.' A current survey of monetary theory and policy states that the theory of money supply is virtually an unexplored area of monetary research.2 The contemporary theoretical and empirical controversies arising around the role of financial intermediaries reflect an awakening interest in money; and several recently completed studies of the money supply in developed economies provide further proof of this new interest.3 This study is intended to further knowledge of the process by which the supply of money is determined, but unlike previous studies it concerns money in a developing economy.

In this article we study the variations in capitallabor ratios among states for manufacturing industries and the role of price-induced substitution as a factor influencing the observed variations. In the first part, differences in output composition within industries are ignored. In the second part, these differences are considered and we are able to suggest whether the observed substitution is achieved through an appropriate selection of output mix, or through pure substitution, that is, substitution of factors given the same output mix.

M Y working view of the balance of payments, a reasonably commonplace one, places it on three levels. At the bottom and most basic for policy is the net balance of goods and services. This yielded a surplus of $3.8 billions in 1960, $5.4 billions in 1961 and $4.8 billions in 1962, the result of a merchandise surplus of roughly the same size and a (net) investment income which had reached $3.3 billions in 1962. Against this were military expenses (amounting to $3.1 billions in 1962), net travel outlays (amounting to about a billion in 1962) and a variety of other payments and remittances including United States Government grants of nearly $2 billions. Preliminary figures for 1963 show an improvement in the net balance of about a billion dollars, the result of further increases in investment income, a modestly larger increase in exports than in imports and a slight decline in military spending.' At the next level are the long-term private capital outflows ($2.8 billions net in 1962) and government loans (amounting net to $1.5 billions in 1962). This outflow creates a corresponding claim by Americans on overseas resources and portends a possible later improvement in the payments balance as the result of interest, dividends and repatriated earnings. These items were evidently about the same in total in 1963 as 1962. But this was as the result of a sharp curtailment of private capital outflow in the second half of the year following a very large increase in the first half. Long-term outflows are continuing at a low level as this is written in early 1964. In 1962 all the foregoing transactions the so-called basic balance involved a deficit of $2.1 billions. There has been a deficit in this account in every year since 1947. At its highest in 1959 it amounted to $4.7 billions.2 In late 1963 and early 1964, the movement in this deficit was sharply down. The third level is ultimately derivative from the foregoing. Dollar claims accumulate as the result of the foregoing commercial transactions and capital movements. They can be held in the form of dollar deposits or converted into foreign currencies or gold. In the main they have been held in dollars and thus the large accumulation of current dollar claims in recent years -from around $7 billions in 1950 to some $25 billions at present. But some $7 billions has been converted to gold and removed from the monetary gold stock in the last six years. This has been the most visible and publicized aspect of the balance of payments problem and also the one that is most purely a consequence, rather than a cause, of changes at the other levels. Few public problems can ever have been so ingeniously contrived to maximize difficulty as that of the balance of payments. There has continued to be a question as to whether there is a problem. There has been a puzzling choice between real and spurious solutions. And each of the real solutions has been protected by a stout framework of vested ideological and economic interest reinforced, in some cases, by distinctly non-secular conviction. The sources of difficulty may be dealt with under the following heads: (1) The question as to whether there is a problem; 'In the last three years, apart from secondary discussions and memoranda, I have been concerned with the balance of payments problem on two major occasions. In 1961, during the first weeks of the new administration, I had general coordinating responsibility for the special message which was transmitted to the Congress in February, 1961. On my return from India in the summer of 1963, I was asked by President Kennedy to review the problem and report. This paper draws on this experience. But, as will be evident from the context, it does not reflect accepted policy and cannot be read as any indication thereof. Moreover it was, in some measure, my task in 1963 to consider ultimately rather than presently necessary action. 2 Data from Statistical Supplement to Survey of Current Business (1963), and Survey of Current Business (June, 1963), as used in The United States Balance of Payments in 1968, The Brookings Institution (Washington, D.C., 1963). Appendix Tables for 1963 from Economic Report of the President.

T a given rate of growth in the general A level of personal income, which kind of expenditure will increase its share and which will decrease and, further, what will be the extent of these changes? requirement for this kind of knowledge has increased in recent years in relation to the theory of economic development as well as for purposes of short-run projection. Prior to the latter half of the 1940's, it had been thought that the above questions might be readily answered by the straightforword application of the generalized Engel's Law. Professors Allen and Bowley I gave the theoretical explanation with a specified form of preference function which was found to be consistent with the empirical cross-section regressions. Thus, it was suggested that if we could assume the invariability of the consumers' preferences both among income groups and over time, it would be possible to predict the consumption of various categories of goods and services and future savings, given income and prices and with the knowledge of the numerical values of the preference parameters. This line of approach had been tried from the time of Professors I. Fisher and R. Frisch.2 It is well known, however, that the validity of the analogy between the cross-section and the time series came to be doubted with the discovery of the long-run stability of the savings ratio in the aggregate time series by Professor Kuznets. Several new theories of consumption appeared with the common target of explaining with a unified theory all of these three kinds of empirical observations: the long-run time series, the short-run time series, and the cross-sectional relations. About ten years ago, the present authors began to try to estimate the consumers' preference functions in a numerical form, making use of continuous time series of the family budget data which were available, at that time, for interwar years in Japan. We undertook this task partly because of pure curiosity and partly because of the practical desire to improve the analysis of index-number problems,3 as well as to make predictions on the simultaneous determination of family expenditures. Starting from the classical model of Professors Allen, Bowley, and A. Wald,4 and after making some tentative computations, we came to see the necessity of introducing some shift elements into the structural equations which were used. First, we tried to adopt Professor Tobin's 5 liquid asset hypothesis in a generalized form which took not only the liquid assets, but also the asset holdings for every individual category of family expenditure into account. results of the empirical tests, however, did not show a logical consistency with our interpretation of Tobin's hypothesis. This forced us to examine the applicability of Professor Duesenberry's theory of interdependent preferences.6 * work on this paper was done as part of the Keio Economic Research Project financially supported by the Institute of Industry & Labor Studies, Keio University. final, considerably revised, version was prepared at Professor W. W. Leontief's Research Seminar during Tsujimura's stay at Harvard as a Fulbright Research Scholar, 1961 to 1962. We are also heavily indebted to Professors J. S. Duesenberry and H. S. Houthakker for valuable suggestions. They, of course, are not responsible for any remaining errors. 'R. G. D. Allen and A. L. Bowley, Family Expenditure: A Study of Its Variation (London, 1935), especially appendix. 2 Ragnar Frisch, New Methods of Measuring Marginal Utility (Tubingen, 1932). It is interesting to see that Frisch's analogy of the spring balance on the dynamic feature of consumer's taste appears to be very close to our present specification of Duesenberry's theory of habit formation. 'H. S. Houthakker, The Influence of Prices and Incomes on Household Expenditures, Bulletin of the International Statistical Institute (Bruxelles, 1960); W. W. Leontief, Composite Commodities and the Problem of Index Numbers, Econometrica, iv (1936); and P. A. Samuelson, Foundations of Economic Analysis (Harvard, 1945). 'A. Wald, The Approximate Determination of Indifference Surfaces by Means of Engel Curves, Econometrica, viii (April 1940). 'James Tobin, Relative Income, Absolute Income, and in, Money Trade, and Economic Growth (Macmillan: New York, 1951). 6 J. S. Duesenberry, Income, Saving, and the Theory of Consumer Behavior (Harvard, 1949).

Soviet spokesmen have claimed repeatedly that the USSR is an ideal market for primaryproduct exports of underdeveloped countries. The markets of leading western industrial countries, on the other hand, are said by the Soviets to be extremely unsatisfactory due to the chaos and stagnation allegedly inherent in the capitalist system. The purpose of this paper is to assess the validity of these Soviet claims by comparing the relative performance of the USSR and leading western industrial countries as markets for primary products in the period 1955 to 1961. The method used is one which tests whether Soviet primary product imports were larger, more rapidly growing, and more stable than western imports. This comparison is based entirely on available official foreign trade statistics of each country.

Harry G. Johnson, The International Competitive Position of the United States and the Balance of Payments Prospect for 1968, The Review of Economics and Statistics, Vol. 46, No. 1 (Feb., 1964), pp. 14-32

H OUSING demand is a major factor in determining national income via private residential capital formation. Moreover, it fluctuates so widely, in many cases independently, in comparison with the demand for other consumer goods that it has been the focus of considerable attention on the part of economists. Yet there are markedly different opinions about the basic relationship of housing demand to changes in income or prices. As early as 1857, Engel made the first classic study of the relationship of family expenditures to income based on budget data; among other things, the percentages of housing to total expenditure were roughly estimated for three different socioeconomic groups. Later, Wright interpreted these estimates to mean that housing expenditure for lodging or rent takes a constant percentage of income at all levels of income. This is known as one of Engel's laws of consumption. However, Schwabe in 1868 presented empirical evidence that the percentage of income spent on rent falls as income rises.1 On the other hand, Marshall in his theoretical analysis, viewed housing as a means of obtaining social distinction as well as shelter, and said that where the condition of society is healthy, and there is no check to general prosperity, there seems always to be an elastic demand for house room, on account of both the real conveniences and the social distinction which it affords. 2 With these views Marshall seems to distinguish himself from his predecessors by stating that the demand for housing is rather elastic with respect to income. In recent years further controversy based on various empirical evidences has arisen. These dissimilar findings have led to radically different implications for important issues in the field of housing such as residential capital formation and the incidence of property taxes. Morton arrived at an income elasticity of demand of around 0.6 for the value of a house purchased, using cross-section data. Combining his estimate with the view that the property tax rate is constant over the different levels of property value, Morton concluded that the property tax was regressive.3 Winnick similarly derived an income elasticity of demand for the value of a house purchased of about 0.5, and noted a downward trend in per capita residential housing stock since 1900 (observed by Grebler, Blank, and Winnick) when real income was rising. Combining these with the assumption of a low price elasticity for housing, Winnick concluded that there had been a downward shift in consumer preferences for residential capital formation since around 1900. Recently Muth presented an intensive study 6 of stock demand elasticities for housing in which he rejected Morton's conclusion, stating that the income elasticity of demand for housing is about unity; i.e., more elastic than what Morton estimated. The price elasticity for housing stock estimated by Muth also exceeded unity, differing substantially from Winnick's contention. In view of high elasticities with respect to both income and price Muth cast doubt on

T HROUGH the wide range of Professor Harris' contributions to economics -in his writing, his teaching, his creative role as an editor, and his participation in governmentone characteristic stands dominant among the many. He has injected the vitality of fresh inquiry into every pursuit to which his lively interests have led him. His two most recent careers, at the Treasury and in California, continue to offer the scope and the challenge which he has met with such incredible versatility through the Harvard years. And it is in the spirit of one who has learned much from him not only in trying to find answers but also in formulating questions -that I would like to add a few more questions to the many that he has posed, and the many he has answered, on the processes of payments adjustment. How many of us have, I wonder, been taunted by some of these same questions as we puzzled along our separate ways toward a reconciliation between text and teacher in those ever-changing, ever-lasting Haberler-Harris courses on international trade? And how few of us, at least among my own pre-war vintage, could have thought that the major uses we would find for all of this would be in attempting to find acceptable norms for avoiding the anarchy of unimpeded freedom, rather than for resisting the strangulation of autarky. The leading countries of the non-communist world are now all learning again to live with convertible currencies for current account, and some for capital account, transactions. Most have for more than a decade been committed to an orderly codification of procedures for limiting the constraints that individual countries place upon the flows of goods from one to another. But the vast area that is still left without systematic and comprehensive attention from governments, and for which there is as yet no satisfactory theoretical formulation to use as a starting point under today's conditions, is that of long-term capital movements. Much has evolved, to be sure, concerning short-term capital movements. An alert sensitivity is developing -aided by the increasingly close and frequent consultations among governments and central banks that the jet age now permits -to the sometimes delicate inter-relations between flows of short-term funds and the effectiveness of monetary policy in any country. As a result, a very thorough reappraisal has been set off, in nearly every one of the leading countries, examining the potentialities for a changing mix among monetary, fiscal, and incomes policies potentialities that take account of the requirements of external as well as internal balance. Both in government policy and in underlying economic theory, however, long-term capital flows continue to be the object mainly of improvised rationalization for whatever has been going on. Apart from various efforts to multilateralize development aid, there has not as yet been a sustained effort to work toward a consensus on the role of movements of longterm capital in the adjustment process. There has been interest, primarily among some of the international organizations, in working toward a codification of procedures. But that does not go to the fundamental need for a reconsideration of the influence that movements of long-term capital may be able to exert as a balancing force. That need has now become compelling in a convertible world of gradually freer trade, where general commitments to high employment, continuing growth, price stability, and fixed exchange rates effectively rule out other patterns of adjustment that were familiar in the textbooks, if not always in the practices, of earlier years. Regardless of their merit, these postwar commitments are, in fact, constraints on the ready correction of surpluses or deficits in the overall external accounts of the various leading countries. Indeed, it is very largely on this account that a plausible case has been made for the likelihood that periods of imbalance may