In defending the twin assumptions that commodities can move freely among countries but primary factors are completely immobile internationally, trade theorists generally point out that without the factor-immobility assumption the distinction between international trade theory and domestic production and exchange theory disappears.' However, since the regional pattern of trade as well as the geographic distribution of productive factors becomes indeterminate when it is assumed that both goods and factors are perfectly mobile within a country, domestic production and exchange theorists usually assume all economic activity takes place at one point in space. Consequently, factor movements and their interrelationships with commodity flows have not been analyzed within the mainstreams of either international trade theory or domestic production and exchange theory. Instead, the subject has become a subsidiary topic of economic theorystudied mainly by location theorists, by economic historians, and, more recently, by economists interested in development theory. The leading trade economist who has tried to change the typical practice of separating the treatment of commodity and factor flows is, of course, Bertil Ohlin.2 As he states in the Preface, a major purpose of his treatise is: To analyze the domestic and international movements of factors of production, and particularly their relation to commodity movements.3 Although Ohlin's work is rich in insights on this subject, the general impact of his work has, ironically, been to reinforce the traditional approach of trade writers. For although Ohlin stressed that labor and capital are neither completely mobile or immobile internationally, he in effect assumed in his simplified trade model that knowledge was completely mobile and, therefore, that production functions were everywhere the same.4 It then remained for Samuelson to show that, by adding a few seemingly reasonable assumptions, factor prices become equalized through trade.5 Despite Samuelson's warning that the actual disparity in factor prices among countries meant that these assumptions were not so innocuous after all, the factor-price equalization model has tended to become the cornerstone of international trade theory. And, since the same world production possibilities are attainable in this model with commodity trade alone as with commodity plus factor trade, the tradition of ignoring factor movements has been further justified. Recent events, especially in connection with the operations of international firms, have, however, made it increasingly inappropriate to ignore the interrelations between output and input flows. Trade economists could in the past partly justify their position on the grounds that different decision-making units were usually involved in commodity and factor flows and that in the nineteenth century a large share of factor flows were directed at the production of noninternationally traded services, e.g., canal and railway services, or of commodities effectively unavailable in the developed countries, e.g., tropical products and certain minerals. But, today we frequently observe the phenomenon of an international firm weighing the alternatives of producing a particular commodity in one country and then shipping it to the market of another country or transferring technology and productive factors to this latter country and manufacturing the product there. The possibility of various patterns of trade in intermediate inputs makes the set of feasible alternatives facing the international firm even more complex. In order to understand better the nature of current international commodity and factor flows and to be able to deal more adequately with the policy issues they raise, we should return to Ohlin's broad vision of studying these flows simultaneously. It is also important that we consider the institutional form that these flows take. Fortu1 See, for example, G. Haberler, The Theory of Trade (London: William Hodge, 1936), pp. 4-5. 2 Bertil Ohlin, Interregional and Tr-ade (Harvard Univ. Press, 1952). 3 Op. cit., p. viii. 4 0p. cit., p. 557. ' Paul A. Samuelson, International Trade and Equalization of Factor Prices, Econ. J., June, 1948.

This paper presents a theoretical basis for the argument that large exchange rate shocks—such as the 1980s dollar cycle—may have persistent effects on trade flows and the equilibrium exchange rate itself. We begin with a partial-equilibrium model in which large exchange rate fluctuations lead to entry or exit decisions that are not reversed when the currency returns to its previous level. Then we develop a simple model of the feedback from hysteresis in trade to the exchange rate itself. Here we see that a large capital inflow, which leads to an initial appreciation, can result in a persistent reduction in the exchange rate consistent with trade balance.

Productive factors such as human and phyaical capital are accumulated and trade can affect the steady-state levels of such factors. Consequently, trade liberalization will have dynamic effects on output and welfare as the economy moves to its new steady state, in addition to its usual static effects. The output impact of this dynamic effect is measurable and appears to be quite large. The welfare impact of this dynamic effect is also measurable. The size of this dynamic gain from trade depends on the importance of external scale economies.