From: rob@KAMAN.COM (Rob Vienneau)
Newsgroups: sci.econ
Subject: Free Trade and Keynesianism
Date: 21 Aug 92 00:55:36 GMT
Article-I.D.: lenny.9208210055.AA11397

1.0 Question

Can any professional economist reading this do the following:

1. Summarize the Machlup-Metzler foreign trade multiplier theory

2. Summarize its current standing

3. Tell us whether or not it can be used to analyze the likely effects
   on employment of one country lowering a tariff on imported goods

4. If so, does it imply the level of unemployment in that country
   increases under certain circumstances?

2.0 My Understanding

To start, I'll summarize my understanding of the problem it addresses.

2.1 Simplified Keynesianism

The theory is an application of hydraulic Keynesianism. First,
consider a single country with no government and no foreign trade.
The recipients of the total income generated in a given period of
time, say a year, either spend it on consumer goods or save it. Thus,
national income is the sum of consumption and savings. Income is
generated by the production of either consumption goods or capital
goods (goods that will either be sold in a later period of time
(inventories) or used in the production of goods.) Thus, national
income is also the sum of consumption and investment.

So in any period of time, savings and investment are equal. In any
time period, individuals may not save what they planned at the
beginning of the time period because their income may be different
than expected. Likewise, and more importantly, actual and planned
investment may be unequal because of unintended accumulation of
inventories due to poor sales or because of unforeseen fluctuations in
the value of capital goods. One method of defining short run
equilibrium is that planned quantities are equal to actual quantities.
Keynes believed the economy was always tending towards a short run
equilibrium where planned savings equals planned investment.

What brings about this equality? Assume consumption is an increasing
function of income and that investment is given based on expectations
and certain monetary conditions. Then the level of national income must
move to bring about this equality. Thus, this theory determines the
level of national income and, assuming a short run correlation between
employment and income, the level of employment (or unemployment).

Now assume the economy is in an equilibrium situation, but suddenly
consumers decide to save a greater proportion of income. Asssume
producers do not revise their expectations and that the monetary
system is such that investment is unchanged. So at the given level of
what was formerly an equilibrium income, savings exceeds investments.
Producers find their sales are dropping. They cut back on production
of consumption goods until a lower level of income is reached where
the planned savings out of this income matches the given level of
investment. (The level of income is lower because the proportion of
income saved was assumed to be higher.)

Thus, a desire to increase savings results in an increase in
unemployment, at least in this theory. You can also show, in this
theory, that increased investment results in a higher level of income
and employment.

2.2 Introducing Foreign Trade

Now consider a single country with no government engaged in trade.
National income, when viewed from the side of spending, is now the sum
of consumption, savings, and imports. Likewise, from the viewpoint of
the production generating the income, national income is the sum of
consumption, investment, and exports. Imports, like savings, functions
as a "leakage" that, when increased, lowers national income. Exports,
like investments, consists of an infusion of purchasing power that
increases income.

Suppose this country lowers a tariff on consumer goods. How is the
equilibrium level of income affected? The argument is the same as the
above analysis of savings. Consumers now buy a greater quantity of
imports, for any level of income. Presumably this increased demand for
imports will be at the expense of consumption. Looking at the country
internally, no reason exists to assume exports or investments will
increase. Thus, the lowering of tariff barriers will likely result in
a recession with increased levels of unemployment.

2.3 Many Countries

This argument has at least one defect. Suppose only two countries
exist: Solovia and the A.S.U. Suppose Solovia was the country that
lowered its tariffs, increased its imports, and plunged into
recession. From the viewpoint of the A.S.U., Solovia's imports are
A.S.U.'s exports. Thus, the lowering of Solovia's tariffs increases
the demand and the national income in the A.S.U. Presumably this
increased income will be accompanied by increased demand for A.S.U.
imports from Solovia. Once again, what the A.S.U. calls "imports,"
Solovia calls exports.  Increased Solovian exports are like increases
in investments; they raise the level of national income. Thus, here's
a counter-recessionary influence.

What ultimately happens to Solovian employment with lowered tariff
barriers? How about if these leakages and influxes related to imports
and exports are generated by a pattern of trade among n countries?
Words fail, and one needs to resort to math. I know that Richard
Goodwin, an economist in whom I'm interested, treated this problem by
regarding the multiplier as a matrix. But, a priori, I see no reason
not to assume that the result of one country lowering its tariffs will
sometimes result in increased unemployment in that country.

                                   Robert Vienneau
                                   rob@kaman.com