# Principles of Political Economy (J.S. Mill, 1871), vol. 2/Book III, Chapter XVIII

This is the seventh edition of the Principles, which was first published 1848.
CHAPTER XVIII.
OF INTERNATIONAL VALUES.
§ 1.The values of commodities produced at the same place, or in places sufficiently adjacent for capital to move freely between them—let us say, for simplicity, of commodities produced in the same country—depend (temporary fluctuations apart) upon their cost of production. But the value of a commodity brought from a distant place, especially from a foreign country, does not depend on its cost of production in the place from whence it comes. On what, then, does it depend? The value of a thing in any place, depends on the cost of its acquisition in that place; which in the case of an imported article, means the cost of production of the thing which is exported to pay for it.
Since all trade is in reality barter, money being a mere instrument for exchanging things against one another, we will, for simplicity, begin by supposing the international trade to be in form, what it always is in reality, an actual trucking of one commodity against another. As far as we have hitherto proceeded, we have found all the laws of interchange to be essentially the same, whether money is used or not; money never governing, but always obeying, those general laws.
If, then, England imports wine from Spain, giving for every pipe of wine a bale of cloth, the exchange value of a pipe of wine in England will not depend upon what the production of the wine may have cost in Spain, but upon what the production of the cloth has cost in England. Though the wine may have cost in Spain the equivalent of only ten days' labour, yet, if the cloth costs in England twenty days' labour, the wine, when brought to England, will exchange for the produce of twenty days' English labour, plus the cost ​of carriage; including the usual profit on the importer's capital, during the time it is locked up, and withheld from other employment.
The value, then, in any country, of a foreign commodity, depends on the quantity of home produce which must be given to the foreign country in exchange for it. In other words, the values of foreign commodities depend on the terms of international exchange. What, then, do these depend upon? What is it, which, in the case supposed, causes a pipe of wine from Spain to be exchanged with England for exactly that quantity of cloth? We have seen that it is not their cost of production. If the cloth and the wine were both made in Spain, they would exchange at their cost of production in Spain; if they were both made in England, they would exchange at their cost of production in England: but all the cloth being made in England, and all the wine in Spain, they are in circumstances to which we have already determined that the law of cost of production is not applicable. We must accordingly, as we have done before in a similar embarrassment, fall back upon an antecedent law, that of supply and demand: and in this we shall again find the solution of our difficulty.
I have discussed this question in a separate Essay, already once referred to; and a quotation of part of the exposition then given, will be the best introduction to my present view of the subject. I must give notice that we are now in the region of the most complicated questions which political economy affords; that the subject is one which cannot possibly be made elementary; and that a more continuous effort of attention than has yet been required, will be necessary to follow the series of deductions. The thread, however, which we are about to take in hand, is in itself very simple and manageable; the only difficulty is in following it through the windings and entanglements of complex international transactions.
§ 2."When the trade is established between the two countries, the two commodities will exchange for each other at the same rate of interchange in both countries—bating the cost of carriage, of which, for the present, it will be more convenient to omit the consideration. Supposing, therefore, for the sake of argument, that the carriage of the commodities from one country to the other could be effected without labour and without cost, no sooner would the trade be opened than the value of the two commodities, estimated in each other, would come to a level in both countries.
"Suppose that 10 yards of broadcloth cost in England as much labour as 15 yards of linen, and in Germany as much as 20." In common with most of my predecessors, I find it advisable, in these intricate investigations, to give distinctness and fixity to the conception by numerical examples. These examples must sometimes, as in the present case, be purely supposititious. I should have preferred real ones; but all that is essential is, that the numbers should be such as admit of being easily followed through the subsequent combinations into which they enter.
This supposition then being made, it would be the interest of England to import linen from Germany, and of Germany to import cloth from England. "When each country produced both commodities for itself, 10 yards of cloth exchanged for 15 yards of linen in England, and for 20 in Germany. They will now exchange for the same number of yards of linen in both. For what number? If for 15 yards, England will be just as she was, and Germany will gain all. If for 20 yards, Germany will be as before, and England will derive the whole of the benefit. If for any number intermediate between 15 and 20, the advantage will be shared between the two countries. If, for example, 10 yards of cloth exchange for 18 of linen, England will gain an advantage of 3 yards on every 15, Germany will save 2 out of every 20. The problem is, what are the causes which determine the proportion in ​which the cloth of England and the linen of Germany will exchange for each other.
"As exchange value, in this case as in every other, is proverbially fluctuating, it does not matter what we suppose it to be when we begin: we shall soon see whether there be any fixed point about which it oscillates, which it has a tendency always to approach to, and to remain at. Let us suppose, then, that by the effect of what Adam Smith calls the higgling of the market, 10 yards of cloth in both countries, exchange for 17 yards of linen.
"The demand for a commodity, that is, the quantity of it which can find a purchaser, varies as we have before remarked, according to the price. In Germany the price of 10 yards of cloth is now 17 yards of linen, or whatever quantity of money is equivalent in Germany to 17 yards of linen. Now, that being the price, there is some particular number of yards of cloth, which will be in demand, or will find purchasers, at that price. There is some given quantity of cloth, more than which could not be disposed of at that price; less than which, at that price, would not fully satisfy the demand. Let us suppose this quantity to be 1000 times 10 yards.
"Let us now turn our attention to England. There, the price of 17 yards of linen is 10 yards of cloth, or whatever quantity of money is equivalent in England to 10 yards of cloth. There is some particular number of yards of linen which, at that price, will exactly satisfy the demand, and no more. Let us suppose that this number is 1000 times 17 yards.
"As 17 yards of linen are to 10 yards of cloth, so are 1000 times 17 yards to 1000 times 10 yards. At the existing exchange value, the linen which England requires will exactly pay for the quantity of cloth which, on the same terms of interchange, Germany requires. The demand on each side is precisely sufficient to carry off the supply on the other. The conditions required by the principle of demand and supply are fulfilled, and the two commodities will continue to be inter​changed, as we supposed them to be, in the ratio of 17 yards of linen for 10 yards of cloth.
"But our suppositions might have been different. Suppose that, at the assumed rate of interchange, England has been disposed to consume no greater quantity of linen than 800 times 17 yards: it is evident that, at the rate supposed, this would not have sufficed to pay for the 1000 times 10 yards of cloth which we have supposed Germany to require at the assumed value. Germany would be able to procure no more than 800 times 10 yards at that price. To procure the remaining 200, which she would have no means of doing but by bidding higher for them, she would offer more than 17 yards of linen in exchange for 10 yards of cloth: let us suppose her to offer 18. At this price, perhaps, England would be inclined to purchase a greater quantity of linen. She would consume, possibly, at that price, 900 times 18 yards. On the other hand, cloth having risen in price, the demand of Germany for it would probably have diminished. If, instead of 1000 times 10 yards, she is now contented with 900 times 10 yards, these will exactly pay for the 900 times 18 yards of linen which England is willing to take at the altered price: the demand on each side will again exactly suffice to take off the corresponding supply; and 10 yards for 18 will be the rate at which, in both countries, cloth will exchange for linen.
"The converse of all this would have happened, if, instead of 800 times 17 yards, we had supposed that England, at the rate of 10 for 17, would have taken 1200 times 17 yards of linen. In this case, it is England whose demand is not fully supplied; it is England who, by bidding for more linen, will alter the rate of interchange to her own disadvantage; and 10 yards of cloth will fall, in both countries, below the value of 17 yards of linen. By this fall of cloth, or what is the same thing, this rise of linen, the demand of Germany for cloth will increase, and the demand of England for linen will diminish, till the rate of interchange has so adjusted itself that ​the cloth and the linen will exactly pay for one another; and when once this point is attained, values will remain without further alteration.
"It may be considered, therefore, as established, that when two countries trade together in two commodities, the exchange value of these commodities relatively to each other will adjust itself to the inclinations and circumstances of the consumers on both sides, in such manner that the quantities required by each country, of the articles which it imports from its neighbour, shall be exactly sufficient to pay for one another. As the inclinations and circumstances of consumers cannot be reduced to any rule, so neither can the proportions in which the two commodities will be interchanged. We know that the limits within which the variation is confined, are the ratio between their costs of production in the one country, and the ratio between their costs of production in the other. Ten yards of cloth cannot exchange for more than 20 yards of linen, nor for less than 15. But they may exchange for any intermediate number. The ratios, therefore, in which the advantage of the trade may be divided between the two nations, are various. The circumstances on which the proportionate share of each country more remotely depends, admit only of a very general indication.
"It is even possible to conceive an extreme case, in which the whole of the advantage resulting from the interchange would be reaped by one party, the other country gaining nothing at all. There is no absurdity in the hypothesis that, of some given commodity, a certain quantity is all that is wanted at any price; and that, when that quantity is obtained, no fall in the exchange value would induce other consumers to come forward, or those who are already supplied, to take more. Let us suppose that this is the case in Germany with cloth. Before her trade with England commenced, when 10 yards of cloth cost her as much labour as 20 yards of linen, she nevertheless consumed as much cloth as she wanted under any circumstances, and, if she could ​obtain it at the rate of 10 yards of cloth for 15 of linen, she would not consume more. Let this fixed quantity be 1000 times 10 yards. At the rate, however, of 10 for 20, England would want more linen than would be equivalent to this quantity of cloth. She would, consequently, offer a higher value for linen; or, what is the same thing, she would offer her cloth at a cheaper rate. But, as by no lowering of the value could she prevail on Germany to take a greater quantity of cloth, there would be no limit to the rise of linen or fall of cloth, until the demand of England for linen was reduced by the rise of its value, to the quantity which 1000 times 10 yards of cloth would purchase. It might be, that to produce this diminution of the demand a less fall would not suffice than that which would make 10 yards of cloth exchange for 15 of linen. Germany would then gain the whole of the advantage, and England would be exactly as she was before the trade commenced. It would be for the interest, however, of Germany herself to keep her linen a little below the value at which it could be produced in England, in order to keep herself from being supplanted by the home producer. England, therefore, would always benefit in some degree by the existence of the trade, though it might be a very trifling one."
In this statement, I conceive, is contained the first elementary principle of International Values. I have, as is indispensable in such abstract and hypothetical cases, supposed the circumstances to be much less complex than they really are: in the first place, by suppressing the cost of carriage; next, by supposing that there are only two countries trading together; and lastly, that they trade only in two commodities. To render the exposition of the principle complete, it is necessary to restore the various circumstances thus temporarily left out to simplify the argument. Those who are accustomed to any kind of scientific investigation will probably see, without formal proof, that the introduction of these circumstances cannot alter the theory of the subject. ​Trade among any number of countries, and in any number of commodities, must take place on the same essential principles as trade between two countries and in two commodities. Introducing a greater number of agents precisely similar, cannot change the law of their action, no more than putting additional weights into the two scales of a balance alters the law of gravitation. It alters nothing but the numerical results. For more complete satisfaction, however, we will enter into the complex cases with the same particularity with which we have stated the simpler one.
§ 3.First, let us introduce the element of cost of carriage. The chief difference will then be, that the cloth and the linen will no longer exchange for each other at precisely the same rate in both countries. Linen, having to be carried to England, will be dearer there by its cost of carriage; and cloth will be dearer in Germany by the cost of carrying it from England. Linen, estimated in cloth, will be dearer in England than in Germany, by the cost of carriage of both articles: and so will cloth in Germany, estimated in linen. Suppose that the cost of carriage of each is equivalent to one yard of linen; and suppose that, if they could have been carried without cost, the terms of interchange would have been 10 yards of cloth for 17 of linen. It may seem at first that each country will pay its own cost of carriage; that is, the carriage of the article it imports; that in Germany 10 yards of cloth will exchange for 18 of linen, namely, the original 17, and 1 to cover the cost of carriage of the cloth; while in England, 10 yards of cloth will only purchase 10 of linen, 1 yard being deducted for the cost of carriage of the linen. This, however, cannot be affirmed with certainty; it will only be true, if the linen which the English consumers would take at the price of 10 for 16, exactly pays for the cloth which the German consumers would take at 10 for 18. The values, whatever they are, must establish this equilibrium. No absolute rule, therefore, can be laid down for the ​division of the cost, no more than for the division of the advantage: and it does not follow that in whatever ratio the one is divided, the other will be divided in the same. It is impossible to say, if the cost of carriage could be annihilated, whether the producing or the importing country would be most benefited. This would depend on the play of international demand.
Cost of carriage has one effect more. But for it, every commodity would (if trade be supposed free) be either regularly imported or regularly exported. A country would make nothing for itself which it did not also make for other countries. But in consequence of cost of carriage there are many things, especially bulky articles, which every, or almost every country produces within itself. After exporting the things in which it can employ itself most advantageously, and importing those in which it is under the greatest disadvantage, there are many lying between, of which the relative cost of production in that and in other countries differs so little, that the cost of carriage would absorb more than the whole saving in cost of production which would be obtained by importing one and exporting another. This is the case with numerous commodities of common consumption; including the coarser qualities of many articles of food and manufacture, of which the finer kinds are the subject of extensive international traffic.
§ 4.Let us now introduce a greater number of commodities than the two we have hitherto supposed. Let cloth and linen, however, be still the articles of which the comparative cost of production in England and in Germany differs the most; so that if they were confined to two commodities, these would be the two which it would be most their interest to exchange. We will now again omit cost of carriage, which, having been shown not to affect the essentials of the question, does but embarrass unnecessarily the statement of it. Let us suppose, then, that the demand of England for linen is either so much greater than that of Germany for cloth, or so ​much more extensible by cheapness, that if England had no commodity but cloth which Germany would take, the demand of England would force up the terms of interchange to 10 yards of cloth for only 16 of linen, so that England would gain only the difference between 15 and 16, Germany the difference between 16 and 20. But let us now suppose that England has also another commodity, say iron, which is in demand in Germany, and that the quantity of iron which is of equal value in England with 10 yards of cloth, (let us call this quantity a hundredweight) will, if produced in Germany, cost as much labour as 18 yards of linen, so that if offered by England for 17, it will undersell the German producer. In these circumstances, linen will not be forced up to the rate of 16 yards for 10 of cloth, but will stop, suppose at 17; for although, at that rate of interchange, Germany will not take enough cloth to pay for all the linen required by England, she will take iron for the remainder, and it is the same thing to England whether she gives a hundredweight of iron or 10 yards of cloth, both being made at the same cost. If we now superadd coals or cottons on the side of England, and wine, or corn, or timber, on the side of Germany, it will make no difference in the principle. The exports of each country must exactly pay for the imports; meaning now the aggregate exports and imports, not those of particular commodities taken singly. The produce of fifty days' English labour, whether in cloth, coals, iron, or any other exports, will exchange for the produce of forty, or fifty, or sixty days' German labour, in linen, wine, corn, or timber, according to the international demand. There is some proportion at which the demand of the two countries for each other's products will exactly correspond: so that the things supplied by England to Germany will be completely paid for, and no more, by those supplied by Germany to England. This accordingly will be the ratio in which the produce of English and the produce of German labour will exchange for one another.
​If, therefore, it be asked what country draws to itself the greatest share of the advantage of any trade it carries on, the answer is, the country for whose productions there is in other countries the greatest demand, and a demand the most susceptible of increase from additional cheapness. In so far as the productions of any country possess this property, the country obtains all foreign commodities at less cost. It gets its imports cheaper, the greater the intensity of the demand in foreign countries for its exports. It also gets its imports cheaper, the less the extent and intensity of its own demand for them. The market is cheapest to those whose demand is small. A country which desires few foreign productions, and only a limited quantity of them, while its own commodities are in great request in foreign countries, will obtain its limited imports at extremely small cost, that is, in exchange for the produce of a very small quantity of its labour and capital.
Lastly, having introduced more than the original two commodities into the hypothesis, let us also introduce more than the original two countries. After the demand of England for the linen of Germany has raised the rate of interchange to 10 yards of cloth for 16 of linen, suppose a trade opened between England and some other country which also exports linen. And let us suppose that if England had no trade but with this third country, the play of international demand would enable her to obtain from it, for 10 yards of cloth or its equivalent, 17 yards of linen. She evidently would not go on buying linen from Germany at the former rate: Germany would be undersold, and must consent to give 17 yards, like the other country. In this case, the circumstances of production and of demand in the third country are supposed to be in themselves more advantageous to England than the circumstances of Germany; but this supposition is not necessary: we might suppose that if the trade with Germany did not exist, England would be obliged to give to the other country the same advantageous terms which she gives to Germany; 10 yards of cloth for 16, or even less than ​16, of linen. Even so, the opening of the third country makes a great difference in favour of England. There is now a double market for English exports, while the demand of England for linen is only what it was before. This necessarily obtains for England more advantageous terms of interchange. The two countries, requiring much more of her produce than was required by either alone, must, in order to obtain it, force an increased demand for their exports, by offering them at a lower value.
It deserves notice, that this effect in favour of England from the opening of another market for her exports, will equally be produced even though the country from which the demand comes should have nothing to sell which England is willing to take. Suppose that the third country, though requiring cloth or iron from England, produces no linen, nor any other article which is in demand there. She however produces exportable articles, or she would have no means of paying for imports: her exports, though not suitable to the English consumer, can find a market somewhere. As we are only supposing three countries, we must assume her to find this market in Germany, and to pay for what she imports from England by orders on her German customers. Germany, therefore, besides having to pay for her own imports, now owes a debt to England on account of the third country, and the means for both purposes must be derived from her exportable produce. She must therefore tender that produce to England on terms sufficiently favourable to force a demand equivalent to this double debt. Everything will take place precisely as if the third country had bought German produce with her own goods, and offered that produce to England in exchange for hers. There is an increased demand for English goods, for which German goods have to furnish the payment; and this can only be done by forcing an increased demand for them in England, that is, by lowering their value. Thus an increase of demand for a country's exports in any foreign country, enables her to obtain more cheaply even ​those imports which she procures from other quarters. And conversely, an increase of her own demand for any foreign commodity compels her, cæteris paribus, to pay dearer for all foreign commodities.
The law which we have now illustrated, may be appropriately named, the Equation of International Demand. It may he concisely stated as follows. The produce of a country exchanges for the produce of other countries, at such values as are required in order that the whole of her exports may exactly pay for the whole of her imports. This law of International Values is but an extension of the more general law of Value, which we called the Equation of Supply and Demand. We have seen that the value of a commodity always so adjusts itself as to bring the demand to the exact level of the supply. But all trade, either between nations or individuals, is an interchange of commodities, in which the things that they respectively have to sell, constitute also their means of purchase: the supply brought by the one constitutes his demand for what is brought by the other. So that supply and demand are but another expression for reciprocal demand: and to say that value will adjust itself so as to equalize demand with supply, is in fact to say that it will adjust itself so as to equalize the demand on one side with the demand on the other.
§ 5.To trace the consequences of this law of International Values through their wide ramifications, would occupy more space than can be here devoted to such a purpose. But there is one of its applications which I will notice, as being in itself not unimportant, as bearing on the question which will occupy us in the next chapter, and especially as conducing to the more full and clear understanding of the law itself.
We have seen that the value at which a country purchases ​a foreign commodity, does not conform to the cost of production in the country from which the commodity comes. Suppose now a change in that cost of production; an improvement, for example, in the process of manufacture. Will the benefit of the improvement be fully participated in by other countries? Will the commodity be sold as much cheaper to foreigners, as it is produced cheaper at home? This question, and the considerations which must be entered into in order to resolve it, are well adapted to try the worth of the theory.
Let us first suppose, that the improvement is of a nature to create a new branch of export: to make foreigners resort to the country for a commodity which they had previously produced at home. On this supposition, the foreign demand for the productions of the country is increased; which necessarily alters the international values to its advantage, and to the disadvantage of foreign countries, who, therefore, though they participate in the benefit of the new product, must purchase that benefit by paying for all the other productions of the country at a dearer rate than before. How much dearer, will depend on the degree necessary for re-establishing, under these new conditions, the Equation of International Demand. These consequences follow in a very obvious manner from the law of international values, and I shall not occupy space in illustrating them, but shall pass to the more frequent case, of an improvement which does not create a new article of export, but lowers the cost of production of something which the country already exported.
It being advantageous, in discussions of this complicated nature, to employ definite numerical amounts, we shall return to our original example. Ten yards of cloth, if produced in Germany, would require the same amount of labour and capital as twenty yards of linen; but by the play of international demand, they can be obtained from England for seventeen. Suppose now, that by a mechanical improvement ​made in Germany, and not capable of being transferred to England, the same quantity of labour and capital which produced twenty yards of linen, is enabled to produce thirty. Linen falls one-third in value in the German market, as compared with other commodities produced in Germany. Will it also fall one-third as compared with English cloth, thus giving to England, in common with Germany, the full benefit of the improvement? Or (ought we not rather to say), since the cost to England of obtaining linen was not regulated by the cost to Germany of producing it, and since England, accordingly, did not get the entire benefit even of the twenty yards which Germany could have given for ten yards of cloth, but only obtained seventeen—why should she now obtain more, merely because this theoretical limit is removed ten degrees further off?
It is evident that in the outset, the improvement will lower the value of linen in Germany, in relation to all other commodities in the German market, including, among the rest, even the imported commodity, cloth. If 10 yards of cloth previously exchanged for 17 yards of linen, they will now exchange for half as much more, or 25½ yards. But whether they will continue to do so, will depend on the effect which this increased cheapness of linen produces on the international demand. The demand for linen in England could scarcely fail to be increased. But it might be increased either in proportion to the cheapness, or in a greater proportion than the cheapness, or in a less proportion.
If the demand was increased in the same proportion with the cheapness, England would take as many times 25½ yards of linen, as the number of times 17 yards which she took previously. She would expend in linen exactly as much of cloth, or of the equivalents of cloth, as much in short of the collective income of her people, as she did before. Germany on her part, would probably require, at that rate of interchange, the same quantity of cloth as before, because it would ​in reality cost her exactly as much; 251/2 yards of linen being now of the same value in her market, as 17 yards were before. In this case, therefore, 10 yards of cloth for 251/2 of linen is the rate of interchange which under these new conditions would restore the equation of international demand; and England would obtain linen one-third cheaper than before, being the same advantage as was obtained by Germany.
It might happen, however, that this great cheapening of linen would increase the demand for it in England in a greater ratio than the increase of cheapness; and that if she before wanted 1000 times 17 yards, she would now require more than 1000 times 251/2 yards to satisfy her demand. If so, the equation of international demand cannot establish itself at that rate of interchange; to pay for the linen England must offer cloth on more advantageous terms; say, for example, 10 yards for 21 of linen; so that England will not have the full benefit of the improvement in the production of linen, while Germany, in addition to that benefit, will also pay less for cloth. But again, it is possible that England might not desire to increase her consumption of linen in even so great a proportion as that of the increased cheapness; she might not desire so great a quantity as 1000 times 251/2 yards: and in that case Germany must force a demand, by offering more than 251/2 yards of linen for 10 of cloth; linen will be cheapened in England in a still greater degree than in Germany; while Germany will obtain cloth on more unfavourable terms; and at a higher exchange value than before.
After what has already been said, it is not necessary to particularize the manner in which these results might be modified by introducing into the hypothesis other countries and other commodities. There is a further circumstance by which they may also be modified. In the case supposed the consumers of Germany have had a part of their incomes set at liberty by the increased cheapness of linen, which they may indeed expend in increasing their consumption of that ​article, but which they may likewise expend in other articles, and among others, in cloth or other imported commodities. This would be an additional element in the international demand, and would modify more or less the terms of interchange.
Of the three possible varieties in the influence of cheapness on demand, which is the more probable—that the demand would be increased more than the cheapness, as much as the cheapness, or less than the cheapness? This depends on the nature of the particular commodity, and on the tastes of purchasers. When the commodity is one in general request, and the fall of its price brings it within reach of a much larger class of incomes than before, the demand is often increased in a greater ratio than the fall of price, and a larger sum of money is on the whole expended in the article. Such was the case with coffee, when its price was lowered by successive reductions of taxation; and such would probably be the case with sugar, wine, and a large class of commodities which, though not necessaries, are largely consumed, and in which many consumers indulge when the articles are cheap and economize when they are dear. But it more frequently happens that when a commodity falls in price, less money is spent in it than before: a greater quantity is consumed, but not so great a value. The consumer who saves money by the cheapness of the article, will be likely to expend part of the saving in increasing his consumption of other things: and unless the low price attracts a large class of new purchasers who were either not consumers of the article at all, or only in small quantity and occasionally, a less aggregate sum will be expended on it. Speaking generally, therefore, the third of our three cases is the most probable: and an improvement in an exportable article is likely to be as beneficial (if not more beneficial) to foreign countries, as to the country where the article is produced.
§ 6.Thus far had the theory of international values been ​carried in the first and second editions of this work. But intelligent criticisms (chiefly those of my friend Mr. William Thornton), and subsequent further investigation, have shown that the doctrine stated in the preceding pages, though correct as far as it goes, is not yet the complete theory of the subject matter.
It has been shown that the exports and imports between the two countries (or, if we suppose more than two, between each country and the world) must in the aggregate pay for each other, and must therefore be exchanged for one another at such values as will be compatible with the equation of international demand. That this, however, does not furnish the complete law of the phenomenon, appears from the following consideration: that several different rates of international value may all equally fulfil the conditions of this law.
The supposition was, that England could produce 10 yards of cloth with the same labour as 15 of linen, and Germany with the same labour as 20 of linen; that a trade was opened between the two countries; that England thenceforth confined her production to cloth, and Germany to linen; and, that if 10 yards of cloth should thenceforth exchange for 17 of linen, England and Germany would exactly supply each other's demand: that, for instance, if England wanted at that price 17,000 yards of linen, Germany would want exactly the 10,000 yards of cloth, which, at that price, England would be required to give for the linen. Under these suppositions it appeared, that 10 cloth for 17 linen, would be, in point of fact, the international values.
But it is quite possible that some other rate, such as 10 cloth for 18 linen, might also fulfil the conditions of the equation of international demand. Suppose that at this last rate, England would want more linen than at the rate of 10 for 17, but not in the ratio of the cheapness; that she would not want the 18,000 which she could now buy with 10,000 yards of cloth, but would be content with 17,500, for which she would pay (at the new rate of 10 for 18) 9722 yards of cloth. Germany, again, having to pay dearer for cloth than ​when it could be bought at 10 for 17, would probably reduce her consumption to an amount below 10,000 yards, perhaps to the very same number, 9722. Under these conditions the Equation of International Demand would still exist. Thus, the rate of 10 for 17, and that of 10 for 18, would equally satisfy the Equation of Demand: and many other rates of interchange might satisfy it in like manner. It is conceivable that the conditions might be equally satisfied by every numerical rate which could be supposed. There is still therefore a portion of indeterminateness in the rate at which the international values would adjust themselves; showing that the whole of the influencing circumstances cannot yet have been taken into account.
§ 7.It will be found that to supply this deficiency, we must take into consideration not only, as we have already done, the quantities demanded in each country, of the imported commodities; but also the extent of the means of supplying that demand, which are set at liberty in each country by the change in the direction of its industry.
To illustrate this point it will be necessary to choose more convenient numbers than those which we have hitherto employed. Let it be supposed that in England 100 yards of cloth, previously to the trade, exchanged for 100 of linen, but that in Germany 100 of cloth exchanged for 200 of linen. When the trade was opened, England would supply cloth to Germany, Germany linen to England, at an exchange value which would depend partly on the element already discussed, viz. the comparative degree in which, in the two countries, increased cheapness operates in increasing the demand; and partly on some other element not yet taken into account. In order to isolate this unknown element, it will be necessary to make some definite and invariable supposition in regard to the known element. Let us therefore assume, that the influence of cheapness on demand conforms to some simple law, common to both ​countries and to both commodities. As the simplest and most convenient, let us suppose that in both countries any given increase of cheapness produces an exactly proportional increase of consumption: or, in other words, that the value expended in the commodity, the cost incurred for the sake of obtaining it, is always the same, whether that cost affords a greater or a smaller quantity of the commodity.
Let us now suppose that England, previously to the trade, required a million of yards of linen, which were worth at the English cost of production, a million yards of cloth. By turning all the labour and capital with which that linen was produced, to the production of cloth, she would produce for exportation a million yards of cloth. Suppose that this is the exact quantity which Germany is accustomed to consume. England can dispose of all this cloth in Germany at the German price; she must consent indeed to take a little less until she has driven the German producer from the market, but as soon as this is effected, she can sell her million of cloth for two millions of linen; being the quantity that the German clothiers are enabled to make, by transferring their whole labour and capital from cloth to linen. Thus England would gain the whole benefit of the trade, and Germany nothing. This would be perfectly consistent with the equation of international demand: since England (according to the hypothesis in the preceding paragraph) now requires two millions of linen (being able to get them at the same cost at which she previously obtained only one), while the prices in Germany not being altered, Germany requires as before exactly a million of cloth, and can obtain it by employing the labour and capital set at liberty from the production of cloth, in producing the two millions of linen required by England.
Thus far we have supposed that the additional cloth which England could make, by transferring to cloth the whole of the capital previously employed in making linen, was exactly sufficient to supply the whole of Germany's ​existing demand. But suppose next that it is more than sufficient. Suppose that while England could make with her liberated capital a million yards of cloth for exportation, the cloth which Germany had heretofore required was 800,000 yards only, equivalent at the German cost of production to 1,600,000 yards of linen. England therefore could not dispose of a whole million of cloth in Germany at the German prices. Yet she wants, whether cheap or dear (by our supposition), as much linen as can be bought for a million of cloth: and since this can only be obtained from Germany, or by the more expensive process of production at home, the holders of the million of cloth will be forced by each other's competition to offer it to Germany on any terms (short of the English cost of production) which will induce Germany to take the whole. What terms these would be, the supposition we have made enables us exactly to define. The 800,000 yards of cloth which Germany consumed, cost her the equivalent of 1,600,000 linen, and that invariable cost is what she is willing to expend in cloth, whether the quantity it obtains for her be more or less. England therefore, to induce Germany to take a million of cloth, must offer it for 1,600,000 of linen. The international values will thus be 100 cloth for 160 linen, intermediate between the ratio of the costs of production in England and that of the costs of production in Germany: and the two countries will divide the benefit of the trade, England gaining in the aggregate 600,000 yards of linen, and Germany being richer by 200,000 additional yards of cloth.
Let us now stretch the last supposition still farther, and suppose that the cloth previously consumed by Germany was not only less than the million yards which England is enabled to furnish by discontinuing her production of linen, but less in the full proportion of England's advantage in the production, that is, that Germany only required half a million. In this case, by ceasing altogether to produce cloth, Germany can add a million, but a million only, to her pro​duction of linen, and this million, being the equivalent of what the half million previously cost her, is all that she can be induced by any degree of cheapness to expend in cloth. England will be forced by her own competition to give a whole million of cloth for this million of linen, just as she was forced in the preceding case to give it for 1,600,000. But England could have produced at the same cost a million yards of linen for herself. England therefore derives, in this case, no advantage from the international trade. Germany gains the whole; obtaining a million of cloth instead of half a million, at what the half million previously cost her. Germany, in short, is in this third case, exactly in the same situation as England was in the first case; which may easily be verified by reversing the figures.
As the general result of the three cases, it may be laid down as a theorem, that under the supposition we have made of a demand exactly in proportion to the cheapness, the law of international value will be as follows:—
The whole of the cloth which England can make with the capital previously devoted to linen, will exchange for the whole of the linen which Germany can make with the capital previously devoted to cloth.
Or, still more generally,
The whole of the commodities which the two countries can respectively make for exportation, with the labour and capital thrown out of employment by importation, will exchange against one another.
This law, and the three different possibilities arising from it in respect to the division of the advantage, may be conveniently generalized by means of algebraical symbols, as follows:—
Let the quantity of cloth which England can make with the labour and capital withdrawn from the production of linen, be = n.
Let the cloth previously required by Germany (at the German cost of production) be = m.
​Then n of cloth will always exchange for exactly 2m of linen.
Consequently if n - m, the whole advantage will be on the side of England.
If n = 2m, the whole advantage will be on the side of Germany.
If n be greater than m, but less than 2m, the two countries will share the advantage; England getting 2m of linen where she before got only n; Germany getting n of cloth where she before got only m.
It is almost superfluous to observe that the figure 2 stands where it does, only because it is the figure which expresses the advantage of Germany over England in linen as estimated in cloth, and (what is the same thing) of England over Germany in cloth as estimated in linen. If we had supposed that in Germany, before the trade, 100 of cloth exchanged for 1000 instead of 200 of linen, then n (after the trade commenced) would have exchanged for 10m instead of 2m. If instead of 1000 or 200 we had supposed only 150, n would have exchanged for only $^3$⁄$_2$m. If (in fine) the cost value of cloth (as estimated in linen) in Germany, exceeds the cost value similarly estimated in England, in the ratio of p to q, then will n, after the opening of the trade, exchange for $^p$⁄$_q$m.
§ 8. We have now arrived at what seems a law of International Values, of great simplicity and generality. But we have done so by setting out from a purely arbitrary hypothesis respecting the relation between demand and cheapness. We have assumed their relation to be fixed, though it is essentially variable. We have supposed that every increase of cheapness produces an exactly proportional extension of demand; in other words, that the same invariable value is laid out in a commodity whether it be cheap or dear; and the law which we have investigated holds good only on this hypothesis, or some other practically equivalent to it. Let us now, therefore, combine the two variable elements of the question, the variations of each of which we have considered separately. Let us suppose the relation between demand and cheapness to vary, and to become such as would prevent the rule of interchange laid down in the last theorem from satisfying the conditions of the Equation of International Demand. Let it be supposed, for instance, that the demand of England for linen is exactly proportional to the cheapness, ​but that of Germany for cloth, not proportional. To revert to the second of our three cases, the case in which England by discontinuing the production of linen could produce for exportation a million yards of cloth, and Germany by ceasing to produce cloth could produce an additional 1,600,000 yards of linen. If the one of these quantities exactly exchanged for the other, the demand of England would on our present supposition be exactly satisfied, for she requires all the linen which can be got for a million yards of cloth: but Germany perhaps, though she required 800,000 cloth at a cost equivalent to 1,600,000 linen, yet when she can get a million of cloth at the same cost, may not require the whole million; or may require more than a million. First, let her not require so much; but only as much as she can now buy for 1,500,000 linen. England will still offer a million for these 1,500,000; but even this may not induce Germany to take so much as a million; and if England continues to expend exactly the same aggregate cost on linen whatever be the price, she will have to submit to take for her million of cloth any quantity of linen (not less than a million) which may be requisite to induce Germany to take a million of cloth. Suppose this to be 1,400,000 yards. England has now reaped from the trade a gain not of 600,000 but only of 400,000 yards; while Germany, besides having obtained an extra 200,000 yards of cloth, has obtained it with only seven-eighths of the labour and capital which she previously expended in supplying herself with cloth, and may expend the remainder in increasing her own consumption of linen, or of any other commodity.
Suppose on the contrary that Germany, at the rate of a million cloth for 1,600,000 linen, requires more than a million yards of cloth. England having only a million which she can give without trenching upon the quantity she previously reserved for herself, Germany must bid for the extra cloth at a higher rate than 160 for 100, until she reaches a rate (say 170 for 100) which will either bring down her own ​demand for cloth to the limit of a million, or else tempt England to part with some of the cloth she previously consumed at home.
Let us next suppose that the proportionality of demand to cheapness, instead of holding good in one country but not in the other, does not hold good in either country, and that the deviation is of the same kind in both; that, for instance, neither of the two increases its demand in a degree equivalent to the increase of cheapness. On this supposition, at the rate of one million cloth for 1,600,000 linen, England will not want so much as 1,000,000 linen, nor Germany so much as a million cloth: and if they fall short of that amount in exactly the same degree: if England only wants linen to the amount of nine-tenths of 1,600,000 (1,440,000), and Germany only nine hundred thousand of cloth, the interchange will continue to take place at the same rate. And so if England wants a tenth more than 1,600,000, and Germany a tenth more than a million. This coincidence (which, it is to be observed, supposes demand to extend cheapness in a corresponding, but not in an equal degree) evidently could not exist unless by mere accident: and in any other case, the equation of international demand would require a different adjustment of international values.
The only general law, then, which can be laid down, is this. The values at which a country exchanges its produce with foreign countries depend on two things: first, on the amount and extensibility of their demand for its commodities, compared with its demand for theirs; and secondly, on the capital which it has to spare, from the production of domestic commodities for its own consumption. The more the foreign demand for its commodities exceeds its demand for foreign ​commodities, and the less capital it can spare to produce for foreign markets, compared with what foreigners spare to produce for its markets, the more favourable to it will be the terms of interchange: that is, the more it will obtain of foreign commodities in return for a given quantity of its own.
But these two influencing circumstances are in reality reducible to one: for the capital which a country has to spare from the production of domestic commodities for its own use, is in proportion to its own demand for foreign commodities: whatever proportion of its collective income it expends in purchases from abroad, that same proportion of its capital is left without a home market for its productions. The new element, therefore, which for the sake of scientific correctness we have introduced into the theory of international values, does not seem to make any very material difference in the practical result. It still appears, that the countries which carry on their foreign trade on the most advantageous terms, are those whose commodities are most in demand by foreign countries, and which have themselves the least demand for foreign commodities. From which, among other consequences, it follows, that the richest countries, cæteris paribus, gain the least by a given amount of foreign commerce: since, having a greater demand for commodities generally, they are likely to have a greater demand for foreign commodities, and thus modify the terms of interchange to their own disadvantage. Their aggregate gains by foreign trade, doubtless, are generally greater than those of poorer countries, since they carry on a greater amount of such trade, and gain the benefit of cheapness on a larger consumption: but their gain is less on each individual article consumed.
§ 9.We now pass to another essential part of the theory of the subject. There are two senses in which a country obtains commodities cheaper by foreign trade; in the sense of Value, and in the sense of Cost. It gets them cheaper in ​the first sense, by their falling in value relatively to other things: the same quantity of them exchanging, in the country, for a smaller quantity than before of the other produce of the country. To revert to our original figures; in England, all consumers of linen obtained, after the trade was opened, 17 or some greater number of yards for the same quantity of all other things for which they before obtained only 15. The degree of cheapness, in this sense of the term, depends on the laws of International Demand, so copiously illustrated in the preceding sections. But in the other sense, that of Cost, a country gets a commodity cheaper when it obtains a greater quantity of the commodity with the same expenditure of labour and capital. In this sense of the term, cheapness in a great measure depends upon a cause of a different nature: a country gets its imports cheaper, in proportion to the general productiveness of its domestic industry; to the general efficiency of its labour. The labour of one country may be, as a whole, much more efficient than that of another: all or most of the commodities capable of being produced in both, may be produced in one at less absolute cost than in the other; which, as we have seen, will not necessarily prevent the two countries from exchanging commodities. The things which the more favoured country will import from others, are of course those in which it is least superior; but by importing them it acquires, even in those commodities, the same advantage which it possesses in the articles it gives in exchange for them. Thus the countries which obtain their own productions at least cost, also get their imports at least cost.
This will be made still more obvious if we suppose two competing countries. England sends cloth to Germany, and gives 10 yards of it for 17 yards of linen, or for something else which in Germany is the equivalent of those 17 yards. Another country, as for example France, does the same. The one giving 10 yards of cloth for a certain quantity of German commodities, so must the other: if, therefore, in England, ​these 10 yards are produced by only half as much labour as that by which they are produced in France, the linen or other commodities of Germany will cost to England only half the amount of labour which they will cost to France. England would thus obtain her imports at less cost than France, in the ratio of the greater efficiency of her labour in the production of cloth: which might be taken, in the case supposed, as an approximate estimate of the efficiency of her labour generally; since France, as well as England, by selecting cloth as her article of export, would have shown that with her also it was the commodity in which labour was relatively the most efficient. It follows, therefore, that every country gets its imports at less cost, in proportion to the general efficiency of its labour.
This proposition was first clearly seen and expounded by Mr. Senior, but only as applicable to the importation of the precious metals. I think it important to point out that the proposition holds equally true of all other imported commodities; and further, that it is only a portion of the truth. For, in the case supposed, the cost to England of the linen which she pays for with ten yards of cloth, does not depend solely upon the cost to herself of ten yards of cloth, but partly also upon how many yards of linen she obtains in exchange for them. What her imports cost to her is a function of two variables; the quantity of her own commodities which she gives for them, and the cost of those commodities. Of these, the last alone depends on the efficiency of her labour: the first depends on the law of international values; that is, on the intensity and extensibility of the foreign demand for her commodities, compared with her demand for foreign commodities.
In the case just now supposed, of a competition between England and France, the state of international values affected both competitors alike, since they were supposed to trade ​with the same country, and to export and import the same commodities. The difference, therefore, in what their imports cost them, depended solely on the other cause, the unequal efficiency of their labour. They gave the same quantities; the difference could only be in the cost of production. But if England traded to Germany with cloth, and France with iron, the comparative demand in Germany for those two commodities would bear a share in determining the comparative cost, in labour and capital, with which England and France would obtain German products. If iron were more in demand in Germany than cloth, France would recover, through that channel, part of her disadvantage; if less, her disadvantage would be increased. The efficiency, therefore, of a country's labour, is not the only thing which determines even the cost at which that country obtains imported commodities—while it has no share whatever in determining either their exchange value, or, as we shall presently see, their price.
* ↑ Supra, book iii. chap. ii. 4.
* ↑ It may be asked, why we have supposed the number n to have as its extreme limits, m and 2m (or $^p$⁄$_q$m)? why may not n be less than m, or greater than 2m; and if so, what will be the result? This we shall now examine, and when we do so it will appear that n is always, practically speaking, confined within these limits. Suppose, for example, that n is less than m; or, reverting to our former figures, that the million yards of cloth, which England can make, will not satisfy the whole of Germany's pre-existing demand; that demand being (let us suppose) for 1,200,000 yards. It would then, at first sight, appear that England would supply Germany with cloth up to the extent of a million; that Germany would continue to supply herself with the remaining 200,000 by home production: that this portion of the supply would regulate the price of the whole; that England therefore would be able permanently to sell her million of cloth at the German cost of production (viz. for two millions of linen) and would gain the whole advantage of the trade, Germany being no better off than before. That such, however, would not be the practical result, will soon be evident. The residuary demand of Germany for 200,000 yards of cloth furnishes a resource to England for purposes of foreign trade of which it is still her interest to avail herself; and though she has no more labour and capital which she can withdraw from linen for the production of this extra quantity of cloth, there must be some other commodities in which Germany has a relative advantage over her (though perhaps not so great as in linen): these she will now import, instead of producing, and the labour and capital formerly employed in producing them will be transferred to cloth, until the required amount is made up. If this transfer just makes up the 200,000 and no more, this augmented n will now be equal to m; England will sell the whole 1,200,000 at the German values; and will still gain the whole advantage of the trade. But if the transfer makes up more than the 200,000, England will have more cloth than 1,200,000 yards to offer; n will become greater than m, and England must part with enough of the advantage to induce Germany to take the surplus. Thus the case which seemed at first sight to be beyond the limits, is transformed practically into a case either coinciding with one of the limits or between them. And so with every other case which can be supposed.
* ↑ The increase of demand from 800,000 to 900,000, and that from a million to 1,440,000, are neither equal in themselves, nor bear an equal proportion to the increase of cheapness. Germany's demand for cloth has increased one-eighth, while the cheapness is increased one-fourth. England's demand for linen is increased 44 per cent, while the cheapness is increased 60 per cent.
* ↑ Three Lectures on the Cost of Obtaining Money.