Gottfried Haberler’s contribution to trade theory

Gottfried Haberler was a member of what is loosely termed the ‘Austrian’ school of economics, to denote the group of theorists who opposed centralised – government – intervention in money creation, which they argued artificially distorted capital flows and created structural inefficiencies.

He was more closely tied to the Austrian school at the beginning of his career, when while in that country he was a regular contributor to the seminars organised by Austrian economist Ludwig von Mises; as part of the Mises-Kreis, the celebrated group of economic, sociological and philosophical thinkers.

In what was, for the time, a departure from the orthodox theory of value, quantified it in terms of labour and output, the Austrian theory of value focused on the process of production itself. And how in electing to lend part of the finite amount of money to certain industries over others, there was a danger of creating structural inefficiencies which would self-correct over the course of the business cycle.

A Pioneer in Trade Theory

In the 1930s Haberler was instrumental in creating an alternative framework for analysing cost and value, moving away from the theory of comparative costs (advantage) on the single-product model which had underpinned trade theory since Ricardo. Haberler’s framework mapped out the relationship between the opportunity cost of producing two competing goods, under a given supply of productive factors. This he performed both for constant and fluctuating opportunity costs.

Previously orthodox theory had been based on the ‘real-cost’ theory of value, which saw prices as quantified largely in units of labor. The new approach enabled the determination of relative prices to be analysed under more realistic production circumstances as variable factor productions, in a much simpler and more direct manner than under a real-cost approach.

This paradigm shift triggered a wave of writings by other academics, which incorporated and expanded Haberler’s theory, like Lerner (1932, 1933, and 1934), Leontief (1933)  and Viner (1937), who introduced ‘social’ or ‘community indifference’ curves. When these two curves – those of opportunity cost and social indifference – are plotted together – Marshall’s reciprocal demand curves can be derived; and most general equilibrium effects of trade on relative commodity prices, production, and consumption then shown.

What Haberler’s analysis did not include was an attempt to model consumer preferences for the commodities being produced. Nor an explanation of how productive factors evolve as an economy moves along its production-possibilities curve. This would have to wait until Stolper and Samuelson (disciples of Haberler) published their ground-breaking article in 1941, which elucidated more fully the way the production-possibilities curve is determined, and how factor proportions fluctuate along the curve.

 Where Trade Theory Fails

Haberler’s 1950 work, ‘Some Problems in the Pure Theory of International Trade’, examined the less-than-ideal situation of real wage rigidity, which can be caused by insufficient mobility of labour between a developed and less developed sector; one of the scenarios examined by economists who later expanded his model. This article formed the precursor for an extensive body of literature on ‘domestic distortions’ in which orthodox theories of trade relations might be non-applicable.

The consensus that in the majority of situations free, unimpeded trade has a net benefit did not change dramatically. The theory so-called Hicksian optimism rehabilitated the argument for free trade largely on the basis that wider availability of goods and increased competition leading to cheaper prices would yield a welfare gain; the need for protection arises only when there is a market failure in the domestic economy. Where there is a domestic divergence between prices and marginal costs, foreign competition can hurt some domestic industries.

In the event of real wage rigidity, the opening-up of trade – whether in a full customs union or a free trade area – could cause loss of output. Industries which for whatever reason are unable to pay a competitive rate which attracts new workers would be threatened by removing tariff barriers, which would allow unimpeded entry of competing products.

As the marginal return on these products became unviable, but wages were not flexible enough to change accordingly, labour would move out of these struggling industries and into more competitive ones. Often the industries that suffer are those at the breaking edge of new technology and development, which lacks a mature labour pool with the necessary skill set.

Let’s Get Technical

In his econometric model Haberler demonstrated that increased availability of products and a wider market to stimulate output had a net benefit, provided this increase was to the right of the domestic indifference curve.

In trade theory the state of ‘autarky’ is where the factors of production are deployed to their maximum potential, accounting for the limiting factors of the opportunity cost of manufacturing that product over another, which are assumed to increase; and a community indifference curve which has an inverse relationship to the opportunity cost curve, (increasing where there is scarcity of a particular good’.

The material gains from trade are represented in graphical form by the international trade ratio. In a model comprising two exchangeable commodities, this describes the amount of commodity A that can be exchanged for commodity B. If commodity A buys two of commodity B abroad, but at home you need two of commodity A to get one of B, then domestically A is more valuable. Therefore B should be exported.

However, Haberler has a caveat. If T, the international trade ratio representing the increased availability of goods from trade, is such that there is a net outflow of goods, that “these imperfections are persistent, … and that they persistently operate in such a direction as to weaken (rather than to strengthen) the case for free trade,” protection might be justified.

His idea of a desirable welfare position is not an overly naive one in which all individuals are necessarily better off, but “it is sufficient that everybody could be better off.” He distances himself from the idea that “perfect mobility of factors within each country is a necessary condition for the ideal classical model”, going on to assert that “what really causes trouble and may make trade detrimental and justify protection is rigidity of factor prices, which may or may not be associated with immobility of factors.” The most likely factor to experience difficulty transitioning between industries is that of labour.

Expanding this theory further, Brecher (1974) examined a number of scenarios involving real wage rigidity, starting with one in which free trade was combined with unemployment; he analysed the consequences of using different policy instruments. If the importable is labour-intensive to produce, a tariff would increase employment and output, by shielding domestic industry. But capital and labour would move disproportionately into the protected industry; also there would be a by-product consumption distortion.

When the demand for a product, reflected in its price, is proportionate to the marginal cost for each firm and product, there is zero distortion. But protectionism can mean the output swells beyond sustainable consumer demand, as that industry is protected from foreign competition and, more indirectly, may benefit from tariff revenue.

The Austrian school holds that distortions of this kind inevitably self-correct over the course of the business cycle, and ‘creative destruction’ can mean boom-time companies do not survive when they lose policy protection.

The second scenario Brecher modelled was polarised between a subsistence, and an advanced sector, where high skills and/or costly technology necessitated a wage rate in excess of the opportunity cost of labour – i.e. higher than the marginal product of labour in the subsistence sector. To phrase it in plain English, these advanced sectors would have trouble attracting capital which could be profitably employed in more basic industries.

This form of domestic distortion, he argued, necessitates subsidies in place of tariffs or taxes on trade. Because the revenue effect is negative and so higher distorting consumption taxes are needed, he acknowledges the extent of the offsetting subsidies may have to be incomplete.

The distortions not offset are weighed against the new distortions created as a consequence of financing the subsidies. While not a perfect solution, he concludes it is ‘first-best’, the most beneficial option, to deal with distortions in this way.

This theory of ‘domestic distortions’, which Haberler led the field in, is admittedly a far cry away from his origins as an Austrian School disciple, a staunch defender of the principle of unimpeded trade. This just goes to demonstrate his intellectual versatility and ability to break with orthodoxy and form new approaches.

But today it might be time for a new school of thought on the subject. As is so often the case in institutions where collective decision-making is skewed by relative economic and political weight, the WTO is governed to a large extent by the vested interests of the countries with the biggest economic muscle. Trade or customs unions like that existing within the EU and the proposed Trans-Pacific Partnership (TRIPS) which Trump made guillotining one of his first official presidential acts, only yield a net benefit to those participating in them.

For those countries outside the golden circle, they can face significant obstacles to equitable trade not limited to tariffs; customs’ scrutiny of imports is far lower, for example, within the EU which has a unified legislative framework to enforce commercial and legal standards. Trump’s announcement of his intention to renew the North American Free Trade Agreement is another step towards his avowed position as a champion of ‘free trade’[1] and greater competitiveness.

 

Bibliography

Trump’s cancellation of hot-button Asian trade deal shifts U.S. role in world economy

‘The Normative Theory of International Trade’ – W. M. Corden, Australian National University, Canberra  (Seminar Paper no.230)

‘Gottfried Haberler (1900 – 1995)’ – Joseph T. Salerno.   https://mises.org/profile/gottfried-haberler

‘Some Problems in the Pure Theory of International Trade’ – Gottfried Haberler, 1950

‘Gottfried Haberler’s Contributions to International Trade Theory and Policy’ – Robert E. Baldwin, The Quarterly Journal of Economics vol. 97, No. 1 (Feb 1982), p.141-48

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[1] http://www.pressherald.com/2017/01/23/trump-signs-order-to-withdraw-from-trans-pacific-partnership/

Trendwatch. What will impact equity prices in 2015?

Taking the long view

What are the possible storms on the horizon which might make waves in the UK market? Recent macroeconomic trends which will heavily impact the relative success of British equities are the strong pound, and the continuing low price of oil.

Invest in UK Buyers

Companies which depend heavily on exports might not do as well as those selling largely to a domestic market. Sterling is outperforming vs the dollar, with the 200-day moving average this Wednesday standing at 1.5632. The peak providing point of comparison was 1.5710 on December 16th. And the Euro, the currency of Britain’s other main export market, is also waning in comparison with the pound as GBP:EUR continued to increase today, to 1:1.39EUR, correct at time of publication.

The pound surged on the strength of news the Conservatives were back again, and was given an added boost after better than expected UK March industrial output data on Tuesday, which implied a moderate upside revision to Q1 GDP.

Labour market data released today are also positive: the 3-month moving average for earnings (including bonuses) is at 1.9% vs a predicted 1.7%. And unemployment rate is, as predicted, 5.5% though the number of claimants did not fall by nearly as many as expected.

Expert predictions for the Sterling Euro outlook were given to poundsterlinglive.com (https://www.poundsterlinglive.com/eur/2063-forecasts-for-euro-to-pound-mid-may-66456456). They include

Westpac:

“EUR/GBP has slid sharply after the decisive victory by the Conservatives but it has only unwound the election uncertainty premium built in just ahead of the election. Moreover, with Grexit risk on the rise GBP may benefit from some late safe haven flow. Bottom line EUR/GBP risks have flipped and wouldn’t be surprised to see the pair test 0.70 in the next week or two.”

Charles Stanley:

“Pre-election jitters drove the UK currency down to a three-month low of 1.34 last week but Friday’s result provoked a rebound that looks like it might have further to run in the short-term. Despite its recent choppy price action the chart is suggesting that a run back above 1.40 has become a realistic near-term expectation and that we have probably seen the bottom for now. “

And the Consumer Staples and Consumer Discretionary sectors catering to a UK market are likely to look increasingly attractive, as the Conservative electoral victory means an EU referendum is back on the agenda and Britain’s relationship with the Continent is clouded by uncertainty. The Guardian reported today that Cameron plans to bring the referendum forward, from 2017 to 2016.

Black Gold? Fool’s Gold…

And, while oil prices –taking Brent Crude Oil as an indicator – have recovered some ground over the past month, the long-term outlook is not great. Between April 14 and May 12, Brent Crude rose from 58 to 65GBP.

However, a recent OPEC assessment, as reported on by the Wall Street Journal, predicted that over the next ten years it was unlikely oil prices would rise above $100 barrel again. OPEC is allegedly considering re-introducing the quota system it dropped in 2011. The most positive scenario modelled by OPEC was that oil would retail for $76 a barrel in ten years’ time.

Clearly competition from rival energy sources like natural gas and renewables means that now is a time to avoid oil company stocks, unless you are confident in following a contrarian strategy. Green energy, on the other hand, keeps going up and up.

As a general proxy, look at the all-world Dow Jones Sustainability Index (DJSI), whose total return at the end of last month (April) was 1896.15, denominated in USD. The price return of the DJSI World Index, which is a better indicator of the value gains of its constituent parts, had increased to 1305.37 USD from 1264.41 at the end of March.

Historic data are not publicly accessible for beyond the three-month period, which is a shame because February was an unusually volatile period for markets in general so does not offer an accurate point of comparison: The Dow Jones went from around 17200 to 18500USD over the course of February, ending on a 6-month high.

So essentially, consider disinvesting from the big oil corporations which dominate the FTSE 100 and switch to any company which will benefit from cheaper oil prices – which is almost all of them, bar those providing services or equipment in some way to oil companies. Unless you are convinced your oil-producing asset has a strategy to ride out the new pricing norm.

Former military and naval commanders brought out of retirement to battle Somali pirates.

The new private navy Typhon will use armoured patrol boats, manned with 240 former marines and soldiers, who will be armed with both short-range firearms and sniper rifles. They will patrol the east African coast, acting as escorts for oil tankers, freight ships and private yachts.

Its directors claim existing defence measures are insufficient. Despite the creation last year of the multilateral venture Combined Task Force 150, whose specific mandate was to fight piracy off of the coast of Somalia, with the assistance of forces from France, Canada, Germany, Pakistan, Australia, Denmark and the United States. Not to mention Russia, China, India, and the UK’s Royal Navy.by establishing a Maritime Security Patrol Area (MSPA) within the Gulf of Aden

“They can’t do the job because they haven’t got the budget and deploying a billion-pound warship against six guys [pirates] with $500 of kit is not a very good use of the asset,” Anthony Sharp, chief executive of Typhon, the company behind the venture, told the Times.

The Typhon fleet will retain the right to carry weapons, even into harbour, because it is formed of non-civilian personnel and will fly under the British flag. Patrol boats are to report back to a floating military base in the form of a 10,000 ton ship, and under overall command of a former Royal Navy commodore.

Founding members include former commander in chief of the Allied Forces in Europe, General Jack Deverell; Britain’s former chief of general staff, Lord Dannatt; former commander of the US Naval force in Europe, Admiral Henry Ulrich; and millionaire businessman and adventurer Simon Murray.

Typhon’s defence team will begin their first escort mission in March or April, though with the International Marine Bureau reporting pirate attacks at a six-year low, it may be some time before they see action.

As of 31st December 2012, pirates were holding four large ships and an estimated 114 hostages.

 

More Shipping News

Two groups which respectively represent 140 members from the UK maritime sector, and over 80 percent of the world’s shipowners and operators, have offset £40m of pension liabilities to British insurer Pension Insurance Corporation (PIC).

The UK Chamber of Shipping and the International Chamber of Shipping have taken out an indemnity policy on all the funds in the current pot, for members of both trade organisations.

Fixed-income products, particularly government bonds, are becoming increasingly expensive as inflation rises; yield rarely improves to an extent sufficient to offset this price rise. FixedIncomeInvestor.co.uk states that standard UK gilts expiring in 12 years 2 months are priced at £128.24, with a yield of 2.321%.

However, an indication of the level of inflation and volatility is the equivalent figures for UK 11-year 6 month, index-linked gilts, which have a -0.399% yield and are priced at £332.325. At current market conditions, fixed-income products linked to the FTSE or to interest rates give negative yields if the product is held to maturity.

 

French vs German pricing indexes – don’t believe the hype

Europe’s Teutonic juggernaut could be more unstable than it looks, figures revealed this week. For once, France has overtaken Germany in the two-horse race that unfolded in the release of Markit’s Composite Purchasing Managers’ Index (PMI). Why have German service providers suffered a lag, while France’s PMI rose from 45.5 to 46.2?

The answer to the diminution of Germany’s service sector, from 48.4% to 48%, could be simply that managers are reacting pre-emptively to pessimistic outlooks for the future. Demand for contracts has fallen in recent months, and managers have slashed jobs in response, and because they believe – as does the Bundesbank – that Germany will continue to experience sluggish growth.While last year it expanded by 3%, in 2012 economic growth for Q2 was 0.2%, rising to just 0.3% in Q3.

Markit said: “Reports from survey respondents overwhelmingly cited weakness in export markets, especially southern Europe. A number of firms also mentioned subdued demand from the automobiles sector. Some panel members pointed to signs of a slowdown in Asia, especially for investment goods.”

However the IFO business climate index for industry and trade, key indicator of the health of the German economy, paints a different picture. The figures are still negative, but less so than the figures for October: trade and industry, -4.2; manufacturing,  -6.5; construction still flagging at -7.5, while the wholesaling index entered positive integers at 4.9. President of the IFO Institute Hans-Werner Sinn explained that it had risen “again after six successive decreases. Companies expressed slightly greater satisfaction with their current business situation. They were also far less pessimistic about future business developments.” Perhaps the price index simply reflects a prudent caution towards the start of 2013.

And France’s bullish outlook is not necessarily based on concrete fact. In fact, the report indicates that its economic situation is probably worse, with unemployment still rife in manufacturing and services provision – though improved from September’s 33-month low. Its principal problem is lack of confidence and uptake by external investors. Markit reveals: “There were reports that clients, especially some firms in the autos sector, had postponed orders and reined in investment,” due to concerns over “domestic weakness.”

These fears over the climate fostered by Hollande’s government are unlikely to be allayed by the election of right-wing firebrand Jean-François Copé to the head of principal opposition party, the UMP (Union pour une Mouvement Populaire). The UMP has recently adopted a new ‘Islamic Charter’ which talks of reclaiming France’s Judaeo-Christian roots and Latin heritage by prohibiting muslims from praying in public, and from minarets, and from having a distinct voice in local government. If socialism fails, so it seems will social cohesion.

Clash of Central Europe’s Economic Titans

On the other hand, there is talk of taking the prestigious university Ecole des Sciences Po, which trains state functionaires, back under state management. So if the private service sector flags, France will not at least be deficient in civil servants.