Includes bibliographical references (p. 12-14)

Brems, Hans

Illinois Digital Environment for Access to Learning and Scholarship Repository


UNIVERSITY OF
ILLINOIS LIBRARY
AT URBANA-CHAMPAIGN
BOOKSTACKS
Digitized by the Internet Archive
in 2012 with funding from
University of Illinois Urbana-Champaign
http://www.archive.org/details/bertilohlinscont1305brem

<=r^ V:-
FACULTY WORKING
PAPER NO. 1305
Bertil Ohlin's Contributions to Economic Theory
Hans Brems
College of Commerce and Business Administration
Bureau of Economic and Business Research
University of Illinois, Urbana-Champaign

BEBR
FACULTY WORKING PAPER NO. 1305
College of Commerce and Business Administration
University of Illinois Urbana-Champaign
November 1986
"Bertil Ohlin's Contributions to Economic Theory"
Hans Brems, Professor Emeritus
Department of Economics

BERTH OHLIN'S CONTRIBUTIONS TO ECONOMIC THEORY
By HANS BREMS
104-WORD ABSTRACT
Inspired by Cassel and Heckscher Ohlin formulated
the theorem that even if no factor ever crossed a border,
perfect mobility of goods among regions would equalize
real factor prices among them. Few theorems have
inspired as much later work, theoretical and empirical,
as this so-called Heckscher-Ohlin theorem.
Less well-known is Ohlin' s macroeconomics, never
fully translated. Here, inspired by Wicksell and
Lindahl, Ohlin built a dynamic feedback mechanism
between consumption, investment, and output. Two
years ahead of Keynes, Ohlin' s feedback mechanism
used three Keynesian tools, the propensity to consume,
liquidity preference, and the multiplier, and one
non-Keynesian tool, the accelerator.

The New Palgrave
BERTH OHLIN'S CONTRIBUTIONS TO ECONOMIC THEORY
By HANS BREMS
Ohlin was born on 23 April 1899 in Klippan, Sweden. He took a degree
in mathematics, statistics, and economics at the University of Lund in
1917, a degree in economics under Heckscher at the Stockholm School of
Business Administration in 1919, an A.M. degree under Taussig and
Williams at Harvard in 1923, and a Ph.D. degree under Cassel at the
University of Stockholm in 1924. Ohlin taught at the University of
Copenhagen 1925-30 and, as Heckscher' s successor, at the Stockholm
School of Business Administration 1930-65. He was a visiting
professor at the University of California at Berkeley in 1937 and at
Columbia and Oxford in 1947.
For the League of Nations Ohlin prepared a report on the world
depression in 1931 and for the Swedish government a report on
unemployment in 1934. He was a member of the Swedish parliament
-2-
1938-70, a cabinet member 1944-45, the leader of the liberal party
1944-67, and died on 3 August 1979 in Stockholm.
X Trade theory
Ohlin is best known for, and received the 1977 Nobel Prize for,
his modernization of the theory of international trade. The
modernization was long overdue: discredited in general economic
theory after 1870, the labour theory of value was still surviving in
the province of international-trade theory half a century later.
Ohlin' s teacher at Stockholm was Gustav Cassel , and his point of
departure was Cassel' s (1918) version of a Walrasian general
equilibrium of a closed economy with perfect mobility of goods and
factors. Unlike Walras, Cassel assumed the factor endowments of all
households to be fixed. Household income would then be the sum of the
products of factor price and all factor endowments of that household.
Like Walras, Cassel assumed the input-output coefficients of all goods
to be fixed. The competitive price of a good would then be the sum of
the products of factor price and all input-output coefficients of that
good. Facing such household income and such competitive goods prices,
every household would reveal its preference. Goods-market equilibrium
would require industry supply and such household demand to be equal
-3-
for every good. Industry demand for a factor would be the sum of the
products of such industry goods supplies and all input-output
coefficients of that factor. Factor-market equilibrium would require
household supply and such industry demand to be equal for every
factor.
The ultimate determinants of all quantities and relative prices in
such a general equilibrium were, first, factor endowments; second,
technology in the form of the input-output coefficients; and, third,
preferences. Inspired by his other teacher at Stockholm, Eli Filip
Heckscher (1919), Ohlin (1924), (1933) set out to modify the Cassel
model to fit interregional and international trade.
As his first modification Ohlin visualized an economy composed of
regions within which factor mobility was perfect but between which it
was imperfect or, as a first approximation, nonexistent. In the
absence of goods trade, isolation would be complete, and such regions
would simply constitute a system of miniature Casselian closed
economies. Between them relative prices could differ because factor
endowments, technology, or preferences differed. As another first
approximation, Ohlin assumed regions to differ solely in their factor
endowments, not in their technology or preferences. Finally, Ohlin
unfroze Cassel 's fixed input-output coefficients, thus making room for
factor substitution. With such assumptions he had the ingredients to
-4-
what later became known as the 'strong' Heckscher-Ohlin theorem. In
the simple case of two factors, two goods, and two regions the theorem
becomes very tractable. In isolation each region would have a
relatively low-priced and a relatively high-priced good. Since
nothing else than factor endowments differed between regions, the
low-priced good would be low-priced because it required relatively
much of that region's relatively abundant, hence low-priced, factor.
That good will be a candidate for export once we remove isolation.
The high-priced good would be high-priced because it required
relatively much of that region's relatively scarce, hence high-priced,
factor. That good will be a candidate for import once we remove
isolation; but we are not removing it yet. As we know, under profit
maximization, pure competition, and factor substitution the physical
marginal productivity of either factor in terms of either good will
equal the real price of that factor in terms of that good.
Now remove isolation and let goods be traded. Export would expand
a region's demand for its abundant factor and import reduce the demand
for its scarce factor. Thus trade would raise the price of the
abundant factor, reduce the price of the scarce one, and encourage
substitution between them: either good would use less abundant factor
per unit of scarce factor than in isolation. The abundant factor
would then have a higher physical marginal productivity and a higher
-5-
real price in terms of either good than in isolation. Vice versa for
the scarce factor. Does all this mean that trade would eventually
equalize real factor prices in terms of either good between
regions—although no factor ever crossed the border? Yes, in the
absence of transportation costs and in the absence of specialization.
Cne reason for specialization would be increasing returns to scale.
Specialization would leave a region with an unproduced good. Where
nothing is produced, no factor can have a marginal productivity. In
terms of the unproduced good, then, physical marginal productivity
could no longer equal real factor price, and the theorem would fail.
So it would in case of transportation costs or in case regions
differed, not in factor endowments but in technology or preferences.
And so it might if there were more than two factors, goods, or
regions.
Few theorems have been as fruitful, i.e., inspired as much later
work, theoretical and empirical, as the Heckscher-Ohlin theorem.
Neither Heckscher nor Ohlin applied present-day rigour. To Heckscher
factor-price equalization would be complete; to Ohlin—more aware of
the many qualifications—incomplete. The theorem was first taken up,
baptized, and rigourized by Stolper and Samuelson (1941) who examined
a scarce factor's case for protectionism but found 'the definiteness
of the Heckscher-Ohlin theorem [beginning] to fade' with more than two
-6-
factors. More groundwork was done by Samuelson (1948), (1949). Using
his domestic U.S. input-output table with many goods but only two
factors, Leontief (1953), (1956) found the capital-labour ratio to be
lower in U.S. exports than in U.S. import-competing goods. If the
Heckscher-Ohlin theorem were true, then, capital would have to be the
scarce and labour the abundant U.S. factor. This Leontief paradox did
not make the theorem go away but stimulated new contributions. A good
guide to them is the third part of Chipman's (1966) survey of the
theory of international trade.
Ohlin's second modification of Cassel saw international trade as
a special case of interregional trade. What was special about
nations?
First, national differences in factor endowments, technology, and
preferences might be rooted in differences in climate, language,
cultural, and legal institutions. Of international movements of
factors, labour as well as capital, and such obstacles to them Ohlin
gave a full account. His account of international capital movements
found an early and specific expression (1929) in his discussion with
Keynes of the mechanism of the reparation payments imposed upon Germany
by the Versailles treaty. Still influenced by Marshallian tradition,
Keynes saw a drastic worsening of Germany's terms of trade as a
necessary condition for such payments. To Ohlin reparations were
-7-
nothing but huge international transfers of 'buying power. ' Against
an incoraprehending 1929 Keynes, Ohlin advocated the view of a 1936
Keynes, i.e., the income mechanism would do; no price mechanism was
needed.
Second, nations were special in having their own currency and
monetary authorities. In a two-country world such separate currencies
would add a new unknown, i.e. , the price of one currency in terms of
the other—the exchange rate. Fortunately there would also be a new
equation, i.e., the equilibrium condition that in a pure-trade model
the balance of trade would be zero or that in a trade cum lending and
borrowing model the balance of payments would be zero.
X Macroeconoraic theory
Less well known to the English-speaking world is Ohlin 's
macroeconomic theory: its most important work (1934) was never fully
translated. Here, Ohlin was inspired by Wicksell and Lindahl.
Wicksell (1893) had restated Bohm-Bawerk mathematically and (1898)
wondered how a Bohm-Bawerk 'natural' rate of interest was related to
the rate of interest observed in markets where the supply of money met
the demand for it. If such a 'money' rate of interest were lower than
the natural rate of interest, entrepreneurs would be induced—and the
-8-
money supply correspondingly expanded—to pay a higher money wage
rate. Physically speaking, nothing would come of this, for when labour
spent the higher money wage rate, prices would rise correspondingly
and unexpectedly leave the real wage rate unchanged. There would be
a cumulative process of inflation expected by nobody.
Wicksell's answer was made possible by a method fundamentally new
in three respects. Wicksell's method was a macroeconomic
,
dynamic disequilibrium method based upon adaptive expectations whose
disappointment constituted the motive force of the system. But
Wicksell had applied his method to a model with price as the only
variable. Using Wicksell's method and inspired by Lindahl's (1930)
refinement of it, Ohlin (1933), (1934) added physical output as an
additional variable. Two years ahead of Keynes, Ohlin used three
Keynesian tools, i.e., the propensity to consume, liquidity
preference, and the multiplier, and one non-Keynesian tool, i.e., the
accelerator. The four tools would interact as follows in Ohlin 's
feedback mechanism. Let consumption demand be stimulated. As a
result physical output would rise, generating new income. The
propensity to consume would link physical consumption to the level of
physical output and thus establish a consumption feedback. The
accelerator would link physical investment to the growth of physical
output and thus establish an investment feedback. As did the
-9-
Wicksellian one, Ohlin's two feedbacks unfolded in a cumulative
process along a time axis as a succession of disequilibria:
expectations and plans were forever being revised in the light of new
experience. By contrast, Keynes used only the consumption feedback
and telescoped it into an instant static equilibrium along an output
axis.
Ohlin's relation to Keynesian economics was discussed by Steiger
(1976), Patinkin (1978), and Brems (1978). Forty-one years apart
Ohlin expressed his own view on the matter in (1937) and (1978).
Ohlin's (1934) analysis appeared in a report on unemployment
requested by the Swedish government, and his policy conclusions were
quite specific. In times of excess capacity the government should
undertake investment projects—say highway construction or the
electrification of state railroads—which would not compete with
private investment and which should be allowed to generate fiscal
deficits. Tax financing would reduce consumption and thus defeat the
purpose of public works. Ohlin wrote the government budget constraint
deficits might be financed by expanding either the bond or the money
supply. Sale of government bonds would depress bond prices and thus
discourage private investment, again defeating the purpose of public
works. That left central-bank discounting of treasury bills as the
only way which would not deprive private investment of finance. Thus
-10-
financed, public works would generate income. Such income generation
would be magnified by the multiplier and the accelerator.
Except for a nine-page algebraic two-country Cassel general
equilibrium, banished to an appendix, Ohlin used neither algebra nor
diagrams. But in all his work his style was accurate, cautious, and
lucid, often enlivened by relevant statistical and historical
illustrations.
Hans Brems
-11-
Selected Works
1924. Handelns teori (A theory of trade), Stockholm, Centraltryckeriet
1929. Transfer difficulties, real and imagined, Economic Journal
,
March, reprinted in H. S. Ellis and L. Metzler (eds.) Readings in
the theory of international trade , Philadelphia and Toronto,
Blakiston, 1949.
1933. Interregional and International Trade , Cambridge, Harvard
University Press.
1933. Till fragan ora penningteoriens upplaggning, Ekonomisk
Tidskrif
t
,
trans, as On the formulation of monetary theory,
History of Political Economy , 1978, Fall.
1934. Penningpolitik, offentliga arbeten, subventioner och tullar
som medel mot arbetsl'oshet—bidrag till expansionens teori
,
Unemployment Report II, 4, Stockholm, P. A. Norstedt & Soner,
summarized by Brems (1978).
-12-
1937. Some notes on the Stockholm theory of saving and investment,
I-II, Economic Journal , March and June, reprinted in G. Haberler
(ed.), Readings in Business Cycle Theory , Philadelphia and
Toronto, Blakiston, 1951.
1978. Keynesian economics and the Stockholm school. A comment on Don
Patinkin's paper, Scandinavian Journal of Economics.
Bibliography
Breras , H. (1978). What was new in Ohlin's 1933-34 macroeconomics?
History of Political Economy
, Fall.
Cassel, G. (1918). Theoretische Sozialokonomie , Leipzig, Winter,
trans, from the fifth ed. as The Theory of Social Economy
,
New York, Harcourt, Brace, 1932.
Chipman, J. S. (1966). A survey of the theory of international trade
part 3, the modern theory, Econometrica
,
January.
-13-
Heckscher, E. F. (1919). Utrikeshandelns verkan pa
inkomstfordelningen, Ekonomisk Tidsskrift , trans, as The
effect of foreign trade on the distribution of income in H. S.
Ellis and L. Metzler (eds.) Readings in the theory of
international trade , Philadelphia and Toronto, Blakiston, 1949.
Leontief, W. W. (1953). Domestic production and foreign trade; the
American capital position re-examined, Proceedings of the American
Philosophical Society
,
September.
(1956). Factor proportions and the structure of
American trade: further theoretical and empirical analysis,
Review of Economics and Statistics
,
November.
Lindahl, E. (1930). Penningpolitikens medel (Methods of monetary
policy), Lund, Gleerup, partially trans, in Lindahl, E.
(1939). Studies in the Theory of Money and Capital , London, Allen
and Unwin.
Patinkin, D. (1978). On the relation between Keynesian economics and
the 'Stockholm School,' Scandinavian Journal of Economics.
-14-
Samuelson, P. A. (1948). International trade and the equalisation of
factor prices, Economic Journal , June.
(1949). International factor price equalisation once
again, Economic Journal , June.
Samuelson, P. A., and Stolper, W. F. (1941). Protection and real
wages, Review of Economic Studies
,
November, reprinted in H. S.
Ellis and L. Metzler (eds.) Readings in the theory of
international trade
,
Philadelphia and Toronto, Blakiston, 1949.
Steiger, 0. (1976). Bertil Ohlin and the origins of the Keynesian
revolution, History of Political Economy , Fall.
Wicksell, K. (1893). Uber Wert, Kapital und Rente , Jena, G. Fischer,
trans, as Value, Capital and Rent , London, Allen and Unwin, 1954.
(1898). Geldzins und Gilterpreise, Jena, G. Fischer,
trans, with an introduction by Bertil Ohlin as Interest and
Prices, London, Macmillan, 1936.
END
D/436




Bertil Ohlin's contributions to economic theory

IDEALS @ Illinois

https://www.ideals.illinois.edu/bitstream/handle/2142/32721/bertilohlinscont1305brem.pdf?sequence=2

Bertil Ohlin's contributions to economic theory

Abstract

Similar works

Full text

Available Versions

Illinois Digital Environment for Access to Learning and Scholarship Repository

IDEALS @ Illinois