CAUSES AND EFFECTS OF CAPITAL MOVEMENTS (1934)

The theory of capital movements has not been treated systematically, so far, in the literature of economics. The reason for this neglect may well be found largely in the fact that the classical doctrine of international trade, the theory of comparative costs, rests on the fundamental assumption that while the factors of production, labor and capital, are freely mobile inside a given country, they are lacking external freedom of mobility. This basic premise of the international immobility of capital seems to have prevented the possibility of a theoretical approach to capital movements, at least from the standpoint of international trade theory. It is significant that whenever the so-called problem of transfers comes up in the orthodox theory of international trade, the discussion is always concerned with indemnity payments between governments and matters of this kind, never with spontaneous, economic money transfers, i.e., with capital movements in the strict sense.

Secondly, the theory of capital movements undoubtedly suffers from the fact that the transfer problem, which arises in capital movements as well as in indemnity payments, has taken up far too much room at the center of the stage. No attempt has been made to look beyond it, either at the causes of capital movements or at their effects. The discussion has been limited to the immediate process of international transfers, in the belief that practical and theoretical problems could be seen here which actually have turned out to be largely spurious. After the war, the mechanism of transfer naturally attracted more attention than ever on account of the question of reparations. It was generally held that everything there was to observe on the subject of transfer of reparations must also apply automatically to the case of capital movements. This assumption was, to say the least, somewhat premature. Since the causes and effects of capital movements are utterly different from those of reparations and indemnity payments, differences are bound to arise as well with regard to the mechanism of transfers; only a few of these can be mentioned here later. (The general theory of transfers can be assumed to be understood and will not be discussed in this paper.) What it is that divides the causes of capital movements from those of indemnity payments and similar unilateral money transfers is obvious, and needs no explanation. The main difference lies in the fact that the latter are not economically oriented. They move in an opposite direction from that indicated by profit expectation; otherwise the transfer would have taken place earlier, of its own accord. There will be no further reference to reparations and indemnity payments in this paper. We are exclusively concerned with the study of spontaneous, economic and productive capital movements.

II

The immediate cause of profit-oriented capital movements is an interest-rate differential. The main point is to find out how this interest-rate differential can come about. A useful though somewhat superficial view consists in assuming the interest rate to be the outcome of capital supply and demand. Consequently, a change in the interest rate can be induced either from the supply or from the demand side.

An interest-rate differential, hence a capital movement from A to B, can thus come into being in the following way: country A, for one reason or another, saves more than country B; in other words, the supply of capital rises. Or both interest-rate differential and capital movement in the same direction are caused by a fall in the savings rate in country B, which means a decline in the supply of capital. (The possibility of creating an interest-rate differential by increasing the capital supply in country A artificially through credit creation may be mentioned briefly as a factor on the supply side.) These variations in the savings rate have no problems to offer. Of greater interest are the variations that occur in the demand for capital and produce both interest-rate differentials and capital movements.

To begin with, suppose that a technical discovery or an improvement in methods of production takes place in country B, that B's products become cheaper: on this account and that physical output expands. But the value of output will obviously rise only if the elasticity of demand in the relevant sector of the demand curve is greater than one. Industrial profits go up in B, the entrepreneurs strive to increase production, this in turn drives up the cost of the factors of production — including the interest rate — and the result is a capital movement towards B. The more labor-saving the discovery in B and the greater the elasticity of demand for B's product, the more extensive the ensuing capital influx. An opposite effect is conceivable: the improvement in technical methods of production may release capital in B and lead to an export of capital from B. But this is not very likely to happen. It can occur only if (a) the invention is a capital-saving one, and (b) the elasticity of demand is lower than one. That the first requirement alone is not enough is shown by the fact that even if the discovery is only relatively capital-saving, a high elasticity of demand can lead to such substantial extensions in production that surplus capital will be necessary.

In the case we have just considered capital movements were brought about, in the last analysis, by a change in the technical requirements of production. In the case we shall take up next, the cause of capital movements is a shift in demand for various end-products as the result of a change in consumers' tastes.

For the sake of simplifying the demonstration, a gold standard will be assumed. Further, labor as a factor of production is assumed to have no external mobility. Lastly, we will suppose that the world consists of different "countries" in the following sense: each country manufactures several kinds of consumer goods, and the higher stages in production...