6. Tariffs and the Transfer Problem

The transfer problem has attracted much attention in the literature of international trade theory since the famous controversy between Keynes and Ohlin in the late 1920s. Practically, the international transfer of purchasing power is widely observed in various guises such as private remittance, reparation, and economic aid. Theoretically, it poses an interesting question concerning the income effect of income transfers between countries. This question lurks also in the analysis of currency devaluation, often conceived as an attempt to affect the international terms of trade to create a trade surplus. Discussing the German reparation problem, Keynes (1929) held the position that the expenditure of the German people will be reduced, not only by the amount of reparation, but also by a decrease in their gold-rate of earnings. As Ohlin (1929) pointed out quickly, however, Keynes thereby failed to pursue the logic of his own argument: “if ₤ 1 is taken from you and given to me and I choose to increase my consumption of precisely the same goods as those of which you are compelled to diminish yours, there is no transfer problem.” (See Keynes 1929, p. 2.) Later analysis, notably Samuelson (1952, 1954) and Johnson (1955), elucidated the implications of this logic in the context of a two-country, two-commodity model of trade. They showed that the direction of change in the terms of trade depends crucially upon the relative magnitude of the marginal propensities to consume between the two countries. There is, however, no presumption about this relative magnitude under free trade with no trade impediments.