273. J. M. Keynes to Harrod , 26 December 1932 [a]

[The exchange continues at 274 ]

Tilton, Firle, Sussex #

26 December 1932

My dear Roy,

This is a curate's egg! [1] Chapter 2 is excellent. I've never seen the fundamentals of the Comparative Cost doctrine expressed half so well. The trouble is in Chapter 6. I still [2] think this frightfully unsuitable--partly because it is so difficult, partly because it is so very much the opposite of a introduction to other discussions of the topic, but partly because I am not satisfied with it on its merits.

Before I come to this, however, I have a few notes on minor points:--

(1) Chap IV. [b] In various passages hereabouts--whenever equilibrium is not assumed--it would help the reader if he knew quite clearly whether or not a gold standard is supposed. [3] This only arises when disequilibrium is in question

(2) Chap IV pp. 13-15. I am sorry that you have cut out all this in reference to Dennis's criticism. [4] I think you could meet his point by the addition of a couple of sentences, P.P.P. ought to be dealt with [5] and what you have written seems to me to be substantially just.

(3) Section on the price level of the factors of production is not very clear. [6] Obscurity may be due, I think, to (a) your not distinguishing between competitive and non-competitive cheapness and (b) your not bringing out that the age-long struggle for foreign trade is really a struggle to increase investment. [7] If the domestic interest rate is not amenable, increasing the foreign balance is the only way open of increasing investment and therefore of moving nearer to optimum output. This point, to which I attach first class importance, seems to me your major omission.

(4) Chap V p. 10 [8] needs bringing up to date now that we are off the gold standard

(5) ditto p. 11. Isn't India a better example that Hungary of a sterling standard? [9]

(6) ditto p. 12. Couldn't you give a clearer and more elementary description of a bill? [10]

(7) Chapter V sections 5 and 6. I am doubtful if these sections are really necessary.

(8) Ch. VI, p. 2. [11] You are assuming, I think, not merely that the rewards to factors are inflexible, but that prices are constant.

(9) Chapter VI p. 30. The foreign loan may be, and is often, to meet a budget deficit.

(10) Now for my major point.

Your self-regulating theory of the foreign balance seems startling, because you enunciate it in such a way as to make it appear independent of the policy pursued by the Central Bank. But is it? Suppose that an unfavourable balance develops and gold flows out. The effect of this both on the volume of money and on the level of incomes entirely depends on what the Central Bank does about it. If the Bank depletes inadequately, the adverse balance continues indefinitely. This brings us straight back to the orthodox, traditional treatment. An adverse balance does not directly and automatically reduce incomes. You seem to be thinking of a country with no banking system and no circulating money except golden sovereigns. [12]

Nor can I satisfactorily translate into your terms the effects of increased investment. Let us suppose that the Govt. superimposes a housing scheme on an existing situation of a balanced international account. Incomes and prices are increased. More money is needed in circulation. On every ticket the foreign balance turns adverse. By what mechanism is this position self-adjusting, unless we suppose that the Central Bank terrified by its [c] loss of gold takes steps to diminish investment in some other direction? I think it possible that you can pursue your kind of analysis, which is very interesting in itself, by introducing enough assumptions. But it seems to me to be abstract and unrealistic and to encourage false ideas in the mind of an innocent reader. You really have primarily in mind, I think, the abstract case when there is no banking and no foreign investment, where a loss of gold depletes private balances pari passu and where individuals "automatically" reduce their spending in order to restore their balances. [13] But this is quite unrealistic. How, again, do you deal with difficulties arising out of interest rates at home being out of equilibrium with interest rates abroad?

Para p. 32. Why will "a sudden large increase in the volume of foreign lending capacity have a violently adverse effect on the level of income"?

On p. 42 (1) What do you mean by "automatically"? Do you mean "irrespective of the discount policy of the Central Bank". [14]

I agree that unemployment is an alternative remedy to loose wages and that deflation may cure the foreign balance this way before it has cured in the other way. [15] But I see nothing "automatic" about the deflation itself.

(11) Chap IX p. 19. Do you do justice to the point that if tariffs improve the foreign balance, they will increase employment because they will increase investment? [16]

I do not consider the "suitability" of the book to the series a vital matter. [17] There is much in this book which is very good indeed. You are entitled to print any of it. It would be wrong to pester you too much about it. Anything you want to print, I, as General Editor, will be prepared to pass. But I'd like you to think over again the position of Chapter VI.

Yours ever,

J M Keynes

  1. 1. Harrod, International Economics ( 1933:10 ). The draft referred to is not extant, and not all references can be precisely identified.

    2. No documents have been found concerning the occasion of Keynes's earlier dissatisfaction with chapter VI.

    3. Harrod specified on p. 62 that a common world monetary standard is presupposed throughout the chapter.

    4. Robertson's comments on chapter IV are not spelled out in any of the extant letters; they were probably written in the margin of the draft, which is not extant.

    5. Harrod eventually discussed the theory of purchasing-power parity on pp. 70-71 of his book.

    6. Harrod, International Economics ( 1933:10 ), chapter IV § 5.

    7. Harrod dealt with (a) on p. 78, while there is no reference to (b).

    8. Harrod, International Economics ( 1933:10 ), p. 89.

    9. Harrod, International Economics ( 1933:10 ), pp. 89-90. Harrod maintained the reference to Hungary.

    10. Harrod, International Economics ( 1933:10 ), chapter V § 3 on "Bills of Exchange".

    11. Harrod, International Economics ( 1933:10 ), pp. 105-6.

    12. Harrod's chapter VI was further discussed in letters 274 , 277 , 278 and 280 , and during revision it was subject to extensive changes. Specifications on the role of the Central Bank were inserted on pp. 127-28 and 131-34.

    13. Harrod met Keynes's criticism by introducing a section discussing "Equilibrium in Simplified Conditions" ( 1933:10 , pp. 104-15). This was approved by Keynes: letter 277 , [jump to page] .

    14. Harrod eliminated the term "automatically" from chapter VI.

    15. Harrod, International Economics ( 1933:10 ), p. 107.

    16. Probably refers to § 4 of chapter IX. The nexus suggested by Keynes was not made explicit in this chapter (see also note 7 to this letter).

    17. Harrod had already expressed to Robertson in April his concern as to the "suitability" of his book to the Cambridge Economic Handbook series: see letters 234 and 236 .

    1. a. ALS, seven pages numbered from the second, on four leaves. In HP II-25. Reproduced by kind permission of the Provost and Scholars, King's College, Cambridge.

      b. Punctuation was often missing after the indication of chapters and sections; it has been added throughout.

      c. Ms: «is».

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