Short Essay on Pure and Monetary Theory of International Trade

International trade theories are usually classified into “pure” and “monetary” theory. The pure (or equilibrium) theory of international trade deals with “equilibrium” phenomena of trade.

It seeks to analyse and expose the conditions of equilibrium in real terms. It probes into the economic causes and consequences of international trade. The monetary theory of foreign trade is confronted with the monetary mechanism of international economic transactions, including financial transactions and capital movements.

It primarily deals with the determination of exchange rates and seeks to examine the methods and processes of adjustments in the balance of payments equilibrium.

The pure theory of international trade answers three sets of questions: First, why do nations enter into trade? Second, how are gains of trade shared by the trading nations? Third, how does international trade affect the allocation of resources in the domestic economy of the trading country?

A distinctive feature of pure theory of international trade is that it is part of general theory of value. It is, however, static general equilibrium theory (whether it be the classical theory of “comparative costs” or the modern “factor-proportions analysis”). At the most, “pure theory” is a rudimentary dynamic analysis.

The monetary theory of international trade, on the other hand, is at least partly a perfect dynamic theory, which is closely related to the trade cycle theory and Keynes’ General Theory of Income and Employment.

In economic literature so far, however, no successful attempt has been made to explain fully how these two types of theories are interlocked. Perhaps the reason for this may not be far to seek.

The pure theory of international trade fundamentally deals with the shift in the economic equilibrium from one position to another on account of dynamic changes like changes in preferences, technology, economic policy, etc. It seeks to describe and analyse the features of new equilibrium.

The monetary theory of international trade, on the other hand is confined to the process of adjustment leading back to equilibrium. Pure theory generally could not very successfully analyse and describe the process of adjustment. It could only figure out equilibrium positions.

As such, international monetary theory has always to confront one or the other of the following problems: either (1) it is trivially simple or (2) it involves specific and sometimes unrealistic assumptions about the nature of adjustment. The latter fact, however, puts the generality aspect of the theory in doubt. Consequently, it becomes difficult to integrate monetary theory into the skeleton of pure economic theory in a rational and realistic manner.