AUSTRALIAN CAPITAL INFLOW, SECTIONAL PRICES AND THE TERMS OF TRADE: 1870-1939”

DAVID POPE

University of New South Wales

INTRODUCTION

Few students of economics today could fail to be aware of the ‘Dutch Disease’, or among Australian students, its antipodean equivalent. the Gregory Thesis. Certainly over the last few years considerable academic and public attention has been directed at the balance of payments and intersectoral effects of mining booms - whether North Sea oil o r Australian minerals (Gregory, 1976; Corden and Neary, 1982; Corden, 1982). At a formal level analysis proceeds by notionally dividing expenditure into two categories, that on ‘domestic’ or ‘non-traded’ goods and that on ‘international’ or ‘traded’ goods, the prices of the latter being set by world conditions, while the former are free to rise. A boom in a ‘traded’ goods industry brings rising export revenue and capital inflow and affects relative prices (for one thing, of ‘non-traded’ to ‘traded’ goods), relative profitability and the distri- bution of resources.

Almost 50 years before these ideas were taking shape there was a debate in the interna- tional trade literature which paralleled and in many respects anticipated them. The impetus was different. At the heart of it, and here an Australian, Roland Wilson, contributed handsomely, was the question of how international capital was transferred from lender to borrower and the role of ‘traded’ goods prices (in the form of the terms of trade) and ‘domestic’ goods prices in the transfer mechanism. Traditional wisdom was that the terms of trade must move against the capital exporter and in favour of the importer, and it was this doctrine that Wilson helped tumble with his analysis of the relation between Australian capital imports and ‘domestic’ prices. Others have subsequently questioned the relevance of any theory that posits a causal link running from capital inflow to ‘traded’ goods prices, for the relation, as ihey see it, is one that runs the other way.

The purpose of this paper is to examine the causal relations between capital inflow, the terms of trade and ‘domestic’ prices over the sixty years prior to World War 11. The paper is divided into three parts: the first briefly traces Wilson’s hypothesis and his test results; the second discusses measurement problems; the third reports our results of Sargent’s dynamic regression test of causality applied to capital inflow and reltive price movements.

’,, This paper has benefited from discussion with Noel Butlin and Glenn Withers. Lucia Carrozzi provided diligent research assistance.

68 AUSTRALIAN ECONOMIC PAPERS J U N E

(a) Antecedents

Classical doctrine as stated by John Stuart Mill asserts that the volume of imports and exports in the two countries, the capital importer and exporter, change so a s to give the former an excess of commodity imports and the latter an excess of commodity exports. The transfer is complete when the adjustment of trade balances has created a deficit and a surplus equal in amount to the capital borrowed. The transfer is associated with a permanent change in the terms of trade to the advantage of the capital-importing country. In a barter economy the capital-exporter must barter a greater quantity of commodity exports on cheaper terms, In a money economy the same results ensue though in this version they are brought about by the price-specie-flow mechanism. The first remittance is made in money, lowering prices in the capital-exporting country and raising them in the receiving country. This then leads to greater commodity exports from the capital-exporter than before and an excess of imports in the receiving country’s balance of trade.

The classical proposition received support in the writings of Taussig (1927) and Viner (1924, pp. 295-297). The latter introduced some modifications through his analysis of the so-called sectional prices. By this he meant the relative price of imports and exports (‘international’ goods) to those of ‘domestic’ goods. The first result of borrowing, Viner argued, was to swell bank balances in the capital-receiving country, exerting pressure on the prices of ‘domestic’ commodities. By contrast, the prices of import and export commodities might not be appreciably or equally influenced. Some substitution of imports for some home-produced goods might occur, while exports from the capital-receiver could decrease, for the rise in ‘domestic’ prices will mean higher money costs of production in the export industries. Moreover, labour will be drawn away from the export industries (in the case of Australia’s resources boom, ‘traditional’ exports suffer). Finally, the balance of trade of the borrower can still be affected even where the money borrowed is spent on its own ‘domestic’ goods - for this would reduce the commodities available for export in the borrowing country.

In examining the change in ‘international’ prices Viner found that in the Canadian case export prices rose more than import prices (he does not adopt the small country assumption with regard to Canada’s exports arguing that it was only special circumstances - cost-reducing discoveries and technical improvements - that staved off even more rapid rises in export prices). It is this change that is taken as verification of the classical doctrine of the relation between capital movements and the terms of trade.

(b) The Australiati Connection

Bastable (1890) had challenged whether Mill was in fact right when he maintained that the exporter suffered an unfavourable shift in the terms of trade; might not the outcome depend on the shifts to which the capital transfer and purchasing power gave to demands of the two countries for the products of each other? Viner’s discussion of sectional prices acknowledges this challenge. Yet Viner never followed the argument quite through. Roland Wilson, at one time his student, was to d o so.

Wilson explicitly recognised the transfer of income involved in an export of capital and from this position argued that it was possible for the terms of trade to remain constant, to

1986 CAPITAL INFLOW, SECTIONAL PKlCES AND TERMS OF TRADE 69

turn in favour of the capital-exporter, or. as predicted by classical theory, in Favour of the capital-receiver, depending on the propensity to spend out of the redistributed purchasing power on imports. exports and 'domestic' goods and services. This then gives the directiorl. The relative size of the countries i n world trade determines the inagiiitride of change in the terms of trade, and here this would be small unless the borrowing country was the main world supplier of what it exported or the main source of demand for the goods it imported. H e though that this would not normally be the case. The sectional price ratio would change to accomplish the capital transfer. but. and here he differed with Viner, the real cause was not changes in 'international' prices but in those of 'domestic' goods. (From these initial price movements productive effort would be transferred from the traditional export sector towards 'domestic' industries in the receiving country. vice versa in that of the capital- exporter).

Wilson argued that his data, this spanned 1870-1930, offered no support for the link between the terms of' trade and capital imports. ' I t lent,' he said, 'no support to the theory currently accepted ... No consistent correlation. positive or negative, is apparent' (Wilson, 1931, p.103). However, regarding the conncction between shifts in the relative price of 'domestic' to 'international' commodities, his series offered some confirmation that these occurred

Taking the data presented in the Chart as a whole, it may be claimed that some verification is found in Australian experience for the proposition that imports of capital tend to be positively correlated with increases in the ratio of the 'domestic' price level to the price level of 'international' commodities. Complete verification is not possible with the data a t present available (Wilson, 1931, p.106).

(c) Rezierse Causafioii The distinction that Wilson niade so clearly between 'domestic' and 'international' goods

and the division of expenditure into these categories found its way -wittingly or otherwise - into the writings of two subsequent generations of Australian economists.' That the terms

' I t is the hasis of Salter's (1959) analysis. 'Internal and External Balance: The Kolc 0 1 Price and Expenditure Effects' In turn the rudiments can be found in Swan's (1965) 'Longer-Run Problems of the Balance of Payments', originally given to Section G of ANZAAS, Melbourne. 1955, to which Salter acknowledges owing much. James Meade's (1956) 'The Price Mechanism and the Australian Balance of Payments'. adopts the language of 'cxportables', 'importables' (imports and import- competing products) and 'domestic' products. He also etnphasises that the terms of trade for a small country like Australia lay largely outside her control and consequently, changes in 'domestic' prices and costs (relative to other prices) might correct balance of payments problems. Meade acltnow- ledged that ' the ideas contained i n the article owe their origin to many conversations with many economists in Australia' - particularly S w a n And i i i turn Swan explicitly recognised the contri- bution of Wilson. ' I t is significant.' he wrotc. 'that an economist from a primary producing country was one of the first to develop balance of payments theory along new lines by stressing the relationship betuieeri external prices and domestic costs. rather than the terms of trade'. Swan (1960. p. 54) . Bob Gregory relates that his thesisofthebalanceotpayments effectsofa rniningboom was not influenced by a knowledge of Wilson's work. However Gregory was aware of Salter's article before his paper was published and was most helped by Max Corden's insistence that the terms of trade could be taken as a d a t u m This perniittcd Gregory to draw the demand for imports and exports on the same graph - from whence his analysis progressed.

70 AUSTRALIAN ECONOMIC PAPERS JUNE

of trade may not have been critical to the transfer mechanism of international capital movements does not of course mean that variations in the terms of trade could not, and have not, disastrously disturbed external and internal equilibrium.

This raises the question of reverse causation. Instead of treating changes in the terms of trade as a consequence of capital movements, might not the latter be caused by movements in the terms of trade, for instance, capital attracted by rising Australian export prices? Taking the case of British investment in the nineteenth and early twentieth century, Cairncross (1953, p.208) concluded that ‘... it was upon the terms of trade that the distri- bution of investment between home (UK) and foreign ... ultimately depended’. In a similar vein Rostow (1953, p.208; 1980, pp.91-110) has long argued that cyclical movements in the terms of trade reflect underlying powerful shifts in the relation between world demand and supply of particular major commodities and that this has presented opportunities for profitable investment and induced international capital movements.

Not only could the terms of trade affect capital inflow but a t least one researcher, Hall (1963a), has contended that rising ‘domestic’ prices in the capital importing country might feedback on capital inflow providing a reason for its continuance even in the face of adverse movements in the terms of trade.

All this points to the fact that in examining the relationship between Australian capital inflow, the terms of trade and sectional prices, we shall have to be very careful to design a test of the real direction of causality. But before attempting this we turn to the data.

I1 MEASURING CAPITAL I N F L O W A N D PRICE LEVELS

(a) Capital Imports

Chart I shows four separate series of Australian capital inflow. In order to compare the series it was necessary to convert sdme date from calendar to financial years.’ More generally, differing concepts and modes of measurement of capital imports mean that we should not expect perfect agreement between the series. Hall’s (1963a) series relate t o new Australian nominal capital issued on the London Stock Exchange. As such they d o not necessarily catch the flow of funds to Australia. They do not, for instance, include money raised outside the Exchange, nor d o they take into account the extent to which issues were actually taken up. Moreover, n o account is made of repayments of borrowings which were heavy during the 1890s, whereas Butlin’s (1962) and Wilson’s (1931) estimates do. It is not surprising, for this reason, that these series fall more sharply compared to Hall’s in the 1890s, nor, as they include non-Exchange sources of funds, that their volumes exceed Hall’s figures during the 1880s.

While Butlin and Wilson’s series disagree on individual turning points, the correspondence is quite high considering the different methods employed: both depict the same major shifts in the longer term trends, and reflecting this, the correlation between the two is high, r = .90.

* By taking a two year moving average of calendar year data

1986 CAPITAL INFLOW, SECTIONAL PRICES AND TERMS OF TRADE 7 1

CHART I

AUSTRALIAN CAPITAL IMPORTS ( $Am 1

/

Wilson's Series 50

0

- 50

50

0

-50

/ '

n Net Apparent Inflow

A/ V

Hall's New Issues

scale+

Butlin's Direct Estimate

A + scale

1

1880 1890 1900 1910 1920 1930

100

50

0

50

0

-50

For years prior to 1904 Wilson obtained his figures by interpolating earlicr estimates made by Coghlan. How Coghlan compiled his original series is, however, unknown. Butlin's estimates shown in Chart I werc derived directly fom the balance sheets of private institutions, banks, pastoral finance and mining concerns, to which were added government borrowings and estimates of the money introduced by immigrants. The problem with this method of estimation is casting the net to catch the fish, that is, casting it to catch all the investors.

For the years after 1903 Wilson's estimates were derived by the indirect method, net apparent inflow being deduced as the residual in the balance of payments, that is

A F R = ( X - M ) - NPI + (PNAKI+GB) (1)

12

then

AUSTRALIAN ECONOMIC PAPERS J U N E

N A K l = (PNAIiI+GB) = ( M - X ) + N P l t FR

where

dFR: change in Australian foreign reserves

X : value of exports

M : value of imports

NPI: net income paid abroad

PNAKI: private net capital inflow

GB: government borrowing

NAKI: net apparent capital inflow

Wilson later implied that several items in his payments calculations needed to be reconsidered. The graph at the top of Chart I uses equation 2 and draws on Butlin’s (1962) construction of the balance of payments, which incorporates corrections in accord with Wilson’s suggestions, plus subsequent changes to Butlin as proposed by McLean (1968), P. L. Swan (1968) and M. W. Butlin (1977). Two potential sources of error must be mentioned. In our period governments did not control the country’s foreign reserves. These were held largely by the trading banks partly in gold in Australia and partly in gold and sterling in London. And the trading banks did not divulge their London funds. These have been estimated by a similar procedure to the one used originally by Wilson in which Australian and New Zealand assets of Australian trading banks are subtracted off the Australian banking system’s total assets.

The second difficulty concerns government borrowings. Governments were major borrowers. But they often did not transfer money immediately (our figures relate to raisings), nor bank with Australian trading banks; this could affect A F R and N A l i l . Nonetheless it is believed that the series give a reasonably accurate general picture of capital imports over the years of interest to us here. In the next section we examine some coneptual and measurement problems with prices.

(b) Prices

On the surface the concept of ‘non-traded’ or ‘domestic’ goods seems neat enough. However there are many problems in translating the idea into an operational variable, which in turn raise questions about the very nature - and existence - of such goods.

‘International’ goods are not restricted to those goods which directly enter international trade, but also include all those that could enter and in Wilson’s words ‘those whose prices may be expected to fluctuate in sympathy’, for instance, substitutes and goods with traded inputs. The problem is obvious. The number of goods lying outside this class of tradeables is surely very small. Indeed it might be argued, in principle a t least, that all goods are tradeable.

1986 CAPITAL INFLOW, SECTIONAL PRICES AND TERMS OF TRADE 7 3

Historically the telegraph played a major role in linking home prices to world markets. Coghlan observed,

Prior to the discovery of gold. coniniunication by letter with the outside world was at best uncertain, and as late its 1878 the regular mails were made up but once a month. The establishment of telegraphic communication, amongst other results, has had a marked effect on prices. so that except in rare instances, and lor goods produced in excess of the demand. the production of Australia no longer determines the prices of goods required for the local markets. Exception must, of course, be made for perishable produce .. (Coghlan. 1896, p. 795).

Perishables, then, might be seen as ‘domestic’ goods, though with the introduction of cold storage techniques in the early 189Os, this was no longer true of many items. By the turn of the century Australian meat and dairy products were regular fare to many Englishmen,

In the recent literature on resource development and sectional price movements, ‘house- room’ and local services such as those provided by barbers, barmen and house-cleaners. are typically cited as examples of ‘domestic’ goods: houses and haircuts arc not, so the logic runs, traded internationally. But a word of caution is in order. Bricks and building stones were often carried as ballast by ships in the age of sail. In 1854 enough bricks (around six and half million) were landed in Victoria from the UI< to have met substantially all new brick house construction in the state that year. While 1854 was exceptional in this regard, Victorian records reveal not inconsiderable trade in building inputs: in 1881 imports included 16 million super-feet of dressed timber, 20 million of undressed. six thousand boxes of workmens’ tools, 260 tons o f nuts and bolts. 1.5 million super-feet of window glass and, from Boston, 2000 doors. Nor is i t true that ‘domestic service’ was not traded. The rich brought their servants with them, while middle class residents‘ wants were at least partly satisfied by state-subsidised immigration of domestic workers, especially women for house-work and for work in hotels.

Rather than think of the distinction between ‘domestic’ and ‘traded’ as an absolute one, it makes more sense to see it as one ofdegree. that is, to think ofa spectrum, at the top end of which stand those items most easily traded or tradeable, at the other end the converse Technology, relative prices and costs go to determine the position of any good in the spectrum.

Turning f‘rom theory to practical measurement. Wilson investigated movements in sectional prices with the aid of two series of ‘domestic’ prices, money wages and the retail cost of living index. Money wages were reckoned by both Viner and Taussig to be the best single measure of ‘domestic’ prices and Wilson followed their lead. The cost of living was useful ‘since the prices of domestic goods and services such as “house rent” are often included’ (Wilson, 1931, p.94). In fact the cost of living index is especially deficient since most items included in the regimen entered international trade (ziiz. beef, mutton, tea, coffee, butter, cheese, soap, starch).

74 AUSTRALIAN ECONOMIC PAPERS

CHART II

‘DOMESTIC’ AND ‘TRADED’ GOODS PRICES ( 1911 = 1000 )

- I ‘Traded’ I \ .I

JUNE

I I

1880 1890 1900 1910 1920 1930

The construction of our index of ‘domestic’ prices is discussed in detail in the Appendix. Briefly, the index comprises three major components: food, measured by the perishables, potatoes and fresh eggs; ‘domestic’ services, measured by the earnings of service agents including barbers, barmen and domestic servants; finally, ‘house-room’, measured by rent. These indices were aggregated by shares in expenditure and the resulting series is shown in Chart 11. ‘Traded’ goods prices, also shown in Chart 11, are measured by the simple average of import and export prices.

111 TRACKING T H E C A U S A L RELATIONS

(a) Tests of Statistical Causality

A large body of literature has appeared in recent years specifically addressed to the question that concerns us here. How can we determine the ‘facts’ about the causal relationships between variables - in our case between the variables in Chart 111, Australian capital inflow and certain price relatives?

This literature is based upon Granger’s (1969) definition of causality which states that for two variables X and Y, X causes Y if present Y can be better predicted using past values of X than by not doing so. I f X causes Y and also Y causes X, feedback is said to exist. These definitions only pertain to stationary non-deterministic time series, a stationary series being trendless in mean and variance while the deterministic component of a time series is that part which can be prediged from its own past history, hence the non-deterministic component is that which cannot.

1986 CAPITAL INFLOW. SECTIONAL PRICES A N D TERMS OF TRADE 75

CHART 111

AUSTRALIAN TERMS OF TRADE, CAPITAL IMPORTS AND SECTIONAL PRICES

Ratio 1 .40

1 . 2 0

1 . 0 0

. 8 0

($Am) 100

50

0

Ratio

1 . 2 0

1 .oo

. 8 0

n Ratio o f Export to Import Prices

U

Net Apparent Capital Inflow

Ratio o f 'Domestic' to 'Traded' Goods

I

1880 1890 1900 1910 1920 1930

Box-Jenkins' auto-regressive integrated moving average techniques have been widely used to generate data histories with such characteristics, the Box-Pierce statistic being a common criterion for determiningwhether the data can reasonable be so described, that is, that the residuals or transformed series are 'white-noise'. I t is the cross-correlations between these transformed 'white-noise' series which constitute a test a Granger-causality. An alternative procedure which is asymptotically equivalent, but has the advantage of superior small sample properties, employs dynamic regression methods. Originally suggested by Granger and recently developed by Sargent (1976), this involves regressing Y on ( i ) its own past values (the auto-regressive component of the time series), ( i i ) a trend variable and dummies where appropriate, and ( i i i ) lagged values of X which potentially cause changes in Y . A constant term isalso included. Standard t statistics provide the usual evidence on the reliability of the lagged X ' s as predictors of Y , and F, Wald (W). Lagrange

76 AUSTRALIAN ECONOMIC PAPERS JUNE

Multiplier (LM) and Likelihood Ratio (LR) statistics can be used to assess the significance of the group of predictors taken together.’ Reverse causation can be examined by regressing X on lagged values of Y (plus the auto-regressive component, trend and constant term), with any evidence of bi-directional causation being evidence of feedback. It is this method that we shall follow.

In the case of testing undirectional causality from capital imports to changes in the terms of trade, and from capital imports to changes in the ratio of ‘domestic’ to ‘traded’ goods prices, we posit the two following estimating equations,

where

TT:

DTP:

NAKI:

ratio of Australian export to import prices (terms of trade)

ratio of Australian ‘domestic’ to ‘traded’ goods prices (sectional prices)

net apparent capital inflow into Australia

T: time

TS: dislocation dummy

The equations for reverse causality involve the transposition of Vt in equation (3) for NAKlt and similarly of DTPt for NAKlt in (4). The binary variable, TS, takes on the value of unity in 1915 to 1919, zero at all other times. From contemporary accounts of the times capital markets were less disarranged by the war than commodity markets. Wartime controls on both prices and capital markets appear to have been fairly ineffectual. Not all prices, however rose, the demand for ‘house-room’ and residential construction slumped. (Scott, 1936, pp.524, 57 1-73; Will<inson, 1917, p.65).

’ In an equation with T observations and I< independent variables subiect to r restrictions define U E S S as the error sum of squares without the r restrictions imposed and R E S S as the error sum of squares with r restrictions, then,

F = [(RESS-UESS)/UESS) [(T-f<)/rl

and

W = T ( R E S S - U E S S ) / U E S S

LM = W / ( 1 f W l n

LR = T . l n ( l + W I T )

The Wald ( W ) , LM, and LR statistics are asymptotically distributed X’ (r), and the F statistic is distributed F(r, T-I<). The number of restrictions, r. equals the number of causal predictors omittcd from the restricted regression

1986 CAPITAL INFLOW, SECTIONAL PRICES AND TERMS OF TRADE 77

(b) Empirical Resulfs

Equations 1.1 and 1.3 ofTable 1 set out tests for Granger’s definition ofcausality between capital inflow and the terms of trade, while 1.5 and 1.7 of Table 2 report results of similar tests for capital inflow and the sectional price ratio.

Focussing first on Table 1. equations 1.1 and 1.3 suggest that neither capital inflow caused movements in the terms of trade (the classical hypothesis), nor the terms of trade caused changes in the level of Australia’s capital imports. In both cases only the lagged endogenous variables were significant, representing the autoregressive history of the dependent variables (which, with the time trend, theoretically capture forces other than the included X ’ s ) . Equations 1.2 and 1.4 indicate, however. that Australian capital movements and the terms of trade were contemporaneously correlated. But it is not possible to say whether such correlation involved Granger-causality, for the concept rests alone on the structure of the lugged relations.‘

That the terms of trade and capital imports moved together raises the question of whether the equations are misspecified, principally whether the lagged Y s and the time trend adequately represent all influences over and above the included X ’ s . In this respect tests for serial correlation are an important indicator of misspecification. The values of the dw and h statistics suggest, however. that first order serial correlation is unlikely to be a problem in equation 1.1 (and 1.2). As h could not be calculated in our equation testing for the terms of trade as a cause of capital inflow, and the value of dw might be misleading given the inclusion of lagged endogenous variables in the equation. we computed a t value for the first order serial correlation coefficient (rho) which provides an asymptotically equivalent test to Durbin’s h statistic (Johnston, 1972, p.313). On this basis the null hypothcsis of first order serial correlation was rejected. It was also rejected for equation 1.4.

A number of variants of the equations were also cstimatcd, including the incorporation of a non-linear time trend, different lags on the Ys and X ’ s and the exclusion of the insigni- ficant dummy, but without casting further light on the conteniporaneous relations between capital imports and the tcrms of trade. In addition, two further operations were tried: modifying the dcpcndent variable in the instance of capital imports by subracting government borrowing, and secondly, extending the data into the post World-War I I period. The first of these operations yielded results in all respects the sainc as those reported above; the coefficients of contemporaneous X ’ s were significant while those of lagged X ’ s were not. The second operation involved running thc same equations chronicled in Table 1 , but on data for 1870-1980. This produced insignificant coefficients for both contemporaneous and lagged X ’ s .

In summary then. using annual data and Granger’s definition of causality, we find n o evidence of capital inflow into Australia between 1870 and 1939 being caused by changes in the terms of trade or vice versa. However. the two were correlated contemporaneously. Both ruse and fell togcthcr. But this last relation has not been a stable one and in long-run perspective appears to have been statistically insignificant.

’ The contemporaneous period is del’ined i i i this study as the current year Quarterly data. if i t wcrc availablc. might yield a different answer to the question.

78 AUSTRALIAN ECONOMIC PAPERS JUNE

m - - 0

N W m - N m n - m r. n - r. 0 .e - Lo 0 d

0

N

ID 0

r-

0 - m - niD m c c 0 - m 3 - t o p -

- _ _

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N

W m m N

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0 Ln m - r. r. 0 0 - ID n m

Lo

d r- m

2

d m 0

n

Lo d LD

0

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gt3

1986 CAPITAL INFLOW, SECTIONAL PRICES AND TERMS OF TRADE 79

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N

0 N 0

Ln - iD Lc. -r m - r- n m iu -

L r r. r.

3

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0 - 0 - 0 N o m o m a m 0 0 CE

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X z it

zi

I? m

m

it r. X

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c 5" LT

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N - 0 - c n in - 3 u;i t x PI ri r.- F

t - 3 I. -10

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80 AUSTRALIAN ECONOMIC PAPERS IUNE

Rather different results were obtained for the causal links between movements in sectional prices and capital flows. Briefly, the most important of these was that there was no contemporaneous correlation between capital and sectional price movements but that the ‘domestic’ to ‘traded’ goods price ratio revealed statistically significant sensitivity t o lagged capital flows and vice versa. All diagnostic statistics on the joint significance of causal variables are highly significant. In short, the conditions for Granger-causality are met.’

To check how robust these results were to changes in the definition of ‘domestic’ goods, we varied the weights by which the separate price indices were.originally aggregated. The results reported in equations 1.6 and 1.8 were not altered in character (even when the food prices component was entirely omitted). In all cases the null hypothese of the presence of first order serial correlation was rejected (where h again could not be calculated, the t values of rho plus those of the autocorrelation coefficients of the correlograms were used as diagnostic test statistics to supplement dw).

Conctusions

I t is necessary to express some caution about the results that we have reported. Firstly, we stress that the concept of ‘domestic’ goods is a somewhat dubious one and certainly one fraught with measurement difficulties. Secondly, the concept of Granger-causality cannot help us to understand contemporaneous interrelations between variables where they exist, nor can one be sure that the estimating equations designed to test for its conditions are free from misspecification errors (tests for serial correlation are after all probablistic, not absolute).

Nonetheless our results appear sufficiently consistent and robust to at least advance them tentatively so that others might pursue the leads that they offer.’With this in mind we conclude with four points.

First, Wilson argued that the classical doctrine of the transfer mechanism was discon- firmed by the absence of a significant (contemporaneous) positive correlation between the Australian capital inflow and Australia’s terms of trade. Using new time series of capital imports and ‘traded’ goods prices, we have found evidence of a contemporaneous correlation between the two but d o not treat this as necessarily evidence of causation. Using Granger’s definition one arrives in fact at the conclusion that Wilson so clearly sought; that is, that capital imports proceeded without causing the terms of trade of the capital importer to change.

’ The significance, and negative signs, of the dummies in equations testing for NRKI as the cause of DTf is not central to our conclusions. Literally they mean that seine shock damped the ratio of ‘domestic’ to ‘traded’ goods prices. German U boats acting on the denominator of this ratio, and house-room ‘vacated’ by Australian soldiers acting on the numerator, could have produced this disturbance. But we rcadily admit that this is a rationalisation. We did not have a consistent long- r u n series to test the hypothesis on the years 1870-1980. Nor do we wish to suggest that modern causality tests replace conventional structural modelling. Rather, they Carl provide valuable information on theexojierieiryofvariables which can then be used in multi-variable structural representations with which most economists and economic historians are more familiar.

’

1986 CAPITAL INFLOW, SECTIONAL PRICES AND TERMS OF TRADE 81

Second, though Wilson never addressed the question of reverse causation, others have. Again on Granger’s definition and using annual data we could not detect any significant impulse running from the terms of trade to Australia’s capital imports. In our view this is probably not too surprising for the sounds in the ears of rural producers and investors were unlikely to be faithful reproductions of the price signals of international food and raw material markets. For one thing Australian governments from at least the depression of the 1890s have extensively intervened in the production and marketing of rural output to insulate rural producers (and investors) from the instability of markets.

Third, while Wilson argued that the terms of trade did not have t o change as a consequence of capital imports, he thought it more probable that ‘domestic’ prices would rise relative to ‘traded’ goods prices and that this process was an integral part of the so- called transfer mechanism by which capital flows were effected. Wilson reported weak evidence for this in finding positive correlation between capital imports and the sectional price ratio. We found strong evidence of capital inflow exerting pressure on the price ratio with a lag on one year, and take this as confirmatory support for Granger-causalityrunning in the direction proposed by Wilson.

Fourth, domestic prices appear to have positively fedback on the level of Australia’s capital inflow, lifting it when the price ratio rose and causing it to fall, with a lag, when it fell. This is a n extension of the Wilson hypothesis and also finds expression in the new monetary theory of the Balance of Payments (Kreinin and Officer, 1978). Further research is needed to identify, if one can, the ‘domestic’ industries which benefited, but Hall (1963a, 1963b) has argued that the demand for residential housing (‘house-room’ aswe have called it), which was fattened on capital imports from London’s money brokers, boomed in the 1880s, and again before and just after World War I.

A t 1 w N D I x

The data are for June-ended years. Where necessary calendar years were converted to fiscal years by a two year moving average.

(a) Nowtraded Goods Prices. The four series taken to represent the course of’domestic’ pricesare the New South Wales statistician’s series of the prices of fresh eggs and potatoes appearing in the New South Wales YearBook. and N. G. Butlin’s (1962, p. 455) subdivisional price indices of ‘property and finance, government services, professidnal and personal services’, and ‘rent’. Butlin’s index of the first is a simple average of the earnings of specified prokssionals. school-teachers and personal service including the regularly cited classic categories of domestic servants, hairdressers and barmen. The rent series is made up of Victorian and New South Wales building society data to 1900; thereafter it is from the A-series (All Houses) price index in Commonwealth Labour Reports.

Wc do not pretend that there isany easy solution to the problem ofaggrcgating thesevariousseries. We have done the following. The NSW statistician provides detailed estimates of the state’s expenditure for 1900. Grouping ’services’ as expenditure on locomotion. personal attendance and domestic service. medical attendance, education (but excluding state expenditure). charities, art and amusement. yields for 1900, a figure of 13 per cent oftotal expenditure. Rent comprised 10.3 per cent and food 34.1 per cent. The last component largely consisted of foods that entered trade. Here we have assumed that non-tradeable type food goods - represented by perishables like fresh eggs and potatoes - amounted to no more than one-third. Arithmetic then gives the following weights: fresh eggs and potatoes (.326), rent (.299) and services ( .377) .

82 AUSTRALIAN ECONOMIC PAPERS JUNE

(b) Import and Export Prices. 1870- 1900 from Bambrick (1968), ‘Australian Price Indexes’, Tables IV/ 31 and IV/12; 1900/01-1938139 from M. W. Butlin (1977).

(c) Capital Flows. Data for calculating equation 2 from Butlin (1962) and Butlin, M. W. (1977). London Funds from Butline, S. J. , Hall and White (1971).