Economics wilfred Edward Graham Salter



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ECONOMICS


Wilfred Edward Graham Salter:

The Merits of a Classical Economic Education


by

Ernst Juerg Weber

Business School

The University of Western Australia


DISCUSSION PAPER 09.14

Wilfred Edward Graham Salter:

The Merits of a Classical Economic Education

by

Ernst Juerg Weber



University of Western Australia

Business School – Economics Program



Abstract

During his honours research on an index of industrial production at the University of Western Australia, Salter gained an understanding of the composite commodity theorem. The applied work on the index of industrial production provided him with the analytic foundations for his two famous contributions to economic theory, in capital theory and international trade theory. In his Ph.D. thesis at the University of Cambridge he agreed with Joan Robinson that it is impossible to measure the aggregate capital stock because the assumptions of the composite commodity theorem do not hold in a general equilibrium framework. But Salter was not bothered by the elusive nature of capital because he saw no need to measure the capital stock in the first place. He developed a vintage model of capital, in which technical progress occurs at the margin of the capital stock, when new investment goods are installed. In the dependent economy model Salter, however, accepted the aggregation of exportables and importables because in a small open economy the terms of trade are unaffected by domestic economic policy. Thus, Salter recognised that the capital stock is an invalid aggregate in a macroeconomic model, but internationally traded goods are a valid aggregate in the dependent economy model. His success as an economic theorist lies in the fact that he understood when to apply the composite commodity theorem as an analytic tool, and when to avoid it.



1. Introduction

In 1953, Wilfred Edward Graham Salter submitted his honours thesis at the University of Western Australia, in which he constructed an index of industrial production for Australia. The thesis was well received by the faculty and, after some revisions, it was published in a monograph series of the Department of Economics. In this paper the connection between Salter’s honours research and his pioneering contributions to economic theory and policy is considered. Salter was a gifted student who had the good fortune to be involved in a fruitful research project at the beginning of his professional career. During the honours year, he learnt to apply the analytic tools of economics, and he worked with new production data that had become available in many countries, including Australia, after World War II. Both, the analytic skills and the applied statistical work were critical for his Ph.D. research at the University of Cambridge and his distinguished career as an economist in the public service, which was tragically cut short at a young age.

Born in 1929, Salter spent his childhood during the Great Depression and he experienced World War II as a teenager.1 From 1948 to 1953, he studied economics at the University of Western Australia, graduating with first-class honours. Frank Richard Edward Mauldon served as supervisor, and Salter also acknowledged the help of Frank Benson Horner, who worked at the New South Wales Bureau of Statistics in the early 1950s. After the honours thesis, Salter embarked on an ambitious, if not hectic, schedule of research and writing. The honours thesis is dated February 1953 and the revised thesis was published by the University of Western Australia Press in 1954.2 In January 1953, Mauldon asked Salter and Ronald William Peters to conduct a feasibility study on regional income measures for Western Australia. In September, Salter submitted a preliminary report with sectoral income measures at the state level, leaving it to Peters to disaggregate the state figures to the regional level. Pointing out some limitations of his study, Salter (1953a, p. i) mentions that he had been forced to complete it “by a certain date”, which was given by his departure for England in the second half of 1953.

In the Department of Applied Economics at the University of Cambridge, Salter found a research culture that was conducive to his research interests. In 1954, he won the Stevenson Prize for the best graduate essay, and in 1955 he submitted his Ph.D. thesis on technical change and labour productivity. The supervisor, William Brian Reddaway, was an authority on the British index of industrial production who shared Salter’s enthusiasm for applied statistical work. Salter was also helped by Laszlo Rostas, who was an expert on taxation and the measurement of productivity. A post-doctoral fellowship enabled Salter to spend the academic year 1955/56 at Johns Hopkins University, where he added American data to his thesis. At Johns Hopkins University he discussed his work with Fritz Machlup, an eminent Austrian-American economist, and his student Edith Elura Tilton Penrose, who is known for her theory of economic growth, which is based on the acquisition of knowledge by the firm.3 Salter returned to Australia in September 1956 – only three years after he had left the country. He had used his time well since he had hastily submitted the report on income measures for Western Australia in September 1953. The revised honours thesis had been published, his graduate essay had won him the Stevenson Prize, the Ph.D. had been completed, and he had spent a productive postdoctoral year in America.

Back in Australia, Salter spent four years as a research fellow at the Australian National University, a still young institution that had been established ten years earlier. At the ANU Trevor Winchester Swan, the co-author of the Solow-Swan model of economic growth, and Ivor Frank Pearce took an interest in Salter’s research on productivity and technical change. Two works published in this period established Salter’s reputation as a first-rate economic theorist. In Productivity and Technical Change (1960), which was based on his Ph.D. thesis, he developed a vintage model of capital in which technical progress can take place only if there is investment. The second work is the article on ‘Internal and External Balance: The Role of Price and Expenditure Effects’, which appeared in the Economic Record in 1959. In this article Salter put forward a model of international trade for a small open economy – Australia – in which output is divided in internationally traded goods and non-traded goods. Salter’s work on productivity and technical change and his model of international trade are commonly regarded as two independent contributions to economic theory. Andrea Maneschi (1997) writes that “Admirers of Wilfred Salter can be divided into two distinct sets who appear to be unaware of each other, those who praise his work on productivity and technical change, and those who praise his Australian open-economy model.” In this article it will be shown that both contributions of Salter to economic theory have a common source: his honours thesis, which gave him a firm understanding of John Robert Hicks’ composite commodity theorem.

In 1960, Salter became an assistant secretary in the Prime Minister’s Department in Canberra. It seems that he preferred public service and the involvement in the formulation and implementation of economic policy to academic research. One reason for his reluctance to pursue an academic career, which undoubtedly would have been distinguished, was his passion for national income and output data. In the mid-twentieth century, the collection of income and output data became an undertaking of national statistical offices. The League of Nations investigated the feasibility of national income and output statistics and, after World War II, national statistical offices adopted the new system of national accounting of the United Nations. In his honours thesis Salter constructed the first index of industrial production for Australia, and in the report that he submitted to Mauldon on the eve of his departure for England he estimated state income for Western Australia. But he quickly realised that universities lacked the resources needed for the construction of national economic data sets. Salter was not interested in an academic position because the public sector became the driving force behind the collection of quantitative economic information in the mid-twentieth century. In the report on income in Western Australia he commented:

“During the course of this study it has become increasingly obvious that income studies cannot be carried out completely satisfactorily except in a well-equipped research bureau and by a team of research workers. Income research demands complete and detailed knowledge of virtually all statistics and their sources. An individual cannot hope to master completely the intricacies of all the figures he uses. … For these reasons, a University research worker can only hope to present a framework within which future effort can be directed.” (Salter 1953a, p. i)

Salter’s interest in quantitative economic information was not limited to Australia. Taking leave from the Australian public service in 1962, he joined the development advisory service of Harvard University to become an economic advisor to the government of Pakistan. He was attracted to Pakistan because it provided a laboratory for the theory of technical change that he had developed in his Ph.D. thesis. Salter (1955/60) and Leif Johansen (1959, 1961) independently pioneered the vintage model of capital. In Salter’s model machines that are installed now use new technology, whereas old machines that had been installed earlier incorporate obsolete technologies. New and old technologies coexist at the same point in time, with the owners of new machines earning economic (Ricardian) rents. One of the most striking features of a developing economy is the coexistence of new and traditional technologies. In Pakistan lorries coexisted with donkey carts, plantations coexisted with subsistence farming, and factories coexisted with street workshops that were run by artisans. Yet, Salter did not have the time to make a lasting mark on development economics. In 1963, he died in Lahore of heart failure, leaving behind two children and a wife who had loyally supported him during his studies, typing his honours thesis at the University of Western Australia.


2. Relative Prices and Economic Aggregates

In the first chapter of his honours thesis Salter discusses the conceptual difficulties that arise when different goods are aggregated to a quantity index. The three text boxes that are displayed in this article are the first three sections of Chapter I of the honours thesis. The same headings are used as in the honours thesis and the complete text of each section is reproduced. The text of these sections is virtually unchanged in the revised version of the honours thesis, which was published by the University of Western Australia Press in 1954. The same does not apply to other parts of the honours thesis, which Salter revised for publication.

Salter starts his analysis with the premise that the ultimate goal of economic activity is the satisfaction of human wants. Applying standard price theory, he notes that the ‘utility dimension’ of goods is reflected by prices. For this reason, economists are interested in the value of an economic aggregate, and not in its weight or some other physical dimension. It follows that “at one point or another, the price factor must be introduced if a measure [of industrial production] is to be economically significant.” This argument is much deeper than the common quip that prices must be used ‘because it is not possible to add apples and bananas’. According to Salter, a quantity index is an economically meaningful measure because the price weights give it a ‘utility dimension’. Text Box 1 displays the section on the problem of aggregation in Salter’s honours thesis.

Text Box 1

I – THE PROBLEM OF AGGREGATION

The first problem may be stated as: How can we aggregate a series of different goods and services in some way that is economically significant?

While a transport engineer may be interested in their total weight or volume, to the economist the only significant aggregation is total value. This, of course, springs from the economist’s point of view. We are interested in a “thing” not because of its size or weight but its ability to satisfy human wants. Our concern is its “utility dimension”, which we approximate by price. Physical measures only have economic significance to the extent that they are a useful means of expressing price per unit.

The important point for our purpose is that economic measures of quantities cannot be divorced from prices. Whatever else we may do, at one point or another, the price factor must be introduced, if a measure is to be economically significant.

In the next section, Salter considers the difficulties that arise when prices change. He observes that the value of an economic aggregate can change for three reasons: (1) the quantity of goods changes, (2) a change in tastes causes an adjustment in relative prices, and (3) the value of money changes. The price effects – items (2) and (3) – break the link between the value of the aggregate and the quantity of goods that it represents. A change in the value of the aggregate unambiguously reflects a change in the quantity of goods only if relative prices and the value of money remain constant. Salter elaborates “… if relative prices and the value of money are constant and the quantities have doubled, we can say that the economic significance of the aggregation of goods is twice as great.” This section of the honours thesis is reprinted in Text Box 2.

Text Box 2

II – COMPARISONS BETWEEN AGGREGATES

For a comparison at one point of time few difficulties arise since the “utility dimensions” of goods are fixed and the relationship between utility and money is constant. Thus aggregates can be compared simply on the basis of their total values.

It is when we attempt a comparison over time that difficulties arise. Over a period three types of changes can occur that will affect the value totals.


  1. A change in the quantity of goods.

  2. A change in “tastes” or the “utility dimension” of goods. This change is reflected in relative prices.

  3. A change in the value of money or the “money-utility” relationship.

Changes (ii) and (iii) are reflected in price.

Thus while we can aggregate quantities of coal, apples and locomotives on the basis of period A’s relative prices and value of money, and we can similarly aggregate quantities of the same goods at period B’s relative prices and value of money, we cannot compare them. This is because there is no connecting link between the two sets of values. At least two of the three factors must be constant before a comparison can be made.

Thus if relative prices and the value of money are constant and the quantities have doubled, we can say that the economic significance of the aggregation of goods is twice as great.

If quantities and the value of money are constant and relative prices have changed, we can say the economic significance has increased or decreased by so much.

If quantities and relative prices are constant and the value of money has changed, we can use a comparison in the value totals to measure the change in the value of money.

In practice all three changes occur over time. This means we cannot compare changes in the economic significance of quantities without making artificial assumptions about prices. To the extent these assumptions are artificial, any quantity index is only an approximation. Since we can make alternative assumptions (equally artificial) about prices, no unique measure of the economic significance of quantities is possible.23


(2) Value of money only refers to its value within the aggregate under consideration, not to an overall general value of money for the whole economy.

(3) See R. Wilson (2) p. 11 for an extreme example of different results obtained by different approximations.

Finally, in the third section Salter tackles the aggregation problem from a somewhat different angle, enquiring in what sense an index of industrial production measures a ‘real’ change in production. He distinguishes between two distinct concepts of ‘real’: an index that uses the same prices for the aggregation of goods in every year is expressed in “base year prices”, whereas an index that uses current prices for every year is expressed in “constant pounds (or dollars)”. The first type of index is a Laspeyres index and the second is a Paasche index, which Salter introduces at this point:






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