Fritz Machlup · 1950
Fritz Machlup’s article in the Economic Journal examines the postwar dollar shortage by distinguishing market, programme and accounting balances of payments. Their deficits describe different situations and warrant different remedies. His central concern is the conceptual slippage through which national needs, effective demand for foreign exchange and records of past financing become interchangeable.
The confusion concerning the meaning of a deficit or a disequilibrium in the balance of payments is almost as old as the study of political economy.
The market balance is an ex ante model, not a retrospective ledger or an inventory of necessary imports. It represents effective supply and demand under specified conditions:
The market balance of payments is a model of a given situation in the foreign-exchange market, characterised by the effective demand and supply of foreign exchange at the given exchange rate and at alternative, hypothetical rates.
Effective demand requires domestic purchasing power, not simply an urgent need for imported goods. Machlup excludes foreign exchange supplied specifically to support the exchange rate, since counting that intervention as ordinary supply would conceal the imbalance it finances. Similarly, discretionary rationing cannot be treated as though unsatisfied purchasers had ceased to demand foreign exchange. Other controls may remain among the model’s given conditions, depending on the analytical question. The distinction is methodological, not a requirement to imagine an economy without government intervention.
Effective demand for dollars means supply of domestic money in exchange for dollars; and excess demand for dollars means excess supply of domestic money in the exchange market.
This formulation connects a dollar shortage to domestic monetary conditions. Depreciation moves along supply and demand curves; deflation and commercial policies shift them; reserve sales finance the gap; rationing leaves demand unsatisfied while suspending the free market. These operations are not equivalent solutions. Maintaining an exchange rate through controls may perpetuate excess demand rather than eliminate it. Given curves remain principally a short-period instrument: changes in income, purchasing power and policy limit their usefulness for precise forecasts.
The programme balance, also ex ante, compares desired consumption and investment with expected foreign resources. Its requirements depend on politically accepted objectives rather than purchasers’ ability to pay. Higher income can therefore widen a market deficit by increasing purchasing power while narrowing a programme deficit by increasing output available to satisfy national requirements. Programme objectives also respond to anticipated financing: planners adjust proposals to expected resources, while representations of need may influence donors and lenders.
Programme balances can serve planning, negotiation and assessments of development benefits without measuring pressure in the foreign-exchange market. Machlup challenges projections that turn past imports into fixed national necessities: trade patterns can change substantially, even where adjustment entails serious social costs. Assistance cannot be justified merely by treating existing imports as unavoidable.
The accounting balance is an ex post record in which credits and debits necessarily balance. A reported deficit therefore belongs to a selected subset of accounts. Such selection may illuminate a particular question, but records alone cannot establish transactions’ motives, distinguish autonomous movements from induced responses, or reconstruct market conditions obscured by aggregation. Similar accounting outcomes may accompany stable markets, exchange-rate changes, deflation or extensive rationing.
This distinction informs Machlup’s criticism of the International Monetary Fund’s category of compensatory official financing. Treating UNRRA relief and European Recovery Programme assistance as responses to market deficits risks confusing reconstruction needs with effective demand for dollars. Aid may finance imports that would otherwise never have been purchased. Inferring a market deficit from financing already classified as compensatory thus risks circularity.
The conclusion assigns each concept a separate evidential role. Persistent market deficits reveal incompatibility between domestic monetary, fiscal and wage policies and the maintained exchange rate. Programme deficits express prospective uses of foreign resources; accounting deficits record financing obtained. None necessarily establishes either of the others. Machlup separates the economic case for productive foreign assistance from the case for exchange-rate adjustment, while acknowledging their political connection: aid-supported improvements may give governments greater security to undertake difficult adjustments. Conceptual precision clarifies the mechanisms and policy choices concealed by the language of shortage.
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