David Ricardo

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David Ricardo
Classical economics
Birth 18 April 1772(1772-04-18)
Death 11 September 1823 (aged 51)
Nationality Great Britain
Influences Adam Smith, Jeremy Bentham
Influenced Piero Sraffa, Robert J. Barro, Karl Marx, Ricardian Socialists
Contributions Ricardian equivalence, labor theory of value, comparative advantage, law of diminishing returns

David Ricardo (18 April 1772 – 11 September 1823) was a political economist, often credited with systematizing economics, and was one of the most influential of the classical economists, along with Thomas Malthus and Adam Smith.[1] He was also a member of Parliament, businessman, financier and speculator, who amassed a considerable personal fortune. Perhaps the most important of his contributions was the theory of comparative advantage, a fundamental argument in favor of free trade among countries and of specialization among individuals. Ricardo argued that there is mutual benefit from trade (or exchange) even if one party (e.g. resource-rich country, highly-skilled artisan) is more productive in every possible area than its trading counterpart (e.g. resource-poor country, unskilled laborer), as long as each concentrates on the activities where it has relative productivity advantage.[2]

Contents

[edit] Personal life

Born in London, Ricardo was the third of seventeen children of a Sephardic Jewish family of Portuguese origin who had recently relocated from Holland. At age 21, Ricardo eloped with a Quaker, Priscilla Anne Wilkinson, leading to estrangement from his family. It seems that his mother never spoke to him again. At the time of his marriage, Ricardo disconnected from Judaism and became a Unitarian.[3] He had eight children including three sons, of whom Osman Ricardo (1795-1881; MP for Worcester 1847–1865) and another David Ricardo (1803–1864, MP for Stroud 1832–1833) became members of parliament, while the third, Mortimer Ricardo, served as an officer in the Life Guards and was a deputy lieutenant for Oxfordshire. He was one of the original members of The Geological Society.[3]

Ricardo became interested in economics after reading Adam Smith's The Wealth of Nations in 1799 on a vacation to the English resort of Bath. This was Ricardo's first contact with economics. He wrote his first economics article at age 37 and within another ten years he reached the height of his fame.

Ricardo's work with the stock exchange made him quite wealthy, which allowed him to retire from business in 1814 at the age of 42. He then purchased and moved to Gatcombe Park, an estate in Gloucestershire.

In 1819, Ricardo took a seat in the House of Commons as the MP for Portarlington, an Irish rotten borough. He held the seat, which had initially been made available to him by his friend, Conversation Sharp, until his death in 1823. In 1846 his nephew, John Lewis Ricardo, MP for Stoke-on-Trent, advocated free trade and the repeal of the Corn Laws.

Ricardo was a close friend of James Mill, who encouraged him in his political ambitions and writings about economics. Other notable friends included Jeremy Bentham and Thomas Malthus, with whom Ricardo had a considerable debate (in correspondence) over such things as the role of land owners in a society. He also was a member of London's intellectuals, later becoming a member of Malthus' Political Economy Club, and a member of the King of Clubs.

[edit] Ideas

Main article: Ricardian economics

[edit] Value Theory

Ricardo's most famous work is his Principles of Political Economy and Taxation (1817). Ricardo opens the first chapter with a statement of the labor theory of value. Later in this chapter, he demonstrates that prices do not correspond to this value. He retained the theory, however, as an approximation. The labour theory of value states that the relative price of two goods is determined by the ratio of the quantities of labour required in their production. His labour theory of value, however, required several assumptions: 1) both sectors have the same wage rate and the same profit rate; 2) the capital employed in production is made up of wages only; 3) the period of production has the same length for both goods. Ricardo himself realized that the second and third assumptions were quite unrealistic and hence admitted two exceptions to his labour theory of value: 1) production periods may differ; 2) the two production processes may employ instruments and equipment as capital and not just wages, and in very different proportions. Ricardo continued to work on his value theory to the end of his life.

[edit] Trade Restriction

[edit] Protectionism

Like Adam Smith, Ricardo was also an opponent of protectionism for national economies, especially for agriculture. He believed that the British "Corn Laws"—tariffs on agriculture products—ensured that less productive domestic land would be harvested and rents would be driven up. (Case & Fair 1999, pp. 812, 813). Thus, the surplus would be directed more toward feudal landlords and away from the emerging industrial capitalists. Since landlords tended to squander their wealth on luxuries, rather than investments, Ricardo believed that the Corn Laws were leading to the economic stagnation of the British economy. Parliament repealed the Corn Laws in 1846.

[edit] Market Created Restriction on Trade

[edit] Rent

Ricardo is responsible for developing theories of rent, wages, and profits. He defined rent as "the difference between the produce obtained by the employment of two equal quantities of capital and labor." The model for this theory basically said that while only one grade of land is being used for cultivation, rent will not exist, but when multiple grades of land are being utilised, rent will be charged on the higher grades and will increase with the ascension of the grade. As such, Ricardo believed that the process of economic development, which increased land utilisation and eventually led to the cultivation of poorer land, benefited first and foremost the landowners because they would receive the rent payments either in money or in product.

In a careful analysis of the effects of different forms of taxation, Ricardo concludes in chapters 10 and 12 that a tax on land value, equivalent to a tax on the land rent, was the only form of taxation that would not lead to price increases; it is paid by the landlord, who is not able to pass it on to a tennant. He stated that the poorest grade land in use has no (land) rent and so pays no land value tax; as prices are determined at this marginal site for the whole economy, prices will not be increased by a land value tax. His analysis distinguishes between rent of (unimproved) land and rent associated with capital improvements such as buildings.

  • Accumulation of Inequality of Distribution of varied qualities of Accumulatable Scarce Necessary Means of Production.

In his book, Principles of Political Economy and Taxation, Ricardo's concept of rent is layed out. Due to variation in scarcity of land (or some other accumulatable scarce necessities of varied utility), some land pays a higher monopoly value due to it's scarcity than other land. This return on investment is higher than what one would otherwise expect based simply on the value and scarcity of the produce; this return on investment comes from the incident of ownership that allows a monopoly price to be paid. Such premium over real social value that an individual is able to reap due to incident of ownership constitutes real value to an individual but is at best[4] a paper monetary return to society. The portion of such purely individual benefit, and exclusively that portion, that accrues to scarce, accumulatable resources such as land or gold or houses, that is over and above any socially beneficial exchange, Ricardo labels Rent. If all land were equally situated, however scarce, one could determine that all market exchange of the produce thereof was free and equal and that the exact value of the trade was conveyed simultaneously to both parties and to society. In the case of increasing scarcity of the land of higher absolute utility, the free market principle fails to either properly measure or convey value. This gap between personal value accrual and social value accrual, in the case of land, is Ricardian Rent. Rent therefore constitutes value for nothing and as such constitutes a loss to society above maximum production, and one that increases at a faster rate than the decline in production that comes from the scarcity of the land, as land becomes more scarce. Proposals to solve this by various types of land tax are explored further. The key problem then, Ricardo discusses, would be to find a tax that is able to maximally differentiate between tax on profit and tax on such purely Ricardian rent. A no easy task, as he points out, as in the case of how one differentiates between the basic land return, that portion that constitutes such excess above social productivity that he labels rent, and that portion that comes from non-rent producing capital investment in fertilizer, irrigation, deep plowing and land improvements of all types, barns, etc.

  • Malthus's criticism and Extrapolation of the problem of Ricardian Rent

Good Classical Father that he is, Ricardo in demonstrating that Ricardian Rent constitutes value for nothing, momentarily neglecting Say's Law that all savings by-definition-equals investment, overlooks that such value-for-nothing doesn't necessarily disappear upon mis-payment to a landlord. This is what Malthus, Ricardo's personal friend and intellectual opponent, states in his own book on Rent, one of his works that expounds from a point of view of Malthus's Surplus Value theories, rather than Malthus's earlier and more quoted Scarcity Value Theory. Thus, says Malthus, Rent, however mis-placed, constitutes a prime source of savings and investment for the future. We need then, if contented by Malthus, only look for such portion of Ricardian Rent that due to it's over-investment (due to it's misallocation) represents lost economic value to the society as a whole. Malthus' Criticism of Ricardian Rent does not in Malthus' book on Rent touch on this problem of Ricardian over-investment as expounded by Malthus; rather, in his later works, Malthus does so.

[edit] Competitive Advantage
  • The problem of Competitive Advantage

Ricardo extrapolates the problem of monopolistic rent to other situations/resources that are fundamentally scarce: land or gold. He questions whether all trade has a fundamental problem of inequality that is inevitably hard to bridge. This is the problem of absolute competitive advantage -- where one party has an unbridgeable competitive advantage due wealth or productive advantages in every field. If so, can trade profitably continue? Ricardo solves this with Comparative Advantage.

[edit] Comparative Advantage
  • Comparative Advantage

This book, Principles of Political Economy, introduces the theory of comparative advantage. According to Ricardo's theory, even if a country could produce everything more efficiently than another country, it would reap gains from specializing in what it was best at producing and trading with other nations. (Case & Fair, 1999: 812–818). Ricardo believed that wages should be left to free competition, so there should be no restrictions on the importation of agricultural products from abroad.

The benefits of comparative advantage are both distributional and related to improved real income. Within Ricardo's theory, distributional effects implied that foreign trade could not directly affect profits, because profits change only in response to the level of wages. The effects on income are always beneficial because foreign trade does not affect value.

Comparative advantage forms the basis of modern trade theory, reformulated as the Heckscher-Ohlin theorem, which states that a country has a comparative advantage in the production of a product if the country is relatively well-endowed with inputs that are used intensively in producing the product. (Case & Fair 1999, p. 822).

[edit] Ricardian equivalence

Another idea associated with Ricardo is Ricardian equivalence, an argument suggesting that in some circumstances a government's choice of how to pay for its spending (i.e., whether to use tax revenue or issue debt and run a deficit) might have no effect on the economy. Ironically, while the proposition bears his name, he does not seem to have believed it. Economist Robert Barro is responsible for its modern prominence.

[edit] Ricardo's theories of wages and profits

Ricardo believed that in the long run, prices reflect the cost of production, and referred to this long run price as a Natural price. The natural price of labour was the cost of its production, that cost of maintaining the labourer. If wages correspond to the natural price of labour, then wages would be at subsistence level. However, due to an improving economy, wages may remain indefinitely above subsistence level:

Notwithstanding the tendency of wages to conform to their natural rate, their market rate may, in an improving society, for an indefinite period, be constantly above it; for no sooner may the impulse, which an increased capital gives to a new demand for labour, be obeyed, than another increase of capital may produce the same effect; and thus, if the increase of capital be gradual and constant, the demand for labour may give a continued stimulus to an increase of people.…

It has been calculated, that under favourable circumstances population may be doubled in twenty-five years; but under the same favourable circumstances, the whole capital of a country might possibly be doubled in a shorter period. In that case, wages during the whole period would have a tendency to rise, because the demand for labour would increase still faster than the supply. (On the Principles of Political Economy, Chapter 5, "On Wages").

In his Theory of Profit, Ricardo stated that as real wages increase, real profits decrease because the revenue from the sale of manufactured goods is split between profits and wages. He said in his Essay on Profits, "Profits depend on high or low wages, wages on the price of necessaries, and the price of necessaries chiefly on the price of food."

[edit] Publications

Ricardo's publications included:

  • The High Price of Bullion, a Proof of the Depreciation of Bank Notes (1810), which advocated the adoption of a metallic currency
  • Essay on the Influence of a Low Price of Corn on the Profits of Stock (1815), which argued that repealing the Corn Laws would distribute more wealth to the productive members of society
  • On the Principles of Political Economy and Taxation (1817), an analysis that concluded that land rent grows as population increases. It also clearly laid out the theory of comparative advantage, which argued that all nations could benefit from free trade, even if a nation was less efficient at producing all kinds of goods than its trading partners.

[edit] Notes

  1. ^ Sowell, Thomas (2006). On classical economics. New Haven, CT: Yale University Press.
  2. ^ Roberts, Paul Craig (2003-8-28), "The Trade Question", Washington Times 
  3. ^ a b Sraffa, Piero, David Ricardo (1955). The Works and Correspondence of David Ricardo: Volume 10, Biographical Miscellany. Cambridge, UK: Cambridge University Press. pp. 434. ISBN 0-521-06075-3. 
  4. ^ On The Principles of Political Economy and Taxation London: John Murray, Albemarle-Street, by David Ricardo, 1817 (third edition 1821) -- Chapter 6, On Profits: paragraph 28, "Thus, taking the former . . ." and paragraph 33, "There can, however . . ."

[edit] References

[edit] External links

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