David Ricardo

David Ricardo

Classical economics

Born

19 April 1772

Died

11 September 1823 (aged 51)

Nationality

British

Influences

Smith Bentham

Influenced

Ricardian Socialists John Stuart Mill Marx Sraffa Barro

Contributions

Ricardian equivalence, labour theory of value, comparative advantage, law of diminishing returns, Economic rent[1]

David Ricardo (19 April 1772 11 September 1823) was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill.[2] He was also a member of Parliament, businessman, financier and speculator, who amassed a considerable personal fortune. Perhaps his most important contribution was the law of comparative advantage, a fundamental argument in favour of free trade among countries and of specialisation 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 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 a relative productivity advantage.[3]

Personal life
Born in England, Ricardo was the third of 17 children of a Sephardic Jewish family of Portuguese origin who had recently relocated from the Dutch Republic. His father was a successful stockbroker. At age 21, Ricardo eloped with a Quaker, Priscilla Anne Wilkinson, leading to estrangement from his family. His father disowned him and his mother apparently never spoke to him again. Without family support, he started his own business as a stockbroker, in which he became quite successful thanks to the connections he made when working with his father. During the Battle of Waterloo, just like Nathan Mayer Rothschild, he bet against the French victory and invested in British securities. By the time he retired from the Exchange at the age of 43, his fortune was estimated at about 600,000. He then purchased and moved to Gatcombe Park, an estate in Gloucestershire. At the time of his marriage, Ricardo disconnected from Judaism and became a Unitarian.[4] He had eight children, including three sons, of whom Osman Ricardo (17951881; MP for Worcester 18471865) and another David Ricardo (18031864, MP for Stroud 18321833), 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.[4] His daughter was Sarah Ricardo-Porter, who married George R. Porter and was an author in her own right (e.g. "Conversations in Arithmetic'"). 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. In 1819, Ricardo took a seat in the House of Commons, representing Portarlington, an Irish rotten borough. He held the seat, which had initially been made available to him by his friend Richard "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 landowners 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.

Ideas
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 labour 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 realised 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. But the first chapter is but the introduction to a long book that discusses back and forth an extended series of comparisons and contrasts of the various points of views and of Ricardo's own reasoning. In the chapter "On Value and Riches,"[5] Ricardo makes effort to illustrate that exchange value is not the same as "value in use".[6] In this way one can factor two often contradictory results. Point 2, above, that the capital employed in production must be made up of wages only for his value theory to hold, is answered by this: that production may be made up of capital and machinery, but it doesn't change the principle (which he attributes to Adam Smith) that he tries to lay out in this chapter.[7] Machinery may add to one measure of value beyond almost all measure without adding one penny to the other measure of value. In this way, one is able, Ricardo seems to show, to factor out somewhat contradictory assumptions which if confounded lead to equally contradictory results. By making all things perfectly clear, or in attempting to, Mr. Ricardo, seeks to resolve some of those ills of the democratic society in which he lived in so far as reason, and action, could resolve them. In this pursuit, he took action, sitting in parliament, moving with his stirring, and amusing, speeches the inner policies of the British Empire. The key point that Ricardo seems to make, though, is something like this: Accumulation of capital adds riches without decreasing the value of things to be traded, which may bring the various economic actors to a win-win. Ricardo first attempts to show that new riches are not adding as much value as one would think because they are always decreasing somewhat from the exchangeable value of what was produced. The decreasing value in exchange as value-in-use increases he extrapolates to infer that the sum world total of value in exchange is a fixed constant. Therefore, in the growth of the

global economy, the first-world countries, he states, will begin to lose value per trade, even to the purely theoretical extent of taking from the capital base. Yet, Ricardo notes that with more value-in-use for the rich and the poor, both will likely obtain more security as the aggression of competition is mitigated by physical economic growth. Adam Smith had thought that due to its effect on value, the growth of wealth of the poor beyond subsistence levels is likely to take from the overall wealth of the society. All economists (neoliberal through progressive) still worry about that and so they weaken the wealth of the poor to maintain economic growth. Ricardo shows this as unnecessary when we measure value in exchange together with the growth of value-in-riches, rather than by the monopolization value. The extreme aspects of competition then leave, for the rich and poor alike, an appearance of the growth of wealth, yet without the actual result of it. Taking a step back and noticing the growth of actual value-in-use may allow people as corporations and laborers, both rich and poor, to realize this and see a way and means forward.

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 utilized, 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 utilization 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 tenant. 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 quantities of Accumulatable Scarce Necessary Means of Production.

Ricardo's concept of rent is laid out in his book Principles of Political Economy and Taxation. 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 its 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 [8] 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, 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. No easy task, he points out, as in the case of how one differentiates between basic land return, that portion that constitutes such excess above social productivity that he labels rent, and the 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

In demonstrating that Ricardian Rent constitutes value for nothing (Ricardo was momentarily neglecting Say's Law that all savings by-definition-equals investment), Ricardo 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 misplaced, 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 its over-investment (due to its miscalculation) 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 (the General Glut controversy); rather, in his later works, Malthus does so. So: to Ricardo, Economic Rent is a surplus of individual investors' paper profit (which has its value in control over resources rather than directly in the resources themselves) over societal gain. As such, it does not represent any gain but rather an unearned transfer of wealth. To Malthus, there is material gain created in the re-investment which is rent, but at some point such gain may as says Ricardo in regards to the paper profit he believes Economic Rent to be, be in excess of social utility. Earlier writers touched on Economic Rent too. Ricardo advises caution in responses to the problem of Economic Rent To be clear, the topic of Economic Rent, as expounded by Ricardo, was by earlier writers such as Smith. Ricardo's book forms a sort of textbook of such earlier expounded theories, in which he adds his own analysis while comparing and contrasting different views and pointing out the flaws in them. Ricardo, after spending many chapters contented with this view of Rent, ascribes it to Smith and then says it is true but probably not so important in an expanding economy and measures to address it should be marked with caution as they would likely produce different effects in different situations. [9]

Trade theory and policy

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 productsensured 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 stagnation of the British economy. Parliament repealed the Corn Laws in 1846.

Comparative Advantage
The Problem of Competitive Advantage

Ricardo extrapolates the problem of monopolistic rent on the land itself to other situations/resources that are fundamentally scarce: the buildings that sit on the land, due to the long time frame of use and large lump-sum cost of building new ones; or gold, which is a also partial monopoly due to its scarcity, and which is not consumable. He then questions whether all trade has a fundamental problem of inequality that is inevitably hard to bridge. This is the problem of absolute competitive advantagewhere one party has an unbridgeable competitive advantage due to wealth or productive advantages in every field. If so, can trade profitably continue? Ricardo solves this with Comparative Advantage.

Comparative Advantage: The Solution

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: 812818). 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). See the section The Ricardian theory of international trade of this page for another side of the theoretical development. The theory of comparative advantage as he described it seems to be that both those rich in ability and the poor alike concentrate each their own analytical powers on meeting the needs and abilities of the richer, more skilful party to an otherwise unequal exchange and thereby both benefit. Ideas often extrapolated are: that both benefit equally; and that

somehow in such exchange each nation, or person, is enabled to focus on its own area of real specialisation in a bidirectional equal tradebut we only start with an idea of purely comparative specialisation in one direction. For the contemporary development of Ricardo's idea on international trade, see the section The Ricardian theory of international trade in the part His Legacy and Influence.

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.

Ricardo's theories of wages and profits

Some credit Ricardo with the concepts behind the so-called Iron Law of Wages, that wages naturally tend to a subsistence level.[10][11][12] Others dispute the assignment to Ricardo of this idea. 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 labor, 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."

His Legacy and Influence

David Ricardo's ideas had a tremendous influence on later developments in economics. With his highly logical arguments, he has become the theoretical father of the classical political economy. Schumpeter coined an expression Ricardian vice, which indicates that rigorous logic does not provide a good economic theory.[13] This criticism applies also to most neoclassical theories, which make heavy use of mathematics, but are, according to him, theoretically unsound, because the conclusion being drawn does not logically follow from the theories used to defend it. [citation needed]

Ricardian Socialists
Unequal Exchange
Chris Edward includes Emmanuel's Unequal Exchange theory among variations of neo-Ricardian trade theory.[14] Arghiri Emmanuel argued that the Third World is poor because of the international exploitation of labour. [15] The unequal exchange theory of trade has been influential to the (new) dependency theory.[16]

Neo-Ricardians
After the rise of the 'neoclassical' school, Ricardo's influence declined temporarily. It was Piero Sraffa, the editor of the Collected Works of David Ricardo[17] and the author of seminal Production of Commodities by Means of Commodities,[18]who resurrected Ricardo as the originator of another strand of economics thought, which was effaced with the arrival of the neoclassical school. The new interpretation of Ricardo and Sraffa's criticism against the marginal theory of value gave rise to a new school, now named neo-Ricardian or Sraffian school. Major contributors to this school includes Luigi Pasinetti (1930 ), Pierangelo Garegnani (1930), Ian Steedman (1941), Georffrey Harcourt (1931), Heinz Kurz (1946), Neri Salvadori (1951), Pier Paolo Saviotti (-) among others. See also Neo-Ricardianism. Neo-Ricardian school is sometimes seen to be a composing element of Post-Keynesian economics.

Evolutionary growth theory

Several distinctive groups have sprung out of the neo-Ricardian school. One is the evolutionary growth theory, developed notably by Luigi Pasinetti, J.S. Metcalfe, Pier Paolo Saviotti, and Koen Frenken and others. [19][20] The first step came from Pasinetti.[21][22] He argued that the demand of any commodity came to stagnate and frequently decline as Engel curve shows it. The commodities are produced by each industry with different growth rate of labour productivity. The consequences are different rate of growth of output and employment. To any economic development structural change is invitable. If the commodity variety remains constant, demand saturation occurs for any rich eceonmy. Introduction of new commodities (goods and services) is necessary to evade from economic stagnation. The problem of demand saturation and satiety became one of the most topical themes of evolutionary economists. Many articles and books have been written.[23][24][25][26][27] As for the causes and mechanisms of demand saturation, I, Steedman pointed that time plays as important a role as income.[28][29] Indeed, the neocalssical economics admits monetary budget as unique constraint, but for any busy person the

time counts as much as price to enjoy the purchased commodities. Another constraints, such as house surface, are effective for example in the Japanese economy, where people live in a "rabbit hutch." Demand saturation problems are pursured, parallel to evolutionary economists, by Aoki and Yoshikawa [30][31] and other Japanese reserchers.[32][33]

The Ricardian theory of international trade

The Ricardian theory of comparative advantage also became a basic constituent of neoclassical trade theory. Any undergraduate course in trade theory includes expansions of Ricardo's example of four numbers in for form of a two commodity, two country model. Ricardo intended to show by this classic example the benefits of free trade from comparative advantage, as in his example there is one country that is more proficient in producing both commodities relative to the other country. Adam Smith would likely reason, by logic of absolute advantage, that there would be no incentive for trade between the two countries. This model was expanded to many-country and many-commodity cases and also to include migration of people between countries. Major general results were obtained by the beginning of 1960's by McKenzie[34][35] and Jones,[36] including his famous formula.

Contemporary theories
Ricardo's idea was even expanded to the case of continuum of goods by Dornbusch, Fischer, and Samuelson [37] This formulation is employed for example by Matsuyama[38] and others.

Neo-Ricardian trade theory

Inspired by Piero Sraffa, a new strand of trade theory emerged and was named neo-Ricardian trade theory. The main contributors include Ian Steedman (1941) and Stanley Metcalfe (1946). They have criticised neoclassical international trade theory, namely the Heckscher-Ohlin model on the basis that the notion of capital as primary factor has no method of measuring it before the determination of profit rate (thus trapped in a logical vicious circle). [39][40] This was a second round of the Cambridge capital controversy, this time in the field of international trade.[41] The merit of neo-Ricardian trade theory is that input goods are explicitly included to the analytical framework. This is in accordance with Sraffa's idea that any commodity is a product made by means of commodities. The limit of their theory is that the analysis is limited to small country cases. The wage of the Rest of the World is determined by assumption and there is no internal mechanism which generates international wage differences. In this sense the neo-Ricardian trade theory lacks international value theory.[42]

Ricardo-Sraffa trade theory

Traded intermediate goods Ricardian trade theory ordinarily assumes that the labor is the unique input. This is a great deficiency as trade theory, for the intermediate goods occupy the major part of the world international trade. Yeats [43] found that 30% of world trade in manufacturing is intermediate inputs. Bardhan and Jafee[44] found that intermediate inputs occupy 37 to 38% in the imports to the US for years 1992 and 1997, whereas the percentage of intrafirm trade grew from 43% in 1992 to 52% in 1997. McKenzie[34]:1779 and Jones[45] emphasised the necessity to expand the theory to the cases of traded inputs. Paul Samuelson[46] coined a term Sraffa bonus to name the gains from trade of inputs. Theoretical developments John Chipman observed in his survey that McKenzie stumbled upon the questions of intermediate products and discovered that "introduction of trade in intermediate product necessitates a fundamental alteration in classical analysis." [47] It took may years until recently Y. Shiozawa[48] succeeded to remove this deficiency. The Ricardian trade theory was now reconstructed to include intermediate input trade in a very general case of many countries and many goods. This new theory is sometimes called Ricardo-Sraffa trade theory. It is emphasised that the Ricardian trade theory now provides a general theory which includes trade of intermediates such as materials, fuel and machine tools. The traded intermediate goods are then used as inputs of productions. Capital goods are nothing other than inputs to the productions. Thus, in the Ricardian trade theory, capital goods move freely from country to country. Trade in capital goods may transmit the benefit of technological advances across trading countries. [49] Labor is the unique factor of production that remains immobile in the country of its origin. The neoclassical Heckscher-Ohlin-Samuelson theory assumes only production factors and finished goods. It has not the concept of intermediate goods. Therefore, it is the Ricardo-Sraffa trade theory that provides theoretical bases for the topics as outsourcing, fragmentation[50] and intra-firm trade.[51] Recent episode In a blog post of 28 April 2007, Gregory Mankiw compared Ricardian theory and Heckscher-Ohlin theory and stood by the Ricardian side.[52] Mankiw argued that Ricardian theory is more realistic than the Heckscher-Ohlin theory as the latter assumes that capital does not move from country to country. Mankiw's argument contains a logical slip, for the traditional Ricardian trade theory does not admit any inputs. Shiozawa's result saves Mankiw from his slip.[42]

Criticism of the Ricardian theory of trade

Ricardo's plea for free trade received attacks from those people who think trade restriction is necessary. Uta Patnaike claims that Ricardian theory of international trade contains a logical fallacy. Ricardo assumed that in both countries two goods are producible and actually are produced, but developed and underdeveloped countries often trade those goods which are not

producible in their own country. For example, many Northern countries do not produce tropical fruits. In these cases, one cannot define which country has comparative advantage. [53] Ricardo's theory of comparative advantage is also flawed in that it assumes production is continuous and absolute. In the real world, events outside the realm of human control (e.g. natural disasters) can disrupt production. In this case, specialisation could cripple a country that depends on imports from foreign, naturally disrupted countries. For example, if an industrially based country trades its manufactured goods to an agrarian country in exchange for agricultural products, a natural disaster in the agricultural country (e.g. drought) may cause an industrially based country to starve.