David Ricardo

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David Ricardo

David Ricardo (April 18, 1772 – September 11, 1823), a British political economist, is often credited with systematizing economics, and was one of the most influential of the classical economists. He was also a successful businessman, financier, and speculator, and amassed a considerable fortune.

Biography

Born in London, Ricardo was the third of seventeen children in a Sephardic Jewish family (from Portugal) that emigrated from the Netherlands to England just prior to his birth. At age 14 Ricardo joined his father at the London Stock Exchange, where he began to learn about the workings of finance. This beginning set the stage for Ricardo's later success in the stock market and real estate.

Ricardo rejected the orthodox Jewish beliefs of his family and eloped with a Quakeress, Priscilla Anne Wilkinson, when he was 21. He later became a Unitarian, and was disinherited by his family. It is likely that his mother never spoke to him again.

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.

His work with the stock exchange made Ricardo 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 purchased a seat in the British parliament as a representative of Portarlington, a borough in Ireland. He held the post until the year of his death in 1823. As a member of parliament, Ricardo 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 Robert Malthus, with whom Ricardo had a considerable debate (in correspondence) over such things as the role of land owners in 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.

He died at Gatcombe Park at 51 years of age.

Rirardo’s works

Ricardo first gained notice among economists over the "bullion controversy." In 1809 he wrote that England's inflation was the result of the Bank of England's propensity to issue excess bank notes. In short, Ricardo was an early believer in the quantity theory of money, or what is known today as monetarism.

”Essay on the Influence of a Low Price of Corn on the Profits of Stock”

In this work (Ricardo 1815), Ricardo articulated what came to be known as the "law of diminishing returns." One of the most famous laws of economics, it holds that as more and more resources are combined in production with a fixed resource—for example, as more labor and machinery are used on a fixed amount of land—the additions to output will diminish.

Ricardo also opposed the protectionist Corn Laws, which restricted imports of wheat. In arguing for free trade, Ricardo formulated the idea of comparative costs, today called "comparative advantage." Comparative advantage, a very subtle idea, is the main basis for most economists' belief in free trade today. The idea is this:

A country that trades for products that it can get at lower cost from another country is better off than if it had made the products at home.

The gains in foreign trade for both of his imaginary countries, “Richland” and “Poorland”, come, Ricardo observed, because each country specializes in producing the goods for which its comparative cost is lower (Ricardo 1815):

Let us say that Poorland can produce one bottle of wine with five hours of labor and one loaf of bread with ten hours. Richland's workers, on the other hand, are more productive. They produce a bottle of wine with three hours of labor and a loaf of bread with one hour. One might think at first that because Richland requires fewer labor hours to produce either of the goods, it has nothing to gain from trade. Think again. ... Poorland's cost of producing wine, although higher than Richland's in terms of hours of labor, is lower in terms of bread. For every bottle produced, Poorland gives up half of a loaf, while Richland has to give up three loaves to make a bottle of wine. Therefore, Poorland has a comparative advantage in producing wine. Similarly, for every loaf of bread it produces, Poorland gives up two bottles of wine, but Richland gives up only a third of a bottle. ... Therefore, Richland has a comparative advantage in producing bread. If they exchange wine and bread one-for-one, Poorland can specialize in producing wine and trading some of it to Richland, and Richland can specialize in producing bread. Both Richland and Poorland will be better off than if they hadn't traded. By shifting, say, ten hours of labor out of producing bread, Poorland gives up the one loaf that this labor could have produced. ... But the reallocated labor produces two bottles of wine, which will trade for two loaves of bread. Result: trade nets Poorland one additional loaf of bread. Nor does Poorland's gain come at Richland's expense. Richland gains also, or else it would not have traded. By shifting three hours out of producing wine, Richland cuts wine production by one bottle but increases bread production by three loaves. ... It trades two of these loaves for Poorland's two bottles of wine. Richland has one more bottle of wine than it had before, and an extra loaf of bread. (Ricardo 1815)

These gains come, Ricardo observed, because each country specializes in producing the goods for which its comparative cost is lower.

Writing a century before Paul Samuelson and other modern economists popularized the use of equations, Ricardo is still esteemed for his uncanny ability to arrive at complex conclusions without any of the mathematical tools now deemed essential.

As economist David Friedman put it in his textbook, Price Theory, "The modern economist reading Ricardo's Principles feels rather as a member of one of the Mount Everest expeditions would feel if, arriving at the top of the mountain, he encountered a hiker clad in T-shirt and tennis shoes."

Principles of Political Economy and Taxation

The produce of the earth - all that is derived from its surface by the united application of labour, machinery, and capital, is divided among three classes of the community; namely, the proprietor of the land, the owner of the stock or capital necessary for its cultivation, and the labourers by whose industry it is cultivated. But in different stages of society, the proportions of the whole produce of the earth which will be allotted to each of these classes, under the names of rent, profit, and wages, will be essentially different; depending mainly on the actual fertility of the soil, on the accumulation of capital and population, and on the skill, ingenuity, and instruments employed in agriculture.(Ricardo 1817, Preface)

To determine the laws which regulate this distribution, is the principal problem in Political Economy: much as the science has been improved by the writings of Turgot, Stuart, Smith, Say, Sismondi, and others, they afford very little satisfactory information respecting the natural course of rent, profit, and wages. (Ricardo, 1817)

In 1815, Mr. Malthus…..presented to the world the true doctrine of rent; without a knowledge of which, it is impossible to understand the effect of the progress of wealth on profits and wages, or to trace satisfactorily the influence of taxation on different classes of the community; particularly when the commodities taxed are the productions immediately derived from the surface of the earth. …Adam Smith…. not having viewed correctly the principles of rent, have, it appears to me, overlooked many important truths, which can only be discovered after the subject of rent is thoroughly understood. To supply this deficiency, abilities are required of a far superior cast to any possessed by the writer of the following pages; yet, after having given to this subject his best consideration … …. have yielded to the present generation…. opinions on the laws of profits and wages, and on the operation of taxes are presented. (Ricardo, 1817)

Law of Rent

Ricardo formulate the "Law of Rent" around 1809. It was the first clear exposition of the source and magnitude of land rents, and is among the most important and firmly established principles of economics. The Law of Rent states that the rent of a land site is equal to the economic advantage obtained by using the site in its most productive use, relative to the advantage obtained by using marginal (the best rent-free) land for the same purpose, given the same inputs of labor and capital.

This law has a number of important implications, perhaps the most important being its implication for wages. The Law of Rent implies that wages bear no systematic relationship to the productivity of labor, and are instead determined solely by its productivity "on marginal land", as all production in excess of that amount will be appropriated by landowners in rent. This is not the notorious "iron law of wages," which predated Ricardo and is most commonly associated with the writings of Thomas Malthus. Indeed, the Law of Rent explains why the Iron Law of Wages consistently fails to predict actual wages: if there are highly productive land sites available for free, wages will tend to be high, cet.par.; if the only available free land yields little, wages will tend to be lower.

The Law of Rent makes it clear that the landowner has no role in setting land rents: he simply appropriates the additional production his more advantageous site makes possible, compared to marginal sites. The Law also implies that the landowner cannot pass on the burden of any cost such as land taxes to his tenants, as long as such costs do not affect the relative productivity of his land and marginal land.

The "Subsistence Theory of Wages," also known as the "Iron Law of Wages," was an alleged law of economics that asserted that real wages in the long run would tend to the value needed to keep the workers' population constant. The alleged law was named and popularized by the German socialist Ferdinand Lassalle in the mid 1800s.

According to Lassalle, wages cannot fall below subsistence level because without subsistence labourers will be unable to work for long. However, competition among labourers for employment will drive wages down to this minimal level. This followed from Malthus' demographic theory, according to which the growth rate of population was – mainly for cultural reasons – an increasing function of wages, reaching a zero for a unique positive value of the real wages rate, called the "subsistence wage." Assuming the demand for labour to be a given monotonically decreasing function of the real wages rate, the theory then predicted that, in the long-run equilibrium of the system, labour supply (i.e. population) will be equated to the numbers demanded at the subsistence wage. The justification for this was that when wages are higher, the supply of labour will increase relative to demand, creating an excess supply and thus depressing market real wages; while when wages are lower, labour supply will fall, increasing market real wages. This would create a dynamic convergence towards a subsistence-wage equilibrium with constant population.

As Ricardo first noticed, this prediction would not come true as long as a new investment or some other factor caused the demand for labour to increase at least as fast as population: in that case the equality between labour demanded and supplied could in fact be kept with real wages higher than the subsistence level, and hence an increasing population. In most of his analysis, however, Ricardo kept Malthus' theory as a simplifying assumption.

The subsistence theory of wages has been frequently attributed to David Ricardo. However, this attribution is disputed. Ricardo drew a distinction between a natural price and a market price. For Ricardo, the natural price of labour was the cost of maintaining the labourer. However, Ricardo believed that the market price of labour or the actual wages paid could exceed subsistence level indefinitely due to countervailing economic tendencies:

"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...."

Furthermore, not only did Ricardo believe that the market price of labour could long exceed the subsistence or natural wage, he also claimed that the natural wage was not what was needed to physically sustain the labourer, but depended on "habits and customs":

"It is not to be understood that the natural price of labour, estimated even in food and necessaries, is absolutely fixed and constant. It varies at different times in the same country, and very materially differs in different countries. It essentially depends on the habits and customs of the people. An English labourer would consider his wages under their natural rate, and too scanty to support a family, if they enabled him to purchase no other food than potatoes, and to live in no better habitation than a mud cabin; yet these moderate demands of nature are often deemed sufficient in countries where 'man's life is cheap', and his wants easily satisfied. Many of the conveniences now enjoyed in an English cottage, would have been thought luxuries in an earlier period of our history."

Ricardo’s economics principles seen in all his works

Money, from its being a commodity obtained from a foreign country, from its being the general medium of exchange between all civilized countries, and from its being also distributed among those countries in proportions which are ever changing with every improvement in commerce and machinery, and with every increasing difficulty of obtaining food and necessaries for an increasing population, is subject to incessant variations. (McCulloch 1881, p. 31)

A rise in wages, from an alteration in the value of money, produces a general effect on price, and for that reason it produces no real effect whatever on profits. On the contrary, a rise of wages, from the circumstance of the laborer being more liberally rewarded, or from a difficulty of procuring the necessaries on which wages are expended, does not, except in some instances, produce the effect of raising price, but has a great effect in lowering profits. (McCulloch 1881, p. 50 )

Labor, like all other things which are purchased and sold, and which may be increased or diminished in quantity, has its natural and its market price. The natural price of labor is that price which is necessary to enable the laborers, one with another, to subsist and to perpetuate their race, without either increase or diminution. (McCulloch 1881)

With the progress of society the natural price of labor has always a tendency to rise, because one of the principal commodities by which its natural price is regulated, has a tendency to become dearer, from the greater difficulty of producing it. As, however, the improvements in agriculture, the discovery of new markets, whence provisions may be imported, may for a time counteract the tendency to a rise in the price of necessaries, and may even occasion their natural price to fall, so will the same causes produce the correspondent effects on the natural price of labor. (McCulloch 1881, p.52)

The natural price of all commodities, excepting raw produce and labor, has a tendency to fall, in the progress of wealth and population; for though, on one hand, they are enhanced in real value, from the rise in the natural price of the raw material of which they are made, this is more than counterbalanced by the improvements in machinery, by the better division and distribution of labor, and by the increasing skill, both in science and art, of the producers. ... Thus, then, with every improvement of society, with every increase in its capital, the market wages of labor will rise; but the permanence of their rise will depend on the question, whether the natural price of labor has also risen; and this again will depend on the rise in the natural price of those necessaries on which the wages of labor are expended. ... As population increases, these necessaries will be constantly rising in price, because more labour will be necessary to produce them. If, then, the money wages of labor should fall, whilst every commodity on which the wages of labor were expended rose, the laborer would be doubly affected, and would be soon totally deprived of subsistence. Instead, therefore, of the money wages of labor falling, they would rise; but they would not rise sufficiently to enable the laborer to purchase as many comforts and necessaries as he did before the rise in the price of those commodities. (McCulloch 1881, pp. 53 - 57)

Legacy

These, then, are the laws by which wages are regulated, and by which the happiness of far the greatest part of every community is governed. Like all other contracts, wages should be left to the fair and free competition of the market, and should never be controlled by the interference of the legislature.......the clear and direct tendency of the poor laws is in direct opposition to these obvious principles: it is not, as the legislature benevolently intended, to amend the condition of the poor, but to deteriorate the condition of both poor and rich; instead of making the poor rich, they are calculated to make the rich poor; and whilst the present laws are in force, it is quite in the natural order of things that the fund for the maintenance of the poor should progressively increase till it has absorbed all the net revenue of the country, or at least so much of it as the state shall leave to us, after satisfying its own never-failing demands for the public expenditure. (McCulloch, 1881, p, 58)

David Ricardo maintained that the economy generally moves towards a standstill. His analysis is rooted in a modified version of the labor theory of value. He held out the belief that the rate of profit for society as a whole depends on the amount of labor necessary to support the workers who farm "the most barren land that can still maintain agriculture."

Ricardo also believed that the Corn Laws, in particular, constituted a burden to the agricultural economy. He believed that these trade barriers kept food prices artificially high and encouraged a bloated rent rate. In Parliament, Ricardo actively campaigned against the Corn Laws as well as other government interventions.

Essentially this economic stance mirrors Adam Smith's teachings: the market, although imperfect, is best left untouched. Government action only prevents the economy from righting itself. Although Ricardo did not share Smith's complete confidence in the market he recognized that tampering with the system would only result in further economic stagnation.

And, finally, he maintained that England's inflation was the result of the Bank of England's propensity to issue excess bank notes. Which means that Ricardo was an early believer in the quantity theory of money, or what is known today as monetarism.

References

ISBN links support NWE through referral fees

• Case, Karl E. & Fair, Ray C. Principles of Economics (5th ed.). Prentice-Hall, 1999, ISBN 0-13-961905-4.
• Friedman, David D. 1992. Price Theory. ISBN 0538805641
• McCulloch, J. R., (ed. ),The Works of David Ricardo, John Murray, London 1881, pp. 31, 50-58.
• Ricardo, D., The High Price of Bullion, a Proof of the Depreciation of Bank Notes, 1810
• Ricardo, D., Essay on the Influence of a Low Price of Corn on the Profits of Stock ,1815,
• Ricardo, D., Principles of Political Economy and Taxation, 1817 ( reprint: Case & Fair, 1999 )
• Samuel Hollander, The Economics of David Ricardo, University of Toronto Press, Toronto. 1979

External links

• On the Principles of Political Economy and Taxation, by David Ricardo. Complete, fully-searchable text at the Library of Economics and Liberty.
• Biography, at the Concise Encyclopedia of Economics
• Biography at New School University
• Biography on Ricardo for A level students on tutor2u

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