sign in sign up
<<
Home , David Ricardo, James Mill

Economic Insights

FEDERAL RESERVE BANK OF DALLAS VOLUME 9, NUMBER 2 Theory of Free International

Few ideas have been as widely accepted David Ricardo was born in London in 1772, one of 17 children. His parents by and as roundly rejected by were Sephardic Jews who had emi- many other people as the doctrine of free grated to England. His father, Abraham, . Economists base their was a successful stockbroker. Ricardo’s career started when he began acceptance of the mutual benefits from such working for his father at age 14, but at trade on a concept called comparative 21 he married a Quaker, which created advantage. The theory is most closely associ- a family rift that sent Ricardo into the world completely on his own. He none- ated with the writings of the great English clas- theless prospered as a stockbroker and sical school David Ricardo. left a vast estate at his death. Although his career in the field of political Having no problems, Ricardo could afford to spend a great was brief, Ricardo became one deal of time in intellectual pursuits, and of the most influential—and financially he became interested in many subjects. successful—practitioners the discipline has Besides , which he took up after reading ’s ever known. of Nations in 1799, he also stud- David Ricardo Today, world trade agreements are ied mathematics, mineralogy, chemistry under increasing attack. Many people are and geology. His career as an active political economist lasted but 14 years.1 This helped to cement in the pub- deeply concerned about such issues as out- Ricardo’s first major work in the lic’s mind the idea that Ricardo was an sourcing and the physical location—and field of , The High of economist of some standing. That sta- relocation—of firms doing business across Bullion, a Proof of the Depreciation of tus brought him into contact with other Bank Notes, was published in 1810. famous political economists of his time, national borders. In light of these develop- This pamphlet became very influential, notably and Thomas Robert ments, we offer this latest Economic Insights making Ricardo’s name familiar to those Malthus. Mill became Ricardo’s mentor, on the life and ideas of one of ’s most in government who sought economic coaching him and inspiring him to write advice. A parliamentary inquiry into the more in their shared field. ardent theoretical defenders. Anyone inter- high bullion price may have been the In 1814, Ricardo retired from busi- ested in this issue should become familiar with direct result of the pamphlet’s publica- ness life and bought an estate in Glou- Ricardo’s work. We hope this short piece pro- tion, but that’s speculative. In any case, cestershire. A year later, he published the government report’s conclusion— his next major work in economics, vides a useful starting point. that the then occurring in Essay on the Influence of a Low Price of — Bob McTeer England was the result of too many Corn on the Profits of Stock. In that President paper banknotes being created—was work, Ricardo laid out what was to Federal Reserve Bank of Dallas Ricardo’s own claim in his pamphlet. become a key idea in neoclassical eco-

nomics: the so-called law of diminish- The Beneficent Effects of ing returns as it applied to labor and Taxation Impedes Growth, Free Trade and National . Generally, as it applies to culti- and Its Incidence Falls vation of crops, this law states that Equalization increasing the quantities of inputs will Not Necessarily Where increase total production up to a point, the Law Says Under a system of perfectly free com- but then must decline, given merce, each country naturally devotes its that the used is fixed in size. There are no which have not a capital and labour to such Although increasing production is pos- tendency to lessen the power to accumu- as are most beneficial to each. This pursuit sible, and perhaps common at first, at late. All taxes must either fall on capital or some point the marginal returns to of individual advantage is admirably con- revenue. If they encroach on capital, they additional inputs must decline, fol- nected with the universal good of the must proportionably diminish that fund by lowed by their average returns and, whole. By stimulating industry, by reward- whose extent the extent of the productive thus, total output must decline as well. ing ingenuity, and by using most effica- industry of the country must always be Ricardo’s purpose in exploring the ciously the peculiar powers bestowed issue of land rents was British legisla- regulated; and if they fall on revenue, they by nature, it distributes labour most effec- tion called the . Passed in must either lessen accumulation, or force tively and most economically: while, by in- 1815, these laws forbade the importa- the contributors to save the amount of the creasing the general mass of productions, tion into England of food grown else- , by making a corresponding diminution it diffuses general benefit, and binds to- where and sought to maintain the of their former unproductive gether by one common tie of and rising for British agricultural of the necessaries and luxuries of life. intercourse, the universal society of products that had occurred during the Some taxes will produce these effects in a nations throughout the civilized world. It is Napoleonic wars, when the French navy much greater degree than others; but the this principle which determines that wine had embargoed British ports. Facing great evil of taxation is to be found, not so shall be made in France and Portugal, that the loss of food imports, Britain had to much in any selection of its objects, as in corn shall be grown in America and Poland, use more of its own land to feed its the general amount of its effects taken col- and that hardware and other shall be population. This caused crop prices, lectively. manufactured in England. and hence, land rents to rise at rapid Taxes are not necessarily taxes on In one and the same country, profits rates during the war period. The pro- capital because they are laid on capital; nor are, generally speaking, always on the tectionist Corn Laws were an attempt to on income because they are laid on in- same level; or differ only as the employ- maintain the agricultural status quo after come…. The desire which every man has ment of capital may be more or less secure Napoleon’s defeat and a return to peace- to keep his station in life, and to maintain and agreeable. It is not so between differ- ful conditions. his wealth at the height which it has once ent countries. If the profits of capital em- Ricardo, himself a landowner who attained, occasions most taxes, whether ployed in Yorkshire should exceed those of was profiting from the rising rents, nev- laid on capital or on income, to be paid ertheless argued that the Corn Laws capital employed in London, capital would from income; and therefore as taxation pro- should not be enacted and, after they speedily move from London to Yorkshire, ceeds, or as government increases its were, continued to argue strenuously and an equality of profits would be ef- expenditure, the annual enjoyments of for their repeal. Beyond that, the ob- fected; but if in consequence of the dimin- the people must be diminished, unless they served rent increases suggested to Ri- ished rate of production in the lands of cardo a general theory of land rent. are enabled proportionally to increase England, from the increase of capital and The reason rent exists, he argued, was their capitals and income. It should be the population, should rise, and profits that as more and more land of dimin- policy of governments to encourage a dis- fall, it would not follow that capital and ishing fertility was applied to growing position to do this in the people, and never population would necessarily move from food, the better lands commanded a to lay such taxes as will inevitably fall on England to Holland, or Spain, or Russia, premium. This was an argument for capital; since by so doing, they impair the where profits might be higher. I rent on the extensive margin, that is, as funds for the maintenance of labour, and more land was cultivated. But Ricardo thereby diminish the future production of —On the Principles of Political Economy also argued for rent on the intensive the country. I and Taxation (Cambridge, UK: margin, that is, where similar lands Cambridge University Press, 1983), experienced different —On the Principles of Political Economy 133–34 to capital and labor. In Ricardo’s view, and Taxation, 152–53 the Corn Laws generated rents both ex-

tensively and intensively. His analysis of the effects of the Corn Laws produced The Potential Pitfalls the famous Ricardian theory of rent.2 In 1817, he expanded his pamphlet for Paper Monies on rent and retitled it On the Principles of Political Economy and Taxation. By There is no point more important in issuing paper money, than to be fully impressed with the 1819, he had been elected to the House effects which follow from the principle of limitation of quantity. It will scarcely be believed fifty of , where he continued to years hence, that Bank directors and ministers gravely contended in our times, both in parliament, be an active participant in the policy and before committees of parliament, that the issue of notes by the , unchecked discussions of his time. by any power in the holders of such notes, to demand in exchange either specie, or bullion, had Ricardo died suddenly of an ear not, nor could have any effect on the prices of , bullion, or foreign exchanges. After infection in 1823, leaving an estate esti- the establishment of Banks, the State has not the sole power of coining or issuing money. The cur- mated at $126 million (current dollars). rency may as effectually be increased by paper as by coin; so that if a State were to debase its As Mark Blaug comments: “Ricardo may money, and limit its quantity, it could not support its , because the Banks would have an equal or may not have been the greatest power of adding to the whole quantity of circulation. On these principles, it will be seen that it is economist that ever lived, but he was not necessary that paper money should be payable in specie to secure its value; it is only neces- certainly the richest.”3 sary that its quantity should be regulated according to the value of the metal which is declared to be the standard. If the standard were gold of a given weight and fineness, paper might be Ricardo’s Contributions increased with every fall in the value of gold, or, which is the same thing in its effects, with every and System rise in the price of goods…. Experience, however, shows, that neither a State nor a Bank ever have Ricardo’s approach to economics had the unrestricted power of issuing paper money, without abusing that power: in all States, differed markedly from that of Adam therefore, the issue of paper money ought to be under some check and control; and none seems Smith. Ricardo was a pure theoretician, so proper for that purpose, as that of subjecting the issuers of paper money to the obligation of an architect of a simple, highly abstract paying their notes, either in gold coin or bullion. model from which he drew policy con- I clusions. His most important assump- —On the Principles of Political Economy and Taxation, 353–54, 356 tion was that must decline and end due to the of land and its falling marginal productiv- ity. In this, we see the origin of ’s later contention that eco- lation and economic growth.4 Because One of the ideas for which Ricardo nomic stagnation would flow from the his model produced a falling rate of is most remembered is the theory of working out of the capitalist productive profit and an ever-rising price for corn . Ricardo demon- process. It also is very suggestive of later (grains), Ricardo favored an end to the strated that for two nations without arguments by of Corn Laws, arguing that Britain ought input factor mobility, specialization and the continuing potential macrostagnation to import corn from countries better trade could result in increased total that, according to Keynes and many of equipped to produce it at lower cost. output and lower costs than if each his followers, flows from a chronic He hated the rising rents he attributed nation tried to produce in isolation. insufficiency of in to the laws, since they came, in his Since Ricardo’s exposition, the distinc- any relatively closed- economy. view, at the expense of the driving tion between absolute and comparative Ricardo’s foremost contemporary force of the economy—profits. advantage has been taught as one of critic was Malthus, author of the famous Twenty-three years after his death, the field’s most brilliant insights. pamphlet An Essay on the Principle of the laws were repealed and Ricardo’s Nations will export not only what they Population. It was from Malthus that international free trade agenda became have an in produc- Ricardo took the argument of an ever- one with British public policy. Ricardo ing, but also what they have a compar- growing population that pressed had provided an answer to Britain’s ative cost edge in producing. Some his- against all economic expansions, an long-term growth problems, and Britain torians of economic thought have assumption that lay at the heart of became the “workshop of the world,” sought to show that others, specifically Ricardo’s model. His central considera- importing most of its food and “out- James Mill and Robert Torrens, stated tion in his Principles was to show how sourcing” most of its agricultural employ- the idea, or something close to it, prior distributional changes between wages, ment. Ricardo’s ideas became “the to Ricardo. Such writers tend to dis- rent, interest and profit affected the fountainhead of all nineteenth-century count Ricardo’s version of the theory as prospects for long-run capital accumu- free trade doctrine!”5 very short and possibly even incorrect.6

Other economic defend money change prices instead of real Ekelund, Jr., and Robert F. Hébert, 4th ed., Ricardo and argue the contrary.7 factors. New York: McGraw-Hill, 1997, pp. 144–46. Regardless of ongoing academic dis- Ricardo’s theory of rent was tied 3 Great Economists before Keynes, by Mark putes, it is unlikely that historians of directly to the marginal of Blaug, New York: Cambridge University economic thought will reverse their land, his theory of value was tied Press, 1986, p. 201. position on Ricardo’s original author- directly to labor costs, and his theory of 4 Ekelund and Hébert (1997), p. 147. ship of this idea. distribution stood atop both concepts, 5 Blaug (1986), p. 203. Another major contribution Ricar- with Malthusian economic stagnation 6 : An Austrian do made to economics was the doc- as a major assumption. Ricardo was not Perspective on the History of Economic trine of fiscal equivalence, or, as it has so naive as to attempt to explain all Thought, by , vol. 2, Hants, come to be known today, Ricardian market prices by labor costs. He recog- UK: Edward Elgar, 1995, pp. 96–98. equivalence. His argument, as put forth nized the importance of “nonreproduc- 7 “David Ricardo’s Discovery of Comparative in Chapter 17 of his Principles, is as fol- ible” commodities whose value was Advantage,” by Roy J. Ruffin, History of lows: It doesn’t matter whether govern- solely determined by their rarity in the Political Economy, vol. 34, Winter 2002, ment finances itself through taxes market. However, he considered these pp. 727–48. or debt. They are equivalent and things—rare paintings, fine wines—to 8 Ekelund and Hébert (1997), p. 148. have no appreciable effect on house- be a small portion of overall market 9 The General Theory of , Interest hold consumption or capital formation. consumption. He also allowed a role and Money, by John Maynard Keynes, New This is because either the public for capital in determining value and York: Harcourt Brace, 1936, p. 32. sector will save or run a deficit, or argued that an increase in fixed (more will do likewise and at the permanent) capital as opposed to cir- same rate. Further, expectantly, taxpay- culating (perishable) capital would in- ers view a deficit as a future tax crease value. By allowing value to be increase and will save to pay for it, influenced by capital, Ricardo indirectly while a surplus is viewed as a future suggested that time played a major role tax cut with an opposite result. in value, a discovery later generally Households will arrange their private attributed to other economists.8 affairs to frustrate the long-run effects Ricardo’s model, abstract and highly of either finance approach, as judged deductive, became the means by which from a macroeconomic policy perspec- he advocated public policy. A free tive. (To be sure, Ricardo did not want trade enthusiast, he also was not a fan government to issue debt rather than of public expenditure, believing most raise tax revenue, regardless of the truth such spending to be at worst wasteful of his equivalence insight.) or at best incapable of changing aggre- Other concerns that Ricardo de- gate well-being and output. His influ- voted himself to were monetary re- ence should not be underestimated, form, the distribution of national in- especially in Great Britain, for as Keynes come and the determination of an wrote, “Ricardo conquered England as invariant measure of value. Ricardo completely as the Holy Inquisition con- favored redemption of paper money in quered Spain.”9 I gold bullion, argued for decoupling the Bank of England from that nation’s — Robert L. Formaini creation and contended Senior Economist Economic Insights is a publication of the that labor costs were the best long- Federal Reserve Bank of Dallas. The views run invariant measure of the value of expressed are those of the authors and should —a labor cost the- Notes not be attributed to the Federal Reserve System. ory of value not unlike what Smith 1 “David Ricardo,” by G. de Vivo, in The New Please address all correspondence to had also proposed in Wealth of Palgrave: A Dictionary of Economics, ed. Economic Insights Nations. Ricardo was a believer in the John Eatwell, Murray Milgate and Peter Public Affairs Department Federal Reserve Bank of Dallas strict quantity theory of money, Newman, vol. 4, London: Macmillan Press, whereby the is directly pro- P.O. Box 655906 1987, pp. 183–98. Dallas, TX 75265-5906 portional to the quantity of money cir- 2 See the general discussion in A History of Visit our web site at www.dallasfed.org. culating and changes in that quantity of Economic Theory and Method, by Robert B.