Economic Insights FEDERAL RESERVE BANK OF DALLAS VOLUME 9, NUMBER 2 David Ricardo Theory of Free International Trade Few ideas have been as widely accepted David Ricardo was born in London in 1772, one of 17 children. His parents by economists 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, international trade. Economists base their was a successful stockbroker. Ricardo’s business 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 economist David Ricardo. left a vast estate at his death. Although his career in the field of political Having no money problems, Ricardo could afford to spend a great economy 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 political economy, which he took up after reading Adam Smith’s ever known. Wealth 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 economics, The High Price 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 James Mill 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 free trade’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 inflation 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 capital. Generally, as it applies to culti- and Its Incidence Falls vation of crops, this law states that Profit 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 output must decline, given merce, each country naturally devotes its that the land used is fixed in size. There are no taxes which have not a capital and labour to such employments 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 Corn Laws. 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- tax, by making a corresponding diminution it diffuses general benefit, and binds to- where and sought to maintain the of their former unproductive consumption gether by one common tie of interest and rising prices 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 goods 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, wages 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 diminishing returns —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 Commons, 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 Bank of England, unchecked discussions of his time.