David Ricardo

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David Ricardo Classical economics

Birth 19 April 1772(1772-04-19)
Death 11 September 1823 (aged 51)
Nationality British
Influences Smith · Bentham
Influenced Ricardian Socialists · John Stuart Mill · Marx · Sraffa · Barro
Contributions Ricardian equivalence, labor theory of value, comparative advantage, law of diminishing returns

David Ricardo (19 April 1772 – 11 September 1823) was an English 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 his most important contribution 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 a relative productivity advantage.[2]

Personal life

Born in London, Ricardo was the third of 17 children of a Sephardic Jewish family of Portuguese origin who had recently relocated from Holland. His father was a well-to-do 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 of his time.

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.

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 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 labor theory of value states that the relative price of two goods is determined by the ratio of the quantities of labor required in their production. His labor 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 labor 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,"[4] Ricardo makes effort to illustrate that exchangeable value is not the same as "value in use."[5] 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.[6] 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.

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.

In his book, Principles of Political Economy and Taxation, Ricardo's concept of rent is laid 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 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[7] 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

In demonstrating that Ricardian Rent constitutes value for everything, Ricardo was 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 its over-investment (due to its 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 (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.[8]