Economic Ideologies

Chapter 5 – David Ricardo

Introduction:
 David Ricardo (1772-1823) was a stockbroker turned economist who made significant
contributions to various areas of economic theory. He began studying economics around
1799 and published his first pamphlet, "The High Price of Bullion," in 1810.

 Ricardo's essays on the Corn Law controversy, published around 1815, established him
as one of England's most able economists. His major work, "Principles of Political
Economy and Taxation," published in 1817, became the accepted book on economic
questions, replacing Adam Smith's "Wealth of Nations."

 Ricardo made significant contributions to several areas of economic theory, including

methodology, theories of value, international trade, public finance, diminishing
returns, and rent.

 He is best known for developing the comparative advantage economic theory, which
suggests that countries benefit from producing goods with low production opportunity
costs.

 Ricardo also argued in his Iron Law of Wages theory that attempts to increase workers'
wages were futile because wages would eventually return to or hover around the
subsistence level.

Ricardo's Method:
 Adam Smith approached questions of political economy through deductive theory and
descriptive narratives of contemporary and historical institutions, blending theory with
historical material. David Ricardo, on the other hand, was a pure theorist who abstracted
from the economy of his time and developed his analysis based on the deductive
method.

 Despite Ricardo's somewhat clumsy mathematical technique, his skill as a pure theorist is
highly regarded by contemporary theorists. While Ricardo's method may give the
impression of being purely theoretical and impractical, his work in Ricardian economics
had a strong orientation toward policy.

 One of the burning issues during Ricardo's time was the tariffs on grain importation into
England and their impact on income distribution, which Ricardo was acutely aware of.
 Despite his policy orientation, Ricardo steadfastly believed that theory was essential for
conducting concrete analysis of real-world policy issues.

Ricardo and Economic Policy

 David Ricardo was deeply engaged with the economic problems of his time, including
rising grain prices, increasing rents, and the changing structure of England's
economy.

 The changing economic structure, with the relative growth of industry and decline of
agriculture, had implications for the comparative political power of manufacturing and
agricultural interests.

 One key policy question that emerged was the debate between free trade and regulated
international trade. Landlords sought protection from foreign agricultural products while
rising industrialists advocated for free trade.

 Ricardo's approach to policy had a significant influence on subsequent economists in

terms of how they engaged in policy-making. Ricardo's method involved building highly
theoretical models that abstracted from nonessential factors to reveal causal relationships
between variables.

 However, the challenge with this noncontextual theoretical policymaking is that in the real
world, the "frozen" assumptions often have unintended consequences when applied to
policy.

 Adam Smith, in contrast to Ricardo, was more skilled in the art of economics,
considering practical implications and institutional arrangements in his policy
recommendations. Ricardo's highly abstract method and noncontextual approach to
economic policy became mainstream in the twentieth century, but earlier economists like
J.S. Mill and Alfred Marshall followed a more Smithian approach.

 The legacy of Ricardianism includes highly abstract theory that simplifies variables to
reach indisputable conclusions and noncontextual policymaking based on abstract
[Link] degree of abstraction and contextual analysis appropriate for understanding
the economy and making economic policy remains a complex and debated issue in the
history of economic thought.

The Scope of Economics According to Ricardo

 David Ricardo believed that the principal purpose of economics was to determine the
laws that regulate the distribution of income among landlords, capitalists, and laborers.
  He focused on the functional distribution of income, which refers to the relative shares of
yearly output going to labor, land, and capital. Ricardo's analysis of the distribution of
income led him to develop theories explaining profits, interest, rent, and wages.

 While Ricardo also considered various macroeconomic questions, such as population

theory, wages fund doctrine, and the stability of the economy, his primary interest
was in understanding the effects of changes in income distribution on the rate of capital
accumulation and economic growth.

 Ricardo's examination of the labor theory of value became the starting point for
subsequent attempts to explain the formation of relative prices. However, Ricardo's work
had the unintended effect of directing subsequent economic investigation toward
microeconomic issues rather than macroeconomic ones.

 His victory over Malthus concerning the macroeconomic stability of the economy closed
the debate among orthodox theorists for nearly a century.

Ricardo's Theory of Land Rent:

 David Ricardo, along with Malthus, West, and Torrens, formulated the principle of
diminishing returns during the analysis of the Corn Law controversy. The principle of
diminishing returns states that if one factor of production is steadily increased while
others are held constant, the rate at which the total product increases will eventually
diminish.

 Ricardo assumed fixed coefficients of production for labor and capital based on
technological considerations, with a fixed quantity of land to which doses of capital and
labor are added.

 He believed that diminishing returns begin immediately, meaning that the marginal
product of the second dose of capital and labor is less than that of the first. Ricardo's
analysis of land rent was based on the concept of diminishing returns and the
differential theory of rent.

 The differential theory of rent explains that the value of agricultural produce is
regulated by the quantity of labor necessary to produce it on the worst land, while
better lands yield higher values due to the difference between the actual labor
employed and the value of rent paid.

 Ricardo argued that rent is not a part of the price of commodities but rather its effect,
and it cannot be the cause of high corn prices. Ricardo's examination of land rent and
the principle of diminishing returns had a significant impact on subsequent economic
thought.
  The theory of Rent; Assumed that land is a gift of nature that has no supply price or
cost of production. The rent of land is determined by the rate of fertility. It assumed the
law of diminishing marginal retunes in case of cultivated land.

Ricardo’s theory of value:

 Ricardo's theory of value was developed in response to the Corn Law controversy,
where he argued against tariffs and in favor of free international trade. He believed that
high tariffs would reduce the rate of profits, leading to a slower rate of capital
accumulation and lower economic growth.

 Ricardo disagreed with Adam Smith's cost of production theory of value, which was
being used by protectionists to argue that higher tariffs would not result in lower
profits. Both sides agreed that increased tariffs would push down the margin as less
fertile lands were utilized and land under cultivation was farmed more intensively.

 Ricardo wanted to refute the prevailing cost of production theory of value to establish the
benefits of removing the tariffs on grain. He recognized the impact of the Corn Laws on
the distribution of income and the limitations of prevailing economic theory in
explaining it, which led him to develop an alternative theory of value.

 Ricardo's primary concern was to explain the economic forces that cause changes in
relative prices over time, rather than determining relative prices at a given point in
time. He attempted to formulate a measure of absolute value that would be invariant
over time but was unable to provide a satisfactory solution.

Ricardo's Solutions to Fundamental Problems in Labor Theory of Value:

1. Measuring the Quantity of Labor: Ricardo used clock hours as a measure of the
quantity of labor necessary to produce a good, emphasizing that it is the quantity of labor
that determines relative prices, not the wages paid to labor.

2. Differences among labor: Ricardo recognized that workers are not homogeneous and
that their productivity can vary. To account for this, he used wages as a proxy for the
productivity of labor. However, he did not provide a solution to address the issue of
varying skills over time.

3. Accounting for capital goods: Ricardo's solution to incorporating capital goods into the
labor theory of value was not entirely satisfactory. He summed the labor directly applied in
the depreciation of capital during the manufacturing process. This approach attempted to
capture the labor embodied in capital goods.

4. Accounting for land in price determination: Ricardo acknowledged that rents differ
according to the fertility of the land. In his theory, the value of agricultural produce is
 regulated by the quantity of labor necessary to produce it on the worst land, while better
lands yield higher values due to the difference between the actual labor employed and
the value of rent paid.
5. Accounting for profits: Ricardo recognized that profits depend on the real wage rate
and the productivity of labor. The level of wages and the efficiency of labor play a role in
determining the surplus value that accrues to capitalists as profits.

David Ricardo's Theory of Comparative Advantage:

 Development of Comparative Advantage Theory: David Ricardo developed the theory
of comparative advantage, which argues that a country doesn't need to have an absolute
advantage for beneficial trade to occur. This theory represents a more developed
framework than Adam Smith's absolute advantage theory and emphasizes the relative
efficiency of production.

 Definition of Comparative Advantage: Comparative advantage arises when a country

or individual is relatively more efficient in the production of a good than another country or
individual. It measures efficiency in terms of relative magnitudes, allowing countries to
specialize in producing goods or services in which they have a comparative advantage.

 Efficiency and Resource Allocation: Due to limited resources and varying levels of
technology, countries tend to produce goods or services in which they have a
comparative advantage. This leads to the international division of labor, where countries
specialize in the production of certain products to maximize overall efficiency.

 Opportunity Cost and Specialization: Comparative advantage implies an opportunity

cost associated with the production of one good compared to another. This notion leads
to countries specializing in the production of goods or services where they have a
comparative advantage, thereby enhancing overall efficiency and trade relationships.

 Real-world Application: For example, a country with fertile land and a suitable climate
for agriculture may have a comparative advantage in producing agricultural goods, while
a country with advanced technology and skilled labor may have a comparative advantage
in producing high-tech goods.