9
DAVID RICARDO (1772–1823)
The long shadow of the Corn Laws
David Ricardo is in the big league of the classical economists. As far as recognition among the general public goes, only Karl Marx, Adam Smith, Malthus and John Stuart Mill can hope to beat him. Historians also furiously debate what David Ricardo “really meant”. The only other person in this book who produces such fundamental disagreement is Marx. But to get your head around Ricardo–or, at least, around one version of Ricardo–gives you perhaps the best understanding of what the classical economists were all about.
Ricardo had an enormous impact on many foundational economic questions. Among other things he presented complex analysis on the theory of value–ie, why stuff is worth what it is worth. He pretty much devised the theory of “comparative advantage”, one of the cornerstones of the economics of international trade. Though today he is considered by the liberal (in the British sense) economics establishment to be one of their own, in his time people thought of him as a radical. Economists on both extremes of the political spectrum have argued that Ricardo’s writings justify their stances. And perhaps more than anybody else in this book, Ricardo encapsulates the coldness and heartlessness that is commonly associated with the political economy of the 19th century.
Ricardo seemed destined to break from the mainstream. He was an outsider, born in 1772 to a Jewish stockbroker who had migrated to England from Amsterdam (though the family was originally from Portugal). Though he would have had to share it with 14 other children, David was in line to inherit a decent amount of money. Abraham Ricardo’s estate was worth some £45,000 on his death in 1812, roughly 1,500 times what the average British worker at the time earned in a year. But it wasn’t to be. Upon falling in love with a Quaker, he informed his horrified parents that he had decided to convert. His family, who in the words of one biographer had remained “entirely unassimilated”, disowned him and expelled him from the family business. Unlike many of the economists in this book, who lived off the labour of others, Ricardo was forced to make his own way in the world.
He entered the financial sector and began speculating on the price of government debt. What Ricardo did around the time of the Battle of Waterloo is not certain–it may not even have been legal–but it set him up for life. It was a pump-and-dump scheme but in reverse. He began selling his holdings of government debt, and telling everyone he was doing it, because he “knew” that Britain was about to lose to Napoleon. Other traders sold their holdings too. But, perhaps thanks to a spy he had hired, Ricardo knew what was really happening. After everyone had sold and the price of government debt was depressed, he bought lots of it. Once Britain had won the battle, the price of the debt soared. Ricardo made an enormous amount of money–by one estimate over a million pounds. In today’s prices that is around £200 million.
The Wolf of Lombard Street
By his 40s Ricardo was in the fortunate position of never having to work again. He bought an enormous country house, Gatcombe Park in Gloucestershire, which is today owned by Princess Anne. At Gatcombe he did a lot of solitary thinking.
Had he never made a single intellectual contribution, Ricardo might still have been fairly notable. He became an MP and argued passionately against slavery. He was in favour of reducing the number of offences for which the punishment was death. He was famous for his delight in arguing with people. In 1823 Ricardo wrote a letter to Thomas Malthus, challenging him on some obscure point of theory, despite the fact that Ricardo was suffering blinding headaches from an abscess on the brain. “I have only a few words more to say on the subject of value”, the letter began.
As it was, however, Ricardo made a big impact on economics. Happening upon a copy of Smith’s Wealth of Nations (1776) in 1799 and devouring it, he decided that here was his calling. Ricardo’s instinct was to believe that government interference in the economy messed everything up. Around 1810 there was a fierce debate about what was behind the rampant inflation in Britain at the time (in 1812 it hit 11%). Ricardo wrote a series of letters to a newspaper criticising the Bank of England’s monetary policy (he argued that the Bank was printing too many banknotes, which was the biggest factor behind the inflation). That, in turn, led to his first meeting with Thomas Malthus, who by that time was famous for his Essay (1798). The two quickly became friends. James Mill, John Stuart’s dad and a friend of Ricardo, stumbled across a copy of Ricardo’s contribution to one debate with Malthus, a small pamphlet. He urged Ricardo to turn the thing into a full-scale book.
As Robert Dorfman argues, what followed, On the Principles of Political Economy and Taxation, “was the most authoritative and influential text on economics published in the 75-year span between Smith’s Wealth of Nations and John Stuart Mill’s Principles of Political Economy”. Published in 1817, the book has clear weaknesses. The writing is unbelievably dry. Worse, actually: it is just bad. Try to make head or tail of the following sentence (I certainly can’t): “I am by no means ready to admit that we may not have a more limited measure of prosperity not withstanding the continued operation of the Corn Laws.” Ricardo believed that he was “but a poor master of language”.
The subject matter is equally arid. Writers in the Scottish tradition, most notably Smith, had derived theories from looking at the real world. In Ricardo’s view facts are for wimps. His writings are instead deeply theoretical, deeply abstract–so much so that decades later Alfred Marshall would pass many happy hours converting Ricardo’s arguments into mathematical equations. It almost didn’t matter if facts appeared to disprove one of Ricardo’s theories; if the theories had proceeded logically from first principles then they were necessarily true.1 This approach has come to be known by today’s economists as the “Ricardian vice”. Small wonder that Henry Brougham, a fellow MP, remarked that Ricardo had “dropped from another planet”.
What it is all worth
Where to begin with Ricardo’s many theories? Perhaps the best place to start is his theory of value. In the chapter on Smith I offered an explanation as to why Ricardo and other economists were so obsessed with the question of value. It is not clear to me whether or not political economists really achieved anything genuinely useful with all this talk. Robert Dorfman agrees, saying that from the perspective of the modern reader the argument is an “interminable dispute” and “a great waste of words and time”. Mill spoke for many people when he quipped that the dispute over value was “a question of pure curiosity and of no practical use whatever”. The other problem is that none of the theories can be tested: there is no way of knowing, from real-world evidence, whether Smith, or Ricardo, or Jevons, is right.
Nonetheless, as far as value was concerned Ricardo did make a big contribution. Ricardo did not deny that value was governed by supply and demand. But he considered this to be a “wholly superficial view that merely postponed analysis of the real determinants of relative values, namely the factors governing supply”, as George Stigler puts it.
So what count as the “real determinants”? The rough-and-ready consensus is that Ricardo proposed a “labour theory of value”. He wrote: “The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production.”
Patrick O’Brien nonetheless insists that it is not “strictly accurate” to say that Ricardo advocated a labour theory of value. For Ricardo labour has an important–in fact, the most important–role. But he also recognised that capital also played a big role. When a worker makes a chair they do not do so with their bare hands: they use tools, or machines, as well. The thinking goes that this capital must generate some value too–otherwise, why would a boss bother to purchase the tool or the machine for his workers to use? He or she needs to make a profit, after all. Including capital somewhere in the analysis feels intuitive.
Ricardo makes a few qualifications along these lines, but basically sticks with the labour theory of value. George Stigler puts it best: Ricardo has a “93% labour theory of value”. What is definitely true is that Ricardo only really looked at the supply side to explain why something costs what it costs. He didn’t really bother with looking at demand.2 Some economists argue that his theory represents a decisive break from what Smith said; others cannot see much of a difference. The question has consumed literally thousands of pages of academic writing. What you need to know is that they have a similar idea in mind. Ricardo’s theory of value led him towards the three things for which he is most famous today: his theory of wages, his theory of rent and “comparative advantage”.
The unhappy state of pay
Wages first. Ricardo appeared to support something called the “wage-fund doctrine”, an important notion in classical economics which has its roots in the physiocrats’ Tableau Economique. This theory is important because people used it to explain why interfering in the labour market–for instance, by giving power to trade unions–was completely pointless. It suggests that what workers are being paid right now is as good as it will get.
How did Ricardo reach that conclusion? To understand his theory you need to be clear on a few things. The wage-fund is not a “fund” in the sense of a pot of cash. And you must think of there being two points in time: point 1 and point 2. The crucial notion, as William Breit puts it, is that “future wages depend largely on present profits”.
Ricardo argues that, at point 1, there is a fixed amount of stuff in an economy (this is the wage-fund). Bosses can sell that stuff, converting it into money, then pay it to workers in the form of wages. Where else can the money to pay workers come from, if not from selling stuff that has already been produced? The historian Doris Phillips provides perhaps a better explanation of this idea. “The concept of the wages fund originated in the yearly harvest, which is consumed while the next harvest is in preparation; the wages fund can be regarded as a stock of corn, advanced to workers while they are working and reproducing its value.”
Now, imagine that bosses sold all their corn, and paid it all to workers in the form of wages. They would have nothing left to invest in the production of goods for point 2; ie, no seeds to plant for the next harvest. But if the workers are willing to accept lower wages, the boss can himself retain some share of the harvest–and thus can invest for the future. The point is that if trade unions force bosses to pay out higher wages, then workers will get a pay rise only in the short term. In the long term they will get lower wages.
But that was not the only force pressing down on workers’ pay. Ricardo agreed with Malthus on the question of population. If wages went up for whatever reason, workers would respond by having lots of children. They simply could not help it. As the supply of labour rose, wages would fall back to subsistence level. Historians today call this idea Ricardo’s “iron law of wages”.3
Now, as with everything, the iron law of wages is a bit more complex. Some historians believe that for Ricardo, the “iron” was not quite so metallic. He did not deny that, for quite some period, the actual wage paid to workers could be above what he called the “natural wage”. And how exactly do we define “subsistence”? The logic, surely, should be grounded in some physiological idea in order to be consistent with the Malthusian theory. That is, what is below subsistence level will cause people to die from starvation or disease. But Ricardo did not think like that. He incorporated various social norms into his definition of “subsistence”. He argues that “[m]any of the conveniences now enjoyed in an English cottage, would have been thought luxuries in an earlier period of our history.” Might we, by the same token, regard minimum wages paid in rich countries today as “subsistence” level? Perhaps Ricardo might think so. But it makes his “iron” law of subsistence wages look rather elastic.
Today, no economist believes in the wage-fund doctrine or the iron law of wages. For starters you cannot assume that what workers do not get in wages, the boss will put towards extra investment (they might just stuff the money under the mattress instead, or distribute it to shareholders). Empirical research does not find much evidence that trade unions result in wages going up one year, but then down the next. And if you paid workers more, they might work harder, thereby leading to both higher wages and higher profits.
These days most people seem bemused that the wage-fund doctrine was ever taken seriously. The great Paul Samuelson confessed himself shocked by the “falseness and emptiness of the wage fund doctrine”. James Bonar, a Scottish political economist, argued that the theory “is the crowning instance of an untrue abstraction… and it has probably done more injury to the reputation of economic theory than any other generalisation ever received into economics textbooks”. Oswald St Clair, a biographer of Ricardo, reckons that the notion only survived as long as it did because Ricardo was so famous.
Buy land, now!
Yet an understanding of Ricardo’s theory of wages is important. The notion that wages are always sinking towards subsistence level, both in the short and long term, is an important ingredient of Ricardo’s theory of the rents that landowners could earn from their tenants.4 And this is where things get really nasty. A theory of land rents may sound like a marginal contribution (I certainly thought it was not worth bothering with when I first came across it). In fact it contains within it an alarming message. According to Ricardo, the only people who could ever get rich under capitalism are the landed gentry.
The important thing about Ricardo’s theory of rent is that it is pessimistic. To understand it, divide the economy into three sectors: workers, capitalists and landlords. The workers earn wages, the capitalists earn profits, and the landlords earn rents. Wages are what the workers are paid for an honest day’s labour. Profits are the difference between the cost of production and the selling price. Ricardo assumes that owners of land only produce food: rents are what is left over, once the landlords have sold their food and once they have paid out wage and capital costs. This analysis sounds similar to what Smith outlines in the Wealth of Nations. “The whole annual produce of the land and labour of every country… naturally divides itself… into three parts: the rent of land, the wages of labour, and the profits of stock; and constitutes a revenue to three different orders of people.”
Ricardo makes a shocking conclusion: in his view, the only people who will ever get richer under capitalism are the landlords. Everyone else stays about the same–even if there is economic growth. The thinking goes something like this. As the economy grows, wages rise. But workers respond by having more children. That forces wages back down. The workers are left no better off.
The capitalists do scarcely better than the workers. If the population grows, then the price of grain is higher than it was before. Higher grain prices push up the wage costs facing capitalists,5 which eats into their profits. The upshot is that neither capitalists nor workers can really improve their position, even if the economy grows.
Not so for the landlords. As the price of grain increases, it is worth the landlords’ while to start cultivating less productive land, where the cost of production is higher. (The “less productive” bit is really crucial.) So landlords will meet the demand from the population for extra grain, but the price of grain will be higher than it was before.
With higher grain prices, landlords will start to make a juicy return on their most productive land. On that land, the price at which they can sell their grain will be well above the cost of producing it. Ricardo says that the landlord can therefore earn rents. The more fertile the plot of land, the higher the rent. According to Ricardo, as soon as “land of the second degree of fertility is taken into cultivation, rent immediately commences on that of the first quality and that rent will depend on the difference in quality of these two portions of land”. Landlords make bumper earnings at the expense of everyone else. And as capitalism matures, forcing the price of grain up even further, the landlords take a larger and larger share of overall income. Bigger and bigger rents.
It hardly needs saying that this is a very pessimistic notion of capitalism. Ricardo’s hardworking capitalists did their best, but were confronted with higher wage costs and lower profits. The poor old workers were consigned to live on the breadline, and would respond to every increase in their incomes with a brood of children.6 Only the landlord–who, by the way, did practically no work–stood to gain.
To modern pundits, who typically consider Ricardo to be one of the most enthusiastic promoters of early capitalism, his theory will come as quite a shock. Ricardo, the great theorist of free markets, has practically no faith in the system! His account is also quite different from Adam Smith’s more optimistic version, where everybody gets richer.7 Robert Heilbroner argues that the fundamental difference between Ricardo and Smith’s theories is “Smith’s failure to perceive land as a bottleneck to progress. In Smith’s vision there is no shortage of fertile soil, hence no margin behind which rents would rise along with population.” Donald Winch puts it another way: “A secular upward trend in the price of wage or subsistence goods… became the main proposition dividing Smith’s world from that of Malthus, Ricardo, and all those who followed in their footsteps.”
Now, does Ricardo’s theory hold in the real world? Clearly not. Look at data for Britain. Grain prices have not gone up and up over time–actually, food has got a lot cheaper since Ricardo wrote his tracts. Owners of land have not got richer and richer. In fact the opposite has happened. As Thomas Piketty’s calculations show, the value of agricultural land, relative to overall wealth, has plummeted as capitalist economies have advanced.
The declining value of agricultural land, relative to the overall economy, is in part because during the 19th century, Britain flung open its ports to foreign trade. That reduced the cost of food, benefiting both workers and capitalists, and hurting the landed gentry. In the five years following the repeal of the Corn Laws, the cost of a “respectable basket of necessities”, largely food, fell by 20% (from £19 per person per year to £15.50). And, of course, agriculture has become more productive: with less and less input, farmers can produce more and more output.
The English physiocrat
How did Ricardo get it so very wrong? Tony Wrigley puzzles over why he did not show “any inkling of the onset of a period of revolutionary progress in society’s ability to generate wealth and hence to benefit the living standards of the mass of the population”. This is a point worth emphasising. A man held up to be one of the greatest economists of all time, writing during the world’s first-ever period of rapid GDP growth, was arguing that precisely this was impossible.
There are a few possible solutions to this puzzle. Wrigley suggests that the classical economists did not recognise how important inanimate sources of power (such as coal) would be to the industrial revolution. It is true that Ricardo barely discusses energy economics. His pessimism, in other words, “should be understood to be closely linked to [his] implicit belief that the only major sources of energy in the production process were all animate”, namely, people and horses.
But Wrigley’s is not the only possible explanation. Despite rapid GDP growth in Ricardo’s time, the standard of living of the average Briton was barely improving. Average real-wage growth per year during Ricardo’s adulthood was some 0.4%. As Robert Allen has shown, the early part of the industrial revolution was marked by growing profits for capitalists, but stagnant wages for ordinary people (a not dissimilar situation to the one in which rich countries currently find themselves). It was not clear to many people living at that time that capitalism would indeed raise average living standards over the long run. Many feared precisely what Ricardo feared: that the benefits of economic growth would accrue to a small number of people.
Consider the politics
Another possible explanation–and for me the juiciest one–is that Ricardo did not believe his own theory. Or to put it a different way: like the physiocrats of 18th-century France, did he propose this theory with some ulterior motive in mind?
In my view, it is impossible to understand Ricardo’s theory of rent without also understanding the Corn Laws. These had been introduced in England as long ago as the 12th century, largely in order to benefit agricultural producers. The idea went that, in order to be a secure country, you needed to have a guaranteed supply of food. Importing food was all very well and good when you were on friendly terms with other countries, but when things turned nasty you had to be self-reliant.
The Corn Laws raised the price of imported food, which protected domestic producers. The precise rules affecting imported grain varied from year to year–hence laws in the plural–but, according to an act of 1828, if the price of wheat was 52 shillings per quarter or below, the duty on imports would be 34 shillings and 8 pence.8 That is quite some mark-up.
Ricardo did not much like this state of affairs. He denounced the Corn Laws in his correspondence with Malthus, who defended them in turn. In Ricardo’s view the Corn Laws allowed the landlords to make big rents at the expense of everyone else. They could do this because the laws closed off Britain’s agricultural market from the rest of the world. With the supply of agricultural land limited to what was in Britain, any increase in demand for food would push up British food prices and lead to the landlords earning huge rents. Malthus countered that supporting the prices paid to domestic farmers would help them expand production.
But in a way, the precise nature of the disagreement between Malthus and Ricardo does not matter. The motivation for their differing positions probably resulted from their very different backgrounds. As the chapter on Malthus points out, he was from a long aristocratic bloodline.9 Ricardo, by contrast, was an upstart businessman who made his money in “trade” (something that would have been far beneath Malthus). Is it any wonder that one of them supported laws that benefited the landed gentry, while another fiercely opposed those laws?
But back to Ricardo’s argument. Imagine, he says, that Britain flings open its ports, and takes grain from anywhere. If there is more demand for food, there is no need to go to British landlords, who will charge you a premium price. Instead you can simply import more at the world price–from Russia or America, for instance. Workers’ wages can rise, as can capitalists’ profits. As capitalists’ profits rose, they would be able to invest more, making Britain a richer, more productive place.
In other words, it is best to understand Ricardo’s theory of rent as an economic theory with political objectives. By arguing that Britain, in its form at the time, would inevitably end up with a super-rich class of aristocrats, he was trying to persuade MPs to repeal the Corn Laws.10 “The interest of the landlords”, Ricardo argued, “is always opposed to the interest of every other class in the community.” Ricardo died long before the Corn Laws were finally scrapped. But in 1846 his nephew was a member of parliament–and voted in favour of repeal.11
Cloth and wine
Ricardo’s best-known economic contribution is something else to do with trade: the theory of “comparative advantage”. In a nutshell, Ricardo shows that international trade allows countries to buy commodities at a better price–that is, with the loss of less labour time–than they can get at home. But crucially, he demonstrates that two countries can benefit from international trade even if one is better than the other at producing everything.
Quite simply, Ricardo is trying to work out the conditions under which it is a good idea for one country to trade with another. Mercantilist thinkers were pro-trade. Or perhaps 50% pro-trade; most of them thought that imports had no benefit whatsoever. After all, imports resulted in gold and silver draining away from the country. Recall also the mercantilist notion that a trade surplus would help increase employment. If you had to import something, then better to import something “that used the least amount of labour, such as raw materials or foodstuffs”, as Daniel Bernhofen and John Brown put it.
From the 18th century onwards, however, other economists such as Adam Smith began to argue that imports of all sorts could actually be good for the economy. It probably felt intuitively right to make such a claim. In 1700–1800 the value of imports into Britain rose fivefold. But Britain by that stage was also a far richer country, with GDP per person among the highest in Europe. Could imports, therefore, really be that bad?
The more formal argument went that imports could “free up” resources in the domestic economy that could then be put to better use. Take Britain today, which imports almost all its clothes. Doing so allows British workers and capital not to labour away making clothes, but to do other sorts of more remunerative work. This sort of argument appears in Smith’s Wealth of Nations. This notion, among economists, is what is called “absolute advantage”. As Smith puts it, “[i]f a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.” (This, of course, is a big problem with introducing protectionist policies–say, introducing tariffs or pulling out of trade agreements. Some of the stuff you used to import, you now have to make yourself, even if you’re not very good at it.)
Absolute advantage is not the same as comparative advantage, however. And so to Ricardo’s example of Portuguese and English cloth and wine. A helpful way to remember comparative advantage is as follows: England exports the cloth and Portugal exports the wine. Ricardo imagined that Portugal was better at producing both cloth and wine than England–ie, that it could produce both these commodities with less labour input than England.12 According to the Smithian approach, it would seem to make sense for Portugal to import nothing from England. In Smith’s language, the “foreign country”, in this case England, “can [not] supply [Portugal] with a commodity cheaper than [Portugal] can make it”.
Ricardo’s logic goes a step further. The question is, which is Portugal relatively better at producing, wine or cloth?13 In Ricardo’s example, Portugal was relatively more efficient at producing wine, meaning that Portugal would have to give up less cloth to make extra wine than England would. It follows, according to Ricardo, that Portugal should produce wine, and England cloth. Portugal exports wine, England exports cloth. Under that arrangement, both England and Portugal can consume more cloth and wine than under any other arrangement. This, in a paragraph, is the magic of international trade.
So that’s the theory boiled down to its essence. But how useful is it? When he was asked to identify one idea in the social sciences that was both true and non-trivial, Paul Samuelson said: “Ricardo’s theory of comparative advantage”. But as Arnaud Costinot and Dave Donaldson point out, the truth in Samuelson’s reply “refers to the fact that Ricardo’s theory of comparative advantage is mathematically correct, not that it is empirically valid”. Ian Goldin goes a step further. “Despite its central role in economics, the theory is found to be at an impasse, with its usefulness confined mainly to the illustration of economic principles which in practice are not borne out by the evidence.” One problem is that it is tricky to measure relative productivity, ie, how much more of commodity X a country could produce for each unit of commodity Y they gave up producing (though some economists, including Costinot and Donaldson, have made a good go of it). So while comparative advantage is a compelling theory, it is not totally clear that it does much to explain the real world. It’s classic Ricardo, in other words.
Unintended consequences
To end this chapter there is a kicker. It concerns Ricardo’s theory of value, which had an unintended consequence. The theory spawned a group of proto-socialist thinkers–perhaps, even, the first socialist thinkers. These people came to be known as the “Ricardian socialists”. And they almost certainly had an impact on the thinking of Karl Marx. Without the Ricardian socialists, there might have been no Marxism.
How did that come to pass? The year 1817, when Ricardo released his Principles of Political Economy, was a tough one. An influx of men returning from the frontline of the Napoleonic Wars had pushed up unemployment. Food prices were high. The system did not seem to be working for many people. Radicals, therefore, looked for an explanation: was there something inherently problematic with capitalism? And they found it nestled in Ricardo’s labour theory of value.
Recall that, with certain qualifications, Ricardo argues that workers create all the value. The Ricardian socialists took that theory and added an ethical twist. If value originates with workers, they asked, then how is it fair that capitalists make any money at all? All the capitalists have done is to sit there and watch the cash roll in. As Prabhat Patnaik, a Marxist economist, argues, the Ricardian socialists “put forward what was essentially a natural-right doctrine, ie, that labour, as the sole active creator of wealth, had a natural right to the whole produce, and that profits and rent alike were snatched from labour”. Piercy Ravenstone, a pseudonymous Ricardian socialist, argued in 1821 that “the surplus produce of the labour of the industrious” acts as “the fund for the maintenance of the idle”. (Remember: this is before Marx got going!) William Thompson, another Ricardian socialist, reckoned that under free-market competition capitalists snatched so much value from workers that they were left at subsistence.14
The Ricardian socialists’ argument obviously ignores the true value of capital: thrift and risk-taking. Capitalists may also manage the production process.15 Contrary to what they argued, capitalists do create value, and are thus entitled to profits if they manage their investments properly. But ignore whether the theory is right or wrong. More interestingly, it sounds extremely Marxist. Anton Menger, writing in 1899, argues that William Thompson was “the most eminent founder of scientific socialism”, from whom “Marx and Rodbertus have directly or indirectly drawn their opinions”. Paul Samuelson once referred to Marx as a “minor post-Ricardian”. Ricardo would no doubt have enjoyed intellectual battles with Marx as much as he had done with Thomas Malthus. We will learn more about Marx in Chapter 15. For now it is worth noting one thing. It is an oddity of history that someone who is today seen as one of the fathers of abstract classical economics also bequeathed Karl Marx to the world.