David Ricardo never attended college. But he delved into economic theory with more competence than any academic. He never formally studied financial markets. Yet he made millions of pounds in the stock market. His powerful mind and practical knowledge so dominated intellectual foes that he could win fiery debates and then dismiss the rival argument, saying that only a university professor would be silly enough to believe it.
One university professor was “silly” enough to disagree with Ricardo. His name was Thomas Robert Malthus. But critics had so viciously slandered Malthus that he actually enjoyed Ricardo’s thoughtful attacks. After those of Shelley and Coleridge, Ricardo’s snipes must have seemed more like a serenade. And at least Ricardo agreed with his population principle.
The relationship between Ricardo and Malthus began in the press, when each published essays on currency and trade issues criticizing the other. Malthus finally sent a letter to Ricardo in 1811, suggesting, “As we are mainly on the same side of the question, we might supersede the necessity of a long controversy in print . . . by an amicable discussion in private.” At almost the same time, Ricardo was composing nearly the same note. They met a few days later, and it was the beginning of a lifelong friendship. Ricardo composed reams of charming letters to his unlikely friend, punctuated by detailed policy points. Shortly after their first meeting, he wrote that he was “anxious for an opportunity of introducing Mrs. Malthus and Mrs. Ricardo,” adding: “And we have a bed always at your disposal, so that I shall hope on your very first visit to London you will favor me by occupying it.”1 Before his death in 1823, Ricardo wrote to Malthus, stating, that despite numerous disputes, “I should not like you more than I do if you agreed in opinion with me.” Only three people shared in Ricardo’s will, and Malthus was one of them. Later Malthus announced, “I never loved anybody out of my own family so much.”
Malthus never knew anybody who was so outside his “family” as Ricardo. Whereas Malthus came from a stable old English family and took holy orders in the Anglican Church, Ricardo was born the son of a Jewish immigrant in 1772, whose family had fled persecution in Portugal, worked as coral cutters in Livorno (near Pisa, Italy), washed up on the shores of the Netherlands, and then sailed across the North Sea to arrive in England.2 His father, Abraham Ricardo, was one of the twelve “Jew brokers” permitted to practice as a stockbroker at the Royal Exchange in London. An early-nineteenth-century map shows that different national and ethnic groups were assigned to specific stations around the Exchange, like a food court at a modern shopping mall. Jews’ Walk lies in the southeast corner of the Exchange, across from French Walk and sandwiched between Spanish Walk and Portugal Walk.3 How ironic that the saga of the Ricardo family’s travels ended up bringing them just feet from the Portuguese flag they had once fled. In addition to the Royal Exchange, Abraham also listed his business address as Garraway’s Coffee House, a bustling café built after the fire of 1666, where traders, booksellers, and lawyers would sip a strong brew and gab about monarchs and money.
While Malthus received careful tutoring and schooling at Cambridge, Ricardo went to work with his father at fourteen as a messenger and soon began to learn intricate financial systems and strategies on the job, so to speak. And he learned well. By his mid-twenties, the man with the Midas touch had established his own business and amassed a fortune through stocks, bonds, and real estate investments worth hundreds of millions of dollars (in today’s dollars). While the Ricardo family began by trading stocks and commodities, with success and heightened credibility, they began to represent the English government in selling bonds to the public. The only investment money Malthus ever earned, Ricardo made for him. A primary example of their contrasting acumen occurred during Napoleon’s reign. Ricardo had bought some British government stock for himself and Malthus, but after the proclamation of a new French constitution, Malthus grew nervous, fearing that a good turn of events for the French leader would hurt the stock. In tones so timid that they show Malthus better suited for a church bingo game than the stock market, he requested that Ricardo sell the shares, unless “it is either wrong, or inconvenient to you, and whatever may occur . . . I shall always be sensible of your kindness, and not disposed to repine.” Ricardo sold Malthus’s shares but held on to his own a bit longer, earning almost double Malthus’s premium.4
David Ricardo’s hard work and ingenious manner made his father proud, until they didn’t, at which time all hell broke loose, if not literally then theologically. David’s wife, Priscilla, whom he wanted to introduce to Mrs. Malthus, was neither Jewish, like David, nor Anglican, like the Malthus clan. She was a Quaker. Neither Priscilla’s nor David’s parents approved of their marriage. When David refused to bow down to his parents’ wishes, they recited the prayer for the deceased and mourned for a son who was now dead to them. The parents never spoke to their son again. Perhaps David so valued Malthus’s friendship because his own family had fractured.
By marrying a Quaker, Ricardo had not exactly elevated himself in the eyes of high society, for Quakers were also a suspect group whose legal rights were restricted. But for David’s charm and wealth, they would have been a very isolated couple. David’s successes, however, allowed him to buy an estate in Gloucestershire and a house in London’s posh Grosvenor Square, where he and Priscilla raised their six children, one of whom became the high sheriff of Gloucestershire.
Although wealth surrounded Ricardo, he did not read The Wealth of Nations until he was twenty-seven, and then only by “accident.” During a boring vacation in the English resort of Bath, the future leader of classical economics came upon the founder’s greatest work. Recall that Adam Smith began The Wealth of Nations during a dull stay in France. Since economics seems to owe more to boredom than any other discipline, perhaps students should not complain if their professors occasionally repay the favor or commemorate the founding.
In 1809, Ricardo debuted as an economics writer—with newspaper articles and pamphlets on currency and inflation—to rave reviews. At the urging of James Mill, a political economist and the father of philosopher John Stuart Mill, Ricardo entered London’s intellectual society, later becoming a member of Malthus’s Political Economy Club and of the King of Clubs. A splendid raconteur and host, Ricardo especially impressed the novelist Maria Edgeworth, who reported having had “a delightful conversation, both on deep and shallow subjects. Mr. Ricardo, with a very composed manner, has a continual life of mind, and starts perpetually a new game in conversation. I never argued or discussed a question with any person who argues more fairly or less for victory and more for truth.”5
The son of an immigrant soon became the very model of a major English gentleman, wise to the Industrial Revolution and smart in the drawing room. At the bullying of James Mill, in 1817 Ricardo finally wrote a treatise, On the Principles of Political Economy and Taxation, providing a full commentary on Adam Smith as well as contemporary issues. Two years later, and again at Mill’s urging, Ricardo won a seat in the House of Commons, where his high-pitched voice rang out for political freedoms and free trade. Though he took his oath swearing on “the true faith of a Christian,” we will never know whether in deference to his estranged family he kept his fingers crossed behind his back.
We also do not know how many members of Parliament actually understood Ricardo, especially his views on trade. This was not because his views were cloudy or he was inarticulate, but because Ricardo tried to argue perhaps the most complex and counterintuitive principle of economics. Once, President Gerald Ford gave a televised speech on the federal budget deficit using a calendar as a visual aid, all carefully rehearsed so that he would not make any embarrassing hand gestures. No modern president would attempt to do what Ricardo tried to do. Unfortunately, the perplexing principle is the key to modern economic understanding. An insolent natural scientist once asked a famous economist to name one economic rule that is neither obvious nor unimportant. Ricardo’s Law of Comparative Advantage was the immediate response. Regrettably, few politicians then or now can follow the analysis. As a result, quotas, tariffs, and trade wars mar the world’s economic history.
Before examining the principle, let’s see why Ricardo bothered to explain it. As in Adam Smith’s vision, businessmen love to shout about free enterprise at Rotary Club meetings, yet whisper requests for favors into the ears of politicians on Capitol Hill. During Ricardo’s time, landowners whispered and waved their wealth at Parliament, securing protection from the import of grain after the Napoleonic Wars. The price of grain had soared during the wars, partly as a result of Napoleon’s embargo, and landowners feared a sudden drop at the onset of peace. On the other side of the aisle sat the rising bourgeoisie, the new businessmen of the Industrial Revolution. Since the bourgeoisie employed laborers, they preferred to see lower prices for food, so they wouldn’t be forced to pay higher wages. The landowners won the battle of influence, and in 1815 Parliament passed an act that prohibited imports of grain below a certain price, virtually granting farmers a monopoly. British dictionaries define “corn” as grain such as oats, rye, wheat, and barley. Thus, the acts were called Corn Laws. Across Britain today, you can find grand old nineteenth-century buildings called the Corn Exchange, where traders and farmers would haggle. In Leeds, the dramatically domed Corn Exchange resembles Rome’s Pantheon, and is now a shopping mall.
Ricardo saw two futures for Britain: first, as an insular, protectionist island barricaded against foreign goods; second, as an extroverted trader, acting as the “world’s workshop.” The choice was critical. For if Britain chose the former, the self-reliant economy would soon become decrepit. We will first learn why Ricardo preferred the open-door policy and then examine the tricky question of Ricardo’s “stationary state.”
Recall Adam Smith’s absolute-advantage trade model. Imagine him espousing his theory and insulting the French by saying, “We don’t like them. They eat frogs. And I had a tedious time in Toulouse. But if they can make wine cheaper than we can, we should toast them and drink their wine. If they cannot make wine more cheaply, let’s just snicker at them across the English Channel.” A logical, intuitively correct statement.
To understand Ricardo’s response, imagine the old television series Gilligan’s Island. Hapless, hopelessly clumsy Gilligan is washed ashore along with the competent, self-assured skipper. Two tasks must be done: fishing and building shelter. Assume that the skipper can catch a fish dinner in 10 hours and build a thatched hut in 20, and that Gilligan usually hooks himself and takes 15 hours to catch fish and 45 hours to build a hut. By Adam Smith’s logic, the skipper should move as far away from Gilligan as possible, building and fishing on his own, since he outperforms Gilligan in everything. But economists still shudder with reverence when Ricardo shows that the skipper should split the chores with Gilligan!
Let’s first calculate how many fish dinners and huts they could build on their own, spending half their time fishing, the other half building. Assume that during a year, the skipper will work a total of 2,000 hours, and his younger first mate Gilligan is ordered to work 3,600. If the skipper spends 1,000 hours on fishing, he will garner 100 fish dinners; and 1,000 hours of hut building by him will produce 50 huts. Gilligan’s 1,800 hours of fishing will bring 120 dinners; and 1,800 hours of hut building will make 40 huts. So the total number of dinners on the island is 220, eaten in the comfort of 90 huts.
What happens if they specialize? If the skipper spends all his time on huts, he will construct 100; if Gilligan concentrates on fish, he will return with 240 fish dinners. Thus, the island has increased output dramatically just by specializing, even though Gilligan is far less competent at both tasks!
Imagine Ricardo responding to Smith’s hypothetical insult of the French by saying, “I dislike the French as much as Adam Smith did. But I do not snicker at them just because they cannot do anything as cheaply as we can. I would trade with them despite their inferiority.”
The next key question is how do we know what to specialize in? Let us return to the island. Since it takes the skipper twice as long to erect a hut as it does to catch dinner, he gives up two dinners every time he builds a hut. But Gilligan, who takes three times longer to build a hut than to catch dinner, gives up three dinners every time he builds a hut. Since building huts is a smaller sacrifice for the skipper, he should build huts. Ricardo showed that people and countries should specialize in whatever leads them to give up the least. This is their “comparative advantage.” And the sacrifice they make by not producing a good is their “opportunity cost.” Thus, specialization is determined by whoever has the lower opportunity cost.6
The point of Ricardo’s analysis: free trade makes it possible for households to consume more goods regardless of whether trading partners are more or less economically advanced. The point of Ricardo’s Corn Laws position: if French farmers are willing to feed us for less than it would “cost” us to feed ourselves, let us eat French food and spend our time doing something else.
Let’s say that Santa Claus began delivering free toys, cookies, and clothing all across the United States. Would the United States be better off? Yes, because we could spend our time making other things while our kids enjoy the gifts. Here’s the unavoidable follow-up question: Would everyone be better off? No. Employees of Mattel and Hasbro might find Santa a particularly unfair trade competitor as they are laid off and sent to stand in line at state unemployment offices.
The problem confronting Ricardo and all free traders is that bakers, toy makers, and tailors would prefer that the government intercept and destroy Rudolph. They would claim that jobs depend on sewing and cobbling for ourselves. But they forget the benefits to consumers throughout the country, especially to the lower classes, for whom cheaper food means a substantially better life. Let’s remember how hard life could be for typical families. We know the biblical saying “Man shall not live on bread alone.” At the time Ricardo wrote and argued before Parliament, workers spent 75 percent of their wages on food and more than half their wages buying grain so that they could knead and bake dough for bread. They had just enough money left to smear on some bacon fat, mutton, or cheese and wash it down with a literal splash of tea, less than one-tenth of an ounce per day. The average diet amounted to about 2,300 calories, on par with that of hunter-gatherers in the Congo and New Guinea in 1800. They consumed about 40 percent fewer calories than we do today, stunting growth to an average of five feet, seven inches for adult males. Laborers and farmers exerted themselves six days a week, nearly every hour after the sun would rise. While Shakespeare had portrayed magical midsummers and paeans to pastoral life in As You Like It, Malthus noted that in the countryside “the sons and daughters of peasants will not be found such rosy cherubs in real life, as they are described to be in romances. . . . [They] are very apt to be stunted in their growth, and are a long while arriving at maturity.”7
It was not difficult for Ricardo to see how blocking cheap grain imports injured workers and hampered their employers.
Beyond the damage to consumers, protectionists forget that jobs are created by selling goods and services to other countries. No wonder Ricardo became an enemy of the upper class by declaring that the “interest of the landlords is always opposed to the interest of every other class in the community.” Despite the force of his intellect and argument, Ricardo could not persuade Parliament to relent. The Corn Laws persisted until 1846. Ricardo did, however, persuade subsequent generations of economists that protection is almost always bad for an economy as a whole, though good for a particular group. People sometimes insult economists for frequently disagreeing about policy prescriptions. George Bernard Shaw predicted, “If all economists were laid end to end, they wouldn’t reach a conclusion.” Yet several times during the twentieth century, thousands of economists signed petitions begging the U.S. government not to block imports. Every time the domestic economy appears stagnant, some politicians try to placate voters by threatening foreign economies. The United States imposed its highest tariffs of this century when it and the world needed free trade the most, during the Great Depression. When economies turn inward, they almost always turn downward. There is no such thing as an inward and upward spiral in economics.
During the 1980s, Japanese automakers began “voluntarily” restricting exports to the United States to avoid even harsher measures from Congress. Because the supply of Japanese cars was limited, their prices rose, and American manufacturers were able to charge more for their own cars. Economists estimated that American consumers lost $350 million as a result in the first year, and car prices rose by nearly $3,000 in the first three years of the restraints. Even if, at most, ten thousand jobs were “saved,” the American economy could have paid each worker $35,000 a year just to sit at home. Instead, fewer consumers could afford cars, and those who bought had fewer dollars left to purchase other goods, reducing jobs in other sectors. “Domestic car makers could and probably should cut prices, but the government handed the American consumer to them on a platter, and they couldn’t resist carving them up,” charged Robert Crandall of the Brookings Institution.8
In 1989, automotive lobbyists beseeched the Treasury Department to classify imported minivans and SUVs as trucks. If the Treasury had given in to the pressure, tariffs on such vehicles would have increased tenfold. The British government especially protested the proposal on behalf of Land Rover. Its embassy in Washington, D.C., informed the White House that the queen herself drove a Range Rover, and that the queen would never drive a truck.
Abraham Lincoln put one protectionist argument pithily: “I don’t know much about the tariff, but I do know if I buy a coat in America, I have a coat and America has the money—if I buy a coat in England, I have the coat and England has the money.” He was right—he did not know much about the tariff. Like the mercantilists, Lincoln did not understand that a country is wealthy if it consumes lots of goods and services, not if it stockpiles metals or paper currency with portraits of presidents on them. If Lincoln buys the London coat he prefers, he cashes in some dollars for British pounds. So someone in London now has dollars. Londoners do not give up pounds just to wallpaper their flats with greenbacks. The Londoner will either (1) buy an American product or (2) trade in the dollars for pounds. If she buys an American product, Lincoln is happy because he preferred the London coat, and the Londoner is happy because she liked the American good. If she dumps her dollars, she will dump them on someone else who wants to buy American goods.9
What if we could just stuff a million rowboats full of American money in exchange for the Queen Mary 2 filled with British goods? Then the Treasury could print billions of five-dollar bills. According to Lincoln’s logic, we would get beautiful sweaters, teapots, and tweed suits, while the British would get paper! Although Lincoln did not realize it, this would be a wonderful deal! But the joke’s on us. Lincoln did not understand that the British accept dollars because they can buy American goods and financial assets with them. Money may not make the world go around, but money certainly goes around the world. To stop it prevents goods from traveling from where they are produced most inexpensively to where they are desired most deeply.
The issue is not whether coats will be produced in the United States or not. It is whether we will use our valuable resources to produce goods with a higher or a lower opportunity cost. By allowing trade, nations coerce their citizens to shift resources away from low-productivity industries and toward high-productivity industries. If nations shift, households can enjoy more goods with less sacrifice.
Shifts do cause pain, however, to workers and owners in low-productivity industries. But protection often costs consumers so much, the government would do better to directly compensate the displaced workers and pay to retrain them. Protecting one steelworker’s job cost more than $100,000, while “saving” a shoemaker’s job cost $77,000 in the early 1980s.10 From 2002 to 2006, punitive duties on Canadian lumber drove up the cost of a new American house by about $1,000.11 Further, the logic of protection points toward economic stagnation. Most industries and inventions that have raised our standard of living have forced others out of their jobs. Xerox once produced an award-winning television advertisement depicting a monk working at a monastery, laboriously transcribing pages of ancient prayers. One day his superior praises his handwritten parchment but then asks for five hundred more copies! The harried monk first panics before strutting around the corner to a new copier machine, which does the job in seconds. When he delivers the five hundred copies to his superior, the head monk stares blissfully toward heaven and proclaims “it’s a miracle.” Can you imagine how a well-organized political action committee of monks might demand protection? Picture thousands of monks marching on Washington. How many monks could be displaced by electronic copiers?
Again, the free market is not a pain-free market. The invisible hand does not protect us the way a mother protects her child. If people prefer more stability, perhaps they should opt for protection. But the benefits of economic growth and progress do not usually come to those who huddle in the corner while their government protects the harbors from Greeks bearing gifts and goods.
The world does not admire economists for their sense of humor. But the highlight of social science satire came from the French economic pamphleteer Frédéric Bastiat during the 1840s, when France augmented import duties:
From the Manufacturers of Candles, Tapers, Lanterns, Candlesticks, Street Lamps, Snuffers, and Extinguishers, and from the Producers of Oil, Tallow, Resin, Alcohol, and Generally of Everything Connected with Lighting To the Honorable Members of the Chamber of Deputies.
Gentlemen:
. . . We are suffering from the ruinous competition of a foreign rival who apparently works under conditions so far superior to our own for the production of light, that he is flooding the domestic market with it at an incredibly low price. . . . This rival . . . is none other than the sun. . . .
We ask you to be so good as to pass a law requiring the closing of all windows, dormers, skylights, inside and outside shutters, curtains, casements, bull’s-eyes, deadlights and blinds; in short, all openings, holes, chinks, and fissures. . . .
If you shut off as much as possible all access to natural light and thereby create a need for artificial light, what industry in France will not ultimately be encouraged? . . .
If France consumes more tallow, there will have to be more cattle and sheep. . . .
The same holds true for shipping.12
More seriously for our time, Ricardo’s analysis implies that protectionism by wealthy nations condemns less developed countries to stagnation. It seems contradictory to offer millions of dollars in foreign aid and loans while at the same time planting hurdles in front of the recipients. For example, the U.S. Congress, under pressure from domestic sugar producers, has thwarted the development programs of many Caribbean nations. Import quotas tightened from about 6 million tons of sugar in 1977 to just 1.2 million tons in 1998. Should we be surprised that many farmers south of the border found coca a more attractive crop and the underground American drug industry a more willing trading partner?
Sometimes it helps to imagine protectionist arguments on a small scale. Would a wealthy man be hurt by trading with a poor man? Should Elon Musk make his own shoes rather than buying them? If not, why would the United States be hurt by buying shoes from Malaysia? Would the nation be richer if all people were self-sufficient? If all neighborhoods were self-sufficient? Should individual counties erect trade boundaries? Few would answer yes, and the Constitution would prevent it. But why should a nation be enriched by turning away goods produced more cheaply abroad?
After World War II, many nations entered into the General Agreement on Tariffs and Trade, an organization designed to promote free trade and the forerunner of today’s World Trade Organization. Later, multinational trade negotiations took place, reducing world tariff barriers. Yet the threat of severe isolationist efforts always lurks. Protectionists gathered academic ammunition during the 1980s and 1990s, when some top theorists began poking a few holes in Ricardo’s analysis. Nobel laureate and high-profile columnist Paul Krugman began asking good and tough questions. For example, typical Ricardian examples compare two countries with disparate talents and natural resources, and thereby explain why British looms might need Egyptian wool. But Krugman pointed out that after World War II, most of the increase in trade crossed the checkpoints of countries with similar incomes and resources. Today, the world’s second busiest trading border lies between the United States and Canada, countries that look a great deal alike, except for a fondness for hockey on one side and for firearms on the other. In Europe, even though the Global Skills index shows Germany and Sweden almost precisely matched, Germany sells Porsches to Sweden, and Sweden ships Volvos to Germany (though the Volvo car company is Chinese-owned).13 Why are both countries producing cars? This is not exactly Ricardo’s tale. The developers of Strategic Trade Theory and New Geography Theory (building on the late-nineteenth- and early-twentieth-century work of Alfred Marshall at Cambridge and Bertil Ohlin and Eli Heckscher in Stockholm) explain that companies gain economies of scale by specializing, which drives down their average costs. But to keep costs low, a company will not try to cater to everyone. Volvo caters to people who prize safety above all. It advertises to soccer moms and dads, and doesn’t worry about winning over fanboys who dream of throwing a stick shift into fifth gear. Porsche does. Porsches are faster, and Germany’s traffic fatality rate is 40 percent higher than Sweden’s. Ferraris are fast, too. Soon after Italy passed a law requiring seat belts, merchants in Naples began selling white T-shirts embossed with diagonal black stripes, fooling the traffic police, but probably not fooling dame fortuna.14
Companies often target a plurality of consumers in their home country, leaving foreign companies to rush in to handle the outliers. This spurs a wider variety of products, which is why American car buyers can choose among hundreds of models, made anywhere from Spartanburg, South Carolina, to Chennai, India. Citizens of the old Soviet Union, self-blockaded from free trade, could choose among only a handful of obsolete cars that would break down soon after arrival. Ronald Reagan joked about the Soviet car buyer who hands over his money and is told to come back in ten years. The buyer asks, “Morning or afternoon?” The dealer replies, “In ten years, who cares what time of day?” The buyer says, “Well, the plumber’s coming at nine.”
How does specialization drive down costs, even when two countries, companies, or individuals start off evenly matched? Consider Mike and Manny, two friendly surfers from the Jersey Shore. They both know how to make a foot-long sandwich; they just can’t agree whether to call it a submarine, hero, gyro, po’boy, hoagie, or grinder. Regardless of the name, they know it requires buying a long bread roll, slicing meat and cheese, slapping on mustard, squirting oil and vinegar, adding a tomato, lettuce, etc. If Mike and Manny walk into the same supermarket, it will cost them the exact same amount to make the sandwich (assuming their time is worth the same). But what if Mike decides he really enjoys making sandwiches and wants to start grinding them out for friends, neighbors, and strangers? Instead of strolling down the supermarket aisles and paying the retail price, he starts buying in bulk at lower wholesale prices. He invests in his own slicing machine, and can now churn out submarine sandwiches at a much faster pace. Pretty soon, he might call himself Jersey Mike and operate the fastest-growing restaurant franchise in the United States, with 1,600 locations. Manny, who still shops in the supermarket, cannot compete on price. For a study on restaurants, I developed an index called “cost per gram of protein” and discovered that fast food and casual dining have driven down the cost of protein for consumers (grilled chicken, sliced turkey, hamburger, and fish sandwiches). One may have divergent opinions on the relative tastes of takeout joints, but the relative efficiency of places like Jersey Mike’s is impressive.15 What happens to Manny in our scenario, who started off with talent and resources equal to Mike’s, but had less ardor for sliced meat? Perhaps Manny prefers performing oil changes on automobiles, invests in car lifts and tire changers, and becomes president of the Pep Boys: Manny, Moe, and Jack, with nearly one thousand locations.
Strategic Trade theorists point out that if bigger firms grow even more efficient, in some sectors only a few companies might satisfy world demand and still earn profits. The best example comes from the aircraft sector, where Airbus and Boeing divide up large commercial jetliner sales, with Embraer of Brazil picking up the smaller commuter jets. In one of the most frequently cited papers on international economics, Barbara Spencer and James Brander of Canada warn that in a sector with just a few players, a government might decide to bankroll a particular company so that the firm could wipe out its rivals. Moreover, a rival of this favored firm might shrink back and realize that it cannot win if it is in the boxing ring with a buffed-up company bolstered and subsidized with public treasure and negotiating muscle.
Whenever a market shrinks to a few players, it may begin to resemble a game in which players must guess how their foes will react. If Airbus jacks up prices, will Boeing follow along or swoop in with discounts? If AT&T throws in free international calls, will Verizon match the offer? In the 1940s, long before video games began to dominate entertainment, a young man named John Nash emerged from his childhood home in Appalachia with a brilliant mind and a tempestuous mental life (portrayed in the movie A Beautiful Mind). Nash latched on to game strategy as a key to understanding markets that are not perfectly competitive. Today, professors of economics, mathematics, political science, and philosophy all discuss the “prisoner’s dilemma,” named by Nash’s doctoral adviser at Princeton, Albert Tucker. Here’s how it works. If the police arrest two suspects and keep them together, they can both agree to deny the crime and might be let free, if there’s no other evidence. But if the police throw them into separate cells, the suspects cannot collude, and one may decide to “rat out” the other, as they might say in a Martin Scorsese movie, in exchange for leniency. Separated prisoners must calculate, Is my compatriot loyal or a fink? Likewise, if Uber and Lyft can collude, they can maximize profits by coordinating their prices. But if they cannot collude because of antitrust laws, one of them might try to gain market share by undercutting prices.
Strategic Trade Theory and Prisoner Dilemma games do not prove that Ricardo’s accounting is wrongheaded. They merely imagine certain circumstances in which other options could be optimal. Krugman, the most famous developer and practitioner, is cautious about governments nudging aside Ricardo and pursuing their own hunches. In 2009, the Obama administration was determined that the United States would “own” the solar panel industry and beat Chinese competitors. The Departments of Energy and Defense funneled more than half a billion dollars into a start-up called Solyndra, which quickly built a gleaming plant the size of five football fields in the California desert. It included robots that whistled Disney tunes—possibly the mining song from Snow White and the Seven Dwarfs. Within two years Solyndra collapsed into bankruptcy, and some leftover glass tubes showed up as an outdoor sculpture at the University of California, Berkeley, Botanical Garden, where at least they could provide visual entertainment, if not electrical power. Government bureaucrats could not understand or forecast the changing price for solar inputs such as polysilicon. In a sharp essay titled “Ricardo’s Difficult Idea,” Krugman blasts pop-policy pundits like former labor secretary Robert Reich who do not take the time to grapple with Ricardo and instead pretend that there is an obvious role for governments to reorient trade and pick winners. Krugman ends his essay, “Ricardo’s idea is truly, madly, deeply difficult. But it is also utterly true, immensely sophisticated—and extremely relevant to the modern world.”16
Earlier we noted that Ricardo saw two futures for Britain: a bright future as an extroverted trader and a gloomy one as an isolationist. Through comparative advantage, Ricardo foresaw England emerging as the workshop of the world. And he cheerfully declared before Parliament that “this would be the happiest country in the world, and its progress in prosperity would be beyond the powers of imagination to conceive, if we got rid of two great evils—the national debt and the corn laws.” Far from predicting doom, Ricardo directed his audience toward national progress: “Man from youth grows to manhood, then decays, and dies; but this is not the progress of nations. When arrived to a state of the greatest vigour, their further advance may indeed be arrested, but their natural tendency is to continue for ages, to sustain undiminished their wealth, and their population.”17
Despite such raptures about trade, some authors persistently portray Ricardo as a pessimistic analyst, just as gloomy but more clever than that other goblin, Malthus. In fact, Ricardo did spend much time analyzing a depressing isolationist future. But we cannot forget that this future was used as a foil for the first path in order to frighten politicians into more laissez-faire policies.
What was the second path? Let us start with the sequence of steps before turning to an analysis. Accepting Malthus’s population principles, Ricardo saw that (1) increasing population leads to a higher demand for food, (2) which leads to extending farming to less fertile lands, (3) which leads to higher costs in farming, (4) which leads to higher prices for food, (5) which leads to paying workers more, (6) which leads to lower profits for entrepreneurs, (7) which leads to higher payments to those who own the best lands.
To understand Ricardo’s game plan, we must open the program and identify the players. First and most plentiful are workers. In accord with Malthusian principles, they multiply when wages rise, which in turn reduces their wages. Thus, over the course of a long game, payments will stay at a level high enough to sustain them, according to the customs and expectations of the day. Ricardo does not condemn them to bare biological subsistence, scrounging for scraps and tottering in rags:
It is not to be understood that the natural price of labour, estimated even in food and necessaries, is absolutely fixed and constant. It varies at different times in the same country, and very materially differs in different countries. It essentially depends on the habits and customs of the people. An English labourer would consider his wages under their natural rate, and too scanty to support a family, if they enable him to purchase no other food than potatoes, and to live in no better habitation than a mud cabin.18
Second, we have tenant farmers. But note that they do not own the land they cultivate. Ricardo depicts them as capitalists who rent the land, hire workers, and earn profits. Instead of owning tools in a factory, the farmer owns plows. Ricardo agrees with Adam Smith that capitalists/farmers have a “restless desire” to follow market signals and shift resources and investments to the most profitable projects. Thus, they perform very important tasks for society, but not necessarily because they like society.
Third, and most powerful, Ricardo describes the wealthy landowners who rent the land to the farmers. The landowners live a leisurely life yet ultimately realize more wealth than the other players.
Ricardo revamped economic conventions and the definition of “rent.” Recall the Corn Laws debate. Some claimed that corn cost more because landlords were charging farmers more in rent. Ricardo disagreed, arguing that the price rose because of wartime shortages, which lured entrepreneurs into the farming industry. As they entered, landlords found more capitalists knocking at their doors and bidding up the rental price of land. Thus, land rents were high because the price of corn was high, not vice versa. When blockades tumbled, so would the price of corn, and landlords would have to charge lower rents. In modern economic terms, the desire for renting land is a “derived demand,” determined by the supply and demand for corn.
Ricardo next argued that landlords can charge rents only if there is a demand for their property. Some landowners’ property will be more fertile than others’, and rent levels will be established on the basis of this difference in fertility. If Al owns a plot of land that yields one thousand tons of grain, and Joan owns a plot nearby that yields only five hundred tons, Al will be able to charge a higher rate to a capitalist farmer.
Rents arise because all land is not created equal:
When in the progress of society, land of the second degree of fertility is taken into cultivation, rent immediately commences on that of the first quality, and the amount of that rent will depend on the difference in the quality of these two portions of land. When land of the third quality is taken into cultivation, rent immediately rises on the second, and is regulated as before by the differences in their productive powers. At the same time, the rest of the first quality will rise.19
If Ricardo is right, rents emerge as populations grow. When few people need food, they can raise enough by farming only the best land. As mouths multiply, farmers begin cultivating the second-best land. Because the second-quality land produces less, the owner of the better land can now charge rent. Wages and a normal profit on the secondary land will determine the price of grain. And since costs are lower on better land, a surplus exists. The landlord takes the surplus.
Why did Ricardo’s vision incite frowns and fright? According to it, the path of economic growth ended at a ditch, literally and figuratively. For a while capitalists could expand industrial production and even pay workers higher wages. But soon the happy workers would breed more workers, bidding down wages. How would England feed the hungry crowds? By farming more land. But remember, the additional lands would be less productive and most costly to cultivate, since farmers began by exploiting the richest land first.
The price of grain would rise. But the capitalist would not profit, because he must pay the workers more so that they can survive. If resources are “to be divided between the farmer and the labourer, the larger the proportion to the latter, the less will remain for the former.”20 Furthermore, the landlords who own the best lands collect higher rents when farmers begin tilling inferior land. Who wins? The landlords. Who loses? The capitalists. Who stays the same? The workers, although ultimately starvation could strike when farmers exhaust the lands. Ricardo calls the somber plight the “stationary state.” Literally, hunger forces society to cultivate even ditches. Figuratively, the capitalists and workers are left waving their arms and shouting for help from within a ditch.
Why does Ricardo diverge so strongly from Adam Smith’s merry dream? Smith generally assumes that agriculture will not decay into low productivity and that industry will continually grow more productive. In modern terms, Smith sees constant returns to agriculture and increasing returns to industry, which allows all parties to prosper. Ricardo depicts constant returns to industry and decreasing returns to agriculture. Ricardo does hold some hope that technology will periodically rescue the economy. The tendency for profits to fall “is happily checked at repeated intervals by the improvements in machinery, connected with the production of necessaries, as well as by the discoveries in the science of agriculture which enable us to relinquish a portion of labour before required, and, therefore, to lower the price of the prime necessity of the labourer.”21 Still, we cannot confidently depend on technology always to save us.
But remember Dickens’s A Christmas Carol. The ghost tells the tale of the gruesome future Christmas, defiled by hunger, dread, and despair. Scrooge timorously asks, Is this the way Christmas must be? With the ugly clang of chains and a haunting, raspy wheeze, the ghost leaves tomorrow to Scrooge.
Ricardo is not the goblin some depict, but more like the ghost from A Christmas Carol, warning England that insular, greedy policies will bring harder and greedier times, while an open, extroverted trading position can promise happier days. “I contend for free trade in corn, on the ground that while trade is free, and corn cheap, profits will not fall however great be the accumulation of capital,” he wrote. Economic growth confronts no ditches. And although obstacles arise from “the scarcity, and consequent high value of food and other raw produce . . . let these be supplied from abroad in exchange for manufactured goods, and it is difficult to say where the limit is at which you would cease to accumulate wealth.”22
Ricardo’s analyses proved fertile for criticism and extension. Like Malthus, he underestimated the “restraint” of workers. They did not propagate as quickly as he feared. Milton Friedman, as noted previously, holds a pencil as his emblem of economic freedom. Sometimes the classical economists sound as if they should be holding rabbits’ feet—not for luck, but to symbolize their perception of man’s breeding propensity. Like Malthus, Ricardo bitterly opposed the Poor Laws because they ultimately brought hunger, insisting that “every friend to the poor must ardently wish for their abolition.”
Ricardo’s blasts at landlords and depiction of rents came to the United States in earthy and fervent language through Henry George’s Progress and Poverty in 1879. George, a journalist with messianic visions, led disciples in the “single-tax movement.” Incensed by undeserved gain, George condemned landowners who simply collect rents while others struggle to generate wealth. Proposing a massive tax on land to absorb rents, George divined with more verve than any Old Testament prophet that it would abolish poverty; tame the ruthless passions of greed; dry up the springs of vice and misery; light in dark places the lamp of knowledge; give new vigor to invention and a fresh impulse to discovery; substitute political strength for political weakness; and make tyranny and anarchy impossible.23
There are several problems with the proposal. First, economists distinguish between “economic rent,” which Ricardo discussed, and the simple rent that tenants pay landlords. According to Ricardo, economic rent is a payment beyond what is necessary to keep land or labor or capital in its present use. Since land can be used only for grain in Ricardo’s analysis, nothing has to be paid to keep it as farmland. Owners have no choice but to use it for grain. Therefore any payment to landlords is economic rent. Baseball great Willie Mays used to say that he would play for free. If he would, any payment he received would be economic rent, because it was beyond what was necessary to get him to play.
Movie stars receive economic rents also. Let’s say that Sylvester Stallone constantly makes the choice between acting and working as a professional seamster. If he received less than $30,000 per movie for acting, he would switch to sewing hems and cuffs. Thus if a new movie, Rocky Meets Rambo II in 3-D, paid him $5 million, we would say that $30,000 was “transfer earnings” and $4,970,000 was economic rent. Maybe Henry George would have been brave enough to take away all the rent.
The point is that part of a payment that keeps land, labor, or capital in a particular use is not economic rent, but transfer earnings. Any payment above that is economic rent. Therefore, if a property owner would convert his land into a carnival tenting ground if he did not receive $1,000 per month from tenants, the first $1,000 he receives is not economic rent. Beware of the ambiguity of the language. What apartment tenants usually call “rent” is not economic rent unless it exceeds the necessary payment. But how would Henry George know which part of the total payment is economic rent to be taxed? Here he would need even more heavenly help than he has revealed.
The single-tax-on-land movement also faces moral hurdles to either leap or transcend. If fairness demands taxing economic rents, fairness requires taxing economic rents from land, labor, and capital. How would George distinguish between Stallone’s transfer earnings and economic rents? What about salaries of senators and famous economists? Not everyone is as honest as Willie Mays.
Although George never accomplished his mission, he became famous throughout the United States and England, where devotees set up single-tax societies to spread the good word. And the good book Progress and Poverty spread more quickly than laborers multiply. Despite the movement’s ultimate decline, George fans can proudly point to property taxes as a source of state and local finance. But they cannot point as confidently as they could sixty years ago. George overestimated the future importance of rents and rental income. Governments at every level have grown tremendously in the last century. Even if governments could take all rents without rebellion or severe recession, rents would not come close to covering expenses. In 1929, property rents accounted for about 6 percent of national income. The percentage has steadily dropped to well under 1 percent today. Whereas property taxes once provided 65 percent of state and local budgets, they now supply about 17 percent.
Over the past twenty years, as brick-and-mortar retail stores have lost business to online merchants, many pedestrians walk past empty storefronts. Vacant storefronts used to signal a recession. Now they represent technology and changing tastes (and a lack of imagination for alternative uses). It is hard for a mom-and-pop hardware store to compete with same-day home delivery from Home Depot and Lowe’s. In a bizarre, neo-Georgian manner, some cities like San Francisco and Oakland attempt to battle empty storefronts by raising taxes on landowners. Civic leaders portray the landlords as greedy asset-sitters, waiting for a big payday. Meanwhile, the neighborhood looks glum and gritty. The landlords, of course, think of themselves as victims of structural change who would be delighted to find solvent tenants in an era when once-famous names like Forever 21, Borders, and RadioShack have folded. In San Francisco between 2015 and 2018, despite a strong economy and an overall job growth of 13 percent, the number of retail jobs slumped by 8 percent.24 Landowners also point out that city regulations often prohibit them from leasing to viable tenants—for example, restricting many storefronts from converting to restaurants. In 2019, a falafel restaurant in San Francisco used the city’s convoluted rules to try to prohibit a competitor from opening up a new shop nearby.25 Regardless of the falafel wars and the arguments about vacancy taxes, George might find it amusing to hear that his progeny, instead of levying high taxes on rents, are taxing the absence of rents!
If George caught a Ricardian pitch and ran amok, Ricardo’s contemporary Malthus tried to bat it back. On the Corn Laws question, Malthus accepted much of Ricardo’s analysis regarding rent and diminishing returns from farming. But he posited a four-part rebuttal. First, he maintained that the Corn Laws actually induced more domestic grain output because they boosted grain prices. Second, Malthus thought grain was too important a commodity to be left to foreign producers. Third, he concluded that higher grain prices actually increased wages to workers, since workers are paid according to the price of grain. Malthus thus claimed that higher wages would more than compensate for higher food prices. Ricardo disagreed. In modern terms, he thought that higher “nominal” wages would not be higher “real” wages; that is, they would not allow laborers to buy any more than they could before. To Ricardo, Malthus’s argument sounded like the dictator who, smiling and winking at the masses, promises a doubling of salaries. The crowd cheers. They salute the five-story posters of the despot and rejoice. The next day they go to the stores and find that the employees of the stores spent the whole night marking up the prices by 100 percent.
Fourth, Malthus rather feebly defended the landlord by complimenting Ricardo, who had
now become, by his talents and industry, a considerable landlord; and a more honourable and excellent man, a man who for the qualities of his head and heart more entirely deserves what he has earned . . . I could not point out in the whole circle of landlords.26
Flattery got Malthus nowhere, except perhaps an invitation to Ricardo’s country retreat. For Ricardo never said that landlords intentionally suck the lifeblood from a nation. Like vampires, they are compelled by forces outside their power. Ironically, Ricardo, the lavish landlord, angered the landlords; while Malthus, the modest teacher, infuriated the humble folk.
The Ricardo-Malthus show featured more than landlord debates, however. The two economists also disagreed about economic depressions. Malthus believed in “general gluts,” an ugly phrase meaning that business sometimes supplies more goods and services than people want to buy. Ricardo would have sooner believed in a Godwinian utopia than in general gluts. Ricardo embraced Say’s Law, named for the Frenchman Jean-Baptiste Say, who proved logically that general gluts were fantasies. (Scientists love to discover laws and graphical curves, perhaps because custom lets the laws and curves be named for the discoverer. In economics, we also have the Lorenz curve, Okun’s Law, and Harberger triangles.)
What is Say’s Law? Workers and owners of land and capital are paid wages, rents, and interest that add up to the sale price of the product. Every cost in manufacturing becomes someone’s income. Therefore, consumers—who are simply laborers, capitalists, and landlords after they get home from work—can afford to buy all that has been produced. Say’s Law is generally known by the slogan “Supply creates its own demand.”
Say never forbade “partial gluts,” which occur when consumers decide to purchase less of a particular product. Eventually, the seller will erase the partial glut by lowering the price. But to Say, Smith, Hume, and Ricardo, a general glut remains impossible, because the consumers must do something with their money, and people have infinite desires for more material goods.
Malthus cried nay. First of all, he noticed that in the post–Napoleonic Wars depression of 1818, unemployment seemed very high. But how could he invade the tight circle that Say drew and Ricardo emboldened? He began by tracing the circle and agreeing that consumers could buy all the goods offered, but what if they did not feel like spending all their money? What if they preferred to save or hoard? Would this not leak out of Say’s circle of buying and leave the merchants sitting on top of unsold merchandise?
Ricardo swiftly struck back. If consumers save, they keep their money in banks, which then lend to those who do want to spend money on consumer goods or investment goods. Either way, someone is spending. Even Adam Smith knew that: “What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too; but it is consumed by a different set of people.”27 Ricardo then scolded his friend “Mr. Malthus,” who “never appears to remember” this simple point.
Though he convinced few economists, Malthus still sensed a gap between savings and investment. To cure a general glut, he proposed “the employment of the poor in roads and public works, and a tendency among landlords and persons in property to build . . . and to employ workmen and menial servants” as “the means most within our power and most directly calculated to remedy the evils.”28
But Ricardo responded that Malthus’s Principles present “hardly a page” without “some fallacy.”
Even if Ricardo won the day, a century later, John Maynard Keynes resurrected the loser. In a resplendent paean, Keynes paid tribute to the “first of the Cambridge economists” for his theory on depressions and at the same time denounced Ricardo: “If only Malthus, instead of Ricardo, had been the parent stem from which nineteenth-century economics proceeded, what a much wiser and richer place the world would be today!”29 Keynes surely exaggerates here in both the extent of Ricardo’s dominance (he “conquered England as completely as the Holy Inquisition conquered Spain”) and the similarity between his own analysis and Malthus’s. Though Keynes and Malthus both rejected Say’s Law, Malthus made little headway relating saving to investment and urged public works to slow investment, not to stimulate sales of goods, as Keynes did. Nonetheless, if Keynes says Malthus inspired him, who are we to disagree?
The real difference between Malthus and Ricardo did not revolve around gluts, rents, or protection, but rather around method. Both lived in an age of scientific discovery. Both searched for cause-and-effect links. Both predicted what would occur because of these links. But Ricardo focused more intensely on the intricate sequence of steps along the way. Malthus seemed content to find a general principle and then apply it to the world. Recall Ricardo’s careful seven-step path to the stationary state. Neither Smith nor Malthus constructed such rigorous models. Under the guidance of James Mill, Ricardo attempted long, deductive chains of reasoning. He wanted to derive propositions as certain as Euclidean geometry or Newtonian mechanics. Sometimes his assumptions or first premises were simply wrong. But given those premises, his theory was impregnable. Impregnable, yes; useful, perhaps not. Keynes and Joseph Schumpeter both accused Ricardo of choosing assumptions or examples that ensured the result he desired. Schumpeter called this the “Ricardian vice.” And whom else did Schumpeter accuse of suffering from the Ricardian vice? Keynes.
Ricardo discussed his methodological differences amiably: “Our difference may in some respect, I think, be ascribed to your considering my book as more practical than I intended it to be. My object was to elucidate principles, and to do this I imagined strong cases.” Ricardo also preferred long-run analysis to short-run descriptions, telling Malthus, “You have always in your mind the immediate and temporary effects of particular changes—whereas I put these . . . aside, and fix my whole attention on the permanent state of things which will result from them.”30 No wonder correspondence shows that Ricardo refused to grant Malthus’s empirical observations. They either did not fit into Ricardo’s strong case or appeared to be fleeting. But because Malthus never constructed sophisticated analytical models, he gained the reputation for fickleness. His contemporary Robert Torrens wrote that “in the leading questions of economical science, Mr. Malthus scarcely ever embraced a principle which he did not subsequently abandon.”31 Later, Keynes earned the same reputation, permitting his most acerbic critics to praise his eclecticism—in choosing the worst from the best.
Despite the attacks by Keynes and Schumpeter, exalted economists including Karl Marx, Léon Walras, Alfred Marshall, and Knut Wicksell have declared Ricardo’s preeminence. One prominent twentieth-century student of economic method proclaimed that “if economics is essentially an engine of analysis, a method of thinking rather than a body of substantial results, Ricardo literally invented the technique of economics.”32
One gets the impression that when Malthus died, some came to the funeral to mourn, others to make sure he really was dead. Ricardo attracted more admirers for his intellect, for his kindness, and for his character. In his last year, his fifty-first, he battled slavery proponents and denounced their cause as a stain on the nation’s character. Here was a wealthy man who could have spent his life luxuriating in the country and traveling throughout the world. Instead he used his leisure to study perplexing questions and derive abstract, abstruse, and, he thought, correct solutions. Upon teaching himself about the world, he taught others by book, by newspaper, and by parliamentary speech. His law of comparative advantage and theory of economic rent still appear in textbooks, as persuasive and important as ever.
Although Ricardo’s theories are taught throughout the world, it is the European nations that may best test his legacy. In a bold effort to knit themselves together so tightly that they might avoid a replay of the two world wars that began on their soil in the twentieth century, European Union states fulfilled their 1992 pledge to dismantle all remaining trade barriers among themselves, giving Ricardo a partial victory. For a complete victory, the European Union countries must also keep their second pledge: not to erect fortresses on their shores that would prevent countries in the Americas, Africa, Asia, and post-Brexit United Kingdom from participating in their free-for-all program. So far, the results are mixed. Though U.S. financial firms have made strong inroads (often by merging with European entities), somehow European farmers continue to win special favors to the annoyance of American, Australian, and Latin American agriculture. Despite trumpeting support for struggling Caribbean and African farmers, E.U. nations dump millions of tons of subsidized sugar onto the world market, depressing prices; German potato farmers protest imports of foreign spuds; and French winegrowers fight to keep out South African chardonnays. The most divisive issue might be bananas! Former U.S. secretary of state Madeleine Albright was once interrupted during a tense meeting over battle lines in Kosovo and noted, “I never in my life thought I would spend so much time on bananas.” Europe protects its former colonies in Africa from the banana growers of the Caribbean and Latin America. So far, bananas have been a strong weapon against free trade. Ricardo would be disappointed but hopeful. If there’s a way to gauge the world’s attitude to Ricardo’s legacy, it is this: follow the bananas.