CHAPTER 3

David Ricardo and the Formalization of

Classical Analysis

Ricardo and Malthus worked much the same theoretical territory. Both were concerned with extending the tradition launched by Smith and with sharpening its insights. Moreover the writings of both responded to the unusual circumstances of the Napoleonic wars and their aftermath. On a number of specific points they arrived at quite different conclusions. Nevertheless, both aimed their analytical sights on the classical problem. For his part, Ricardo identified himself with its central issues when he declared that the 'principal problem in Political Economy' was to ‘determine the laws' regulating distribution between the various classes and their relation to the general circumstances of society.

The aspect of this theme on which Ricardo initially focused attention was more restricted in scope: the effects on the economy as a whole of the protection afforded to agriculture by the Corn Laws. In the circumstances of the time, it was by no means accidental that this issue should have occupied a dominant place in Ricardo's thought. The Napoleonic wars - combined with a run of poor harvests- had, as noted earlier, converted the British economy into a net importer of food grains. Corn prices had skyrocketed and meanwhile the income of landlords had been swollen. On one estate for which systematic records have been kept, for example, the landlord's return increased by nearly tenfold between 1776 and 1816. Not all of this return can be interpreted as an `economic rent' in the sense in which Ricardo and Malthus wrote about it in their theories; part represented a return on investments to raise the productivity of the soil. Nevertheless it was abundantly apparent that a fundamental change in the balance of agriculture (relative to the rest of the economy) had occurred.

These problems were aggravated by amendments to the Corn Laws passed shortly after the end of the war. Their effect was to make the protection of domestic agriculture virtually absolute by prohibiting the importation of foreign grain until the domestic price of wheat exceeded sixty shillings per quarter. The problem to which Ricardo addressed himself was clearly real and important. His preoccupation with the significance of agriculture was apparent in the phrasing he chose to preface his major work:

The produce of the earth - all that is derived from its surface by the united application of labour, machinery, and capital, is divided among the three classes of the community; namely, the proprietor of the land, the owner of the stock or capital necessary for its cultivation, and the labourers by whose industry it is cultivated.

But in different stages of society, the proportions of the whole produce of the earth which will be allotted to each of these classes, under the names of rent, profit, and wages, will be essentially different; depending mainly on the actual fertility of the soil, on the accumulation of capital and population, and on the skill, ingenuity, and instruments employed in agriculture.1

In much of his writing Ricardo viewed the whole economy as if it were one giant farm.

The method Ricardo employed in dealing with this problem gave to his analysis a tone of generality. His prose style - by contrast with that of Smith and Malthus (which had been embellished with homely illustrations and the occasional parenthetical homily) - was spare and formal. Moreover, his acute analytical perception led him well beyond the practical issue that had originally turned his mind to theoretical investigations. It was the more general version of his model that was to leave a lasting mark on the techniques of economic theorizing.

1. DAVID RICARDO (1772-1823)

Ricardo began to make his way in the world when, at the age of fourteen, he entered the London Stock Exchange in the employ of his father. Upon the son's marriage outside the Jewish faith seven years later, family relationships were strained and the younger Ricardo struck out on his own. Specializing in dealings in government securities, he soon flourished and, by 1815 , had amassed a sizeable fortune.

His interest in the abstract problems of economics was developed in the middle years of his life. His acquaintance with the subject appears to have dated from 1799 when, on a visit with his wife to the spa town of Bath, he read Adam Smith. A decade later his first published views - dealing with the depreciation of the currency - appeared in the form of letters to the press signed 'R'. Shortly thereafter, he expanded his thoughts on currency questions into a pamphlet which was to bring him public notice and the attention of several prominent literary figures - among them, James Mill. Without the goading of Mill (who insisted that 'as you are already the best thinker on political economy, I am resolved that you shall also be the best writer')2 it is unlikely that Ricardo's Principles would ever have been produced. Ricardo feared that `the undertaking exceeds my powers',3 and lamented after he had begun the work: 'I make no progress in the very difficult art of composition. I believe that ought to be my study before I introduce any more of my crude notions on the public.’4 Despite delays and the author's recurrent periods of despondency, Principles of Political Economy and Taxation appeared in 1817.

This work solidly established his reputation as the leading economic analyst of his day. When he entered Parliament in 1819, it gave to his opinions (expressed though they were in a quiet high-pitched voice) a tone of authority. Indeed he has been described as the first to educate the House of Commons in economic analysis. But his opinions were not unchallenged; the most articulate dissenter was his warm friend Malthus. His last letter to Malthus conveys the manner of the man:

Like other disputants after much discussion we each retain our own opinions. These discussions however never influence our friendship: I should not like you more than I do if you agreed in opinion with me.5

Late in life, despite his protestations on the malevolence of landlords, Ricardo placed the larger part of his substantial fortune in land. On this aspect of his friend's behaviour, Malthus once observed:

He [Ricardo] is now become, by his talents and industry, a considerable land holder; 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, or employs it better, I could not point out in the whole circle of landholders.

It is somewhat singular that Mr Ricardo, a considerable receiver of rents, should have so much underrated their national importance; while I, who never received, nor expect to receive any, shall probably be accused of overrating their importance. Our different situations and opinions may serve at least to skew our mutual sincerity, and afford a strong presumption, that to whatever bias our minds may have been subjected in the doctrines we have laid down, it has not been that, against which perhaps it is most difficult to guard, the insensible bias of situation and interest.6

2. RICARDO'S ANALYTICAL PROGRAMME

The central core of Ricardian theoretical argument was contained in one fundamental proposition: 'that in all countries, and all times, profits depend on the quantity of labour requisite to provide necessaries for the labourers, on that land or with that capital which yields no rent'.7 Indeed the bulk of his analysis was dedicated to supplying arguments to support this conclusion.

The importance of this proposition within the larger context of classical thought can be readily appreciated. The rate of profit for Ricardo, as for the earlier classicists, was a primary regulator of the rate of economic growth. An understanding of the mainsprings of economic expansion and of forces that might check it clearly required a firm grasp on the determinants of this income share.

But what justification had Ricardo for maintaining that the conditions of production in agriculture had a decisive bearing on profit rates throughout the economy? Could it not be held with equal plausibility (as Malthus observed when criticizing Ricardo's position) that the circumstances of other branches of the economy determined rates of return within agriculture? A fully satisfactory answer to this question cannot be found within the pages of Ricardo's Principles. The evidence compiled by Piero Sraffa, the tireless collector and editor of Ricardo's papers, now permits a reconstruction of the argument Ricardo must have had in mind.

Agriculture, it would appear, was to be regarded as unique because of two special attributes. It was the only sector in which the same commodity (Ricardo used `corn' as a composite term to embrace all agricultural output) figured as both input and output. Corn was obviously an input when used as seed. Moreover, because corn was the basic component of subsistence, it was also crucial to the other indispensable input - labour. Following the classical view of `advances' to labour, wages could be reduced to advances of corn and, in turn, all inputs could be expressed in terms of corn. But,' as corn was also the output of agriculture, the net return to producers could be measured in corn terms by subtracting inputs from outputs.

The net return in agriculture, calculated in this fashion, would not, in all cases, provide a measure of profits. Much of the land under cultivation would also yield rent. In their handling of this matter, Malthus and Ricardo adopted much the same approach. The 'niggardliness of nature' had made land scarce and uneven in quality. Acreages of high fertility (which, it could be reasonably assumed, would be the first to be drawn into cultivation) would provide a windfall to their owners. Moreover, the size of this windfall would swell as population growth enlarged the demand for food. As food prices rose, less fertile areas would be brought under the plough, so long as their cultivators could obtain going rates of return for their efforts. Meanwhile, the owners of fertile acreages would reap higher and higher rents. The outputs of the last units, on the other hand, would be sufficient only to cover the costs of cultivation and would fail to yield a rent.

With the aid of this argument, it could thus be maintained that rent and profit could be isolated by observing zero-rent land where the net return would consist entirely of the return on capital - profits. The rate of profit could then be calculated as a percentage by dividing the net return (corn outputs less corn inputs) by total inputs (measured in terms of corn).

With this exercise part of the claim to a unique status for agriculture could be established. In this sector of the economy, profit rates could be determined without reference to prices. In no other sector could a similar calculation be undertaken in real terms (i.e. with physical rather than monetary units of measurement). But agriculture had a further claim to a special position. Its outputs were indispensable as inputs in all other lines of production. The availability of food supplies was required if nonagricultural employers were to make wage advances to their work force.

While Ricardo's argument assigned a special role to agriculture, he rejected the Physiocratic view that agriculture was the economy's only productive sector. For Ricardo, agricultural production had only an analytical primacy in that it supplied useful leverage on the economy as a whole. Once conditions in agriculture had been established, other pieces in the analytical puzzle fell into place. So long as it could be assumed that the market tended to produce uniform rates of return in all sectors of the economy, then profits in agriculture could be interpreted as typical of profit rates prevailing throughout the economic system. By looking first at agriculture, the general behaviour of profits could thus be derived in a manner independent of monetary valuation.

The argument on uniform rates of return throughout the economy applied with equal force to wages. But wages were likely to be tied to an even more basic regulator - the requirements for subsistence. In his handling of this point Ricardo largely absorbed Malthusian teaching on population. He was aware of the differing results yielded by psychological and physiological interpretations of subsistence and his personal hope was that the habits of the working class could be elevated.8 But he saw little prospect that these tastes could be altered except over a prolonged time period. For the immediate future it thus appeared that a natural wage gravitating around the conventional level of subsistence should be regarded as normal.

With population growth, rates of profit were likely to deteriorate even though real wages were unaltered. The margin of cultivation would then be extended to poorer lands where more labour input per unit of output would be required than had previously been the case. More corn would thus have to be advanced to labour in order to obtain the increments to corn output needed to feed a larger population. As Ricardo phrased the outcome, `the quantity of labour required to produce necessaries on zero-rent land' would rise. Hence, rates of profits in agriculture and throughout the economy would be squeezed.

Ricardo's simple model, though built around an analysis of productive conditions in agriculture, thus had contained within it a broad vision of the forces regulating the distribution of the social product and, in turn, of the forces likely to frustrate its continued expansion.

3. THE RICARDIAN REFORMULATION OF THE
THEORY OF VALUE

Ricardo's simplified model of the corn-based economy permitted the mechanisms of distribution to be analysed in real terms without reference to valuation. If, in fact, society had been organized exclusively along the lines of a giant farm in which corn was both the basic input and the only output, this formulation would have required no elaboration. But Ricardo appreciated that the world of reality was more complex. Some headway towards a formulation of rules governing the behaviour of the economic system could be made by isolating a 'basic' sector possessing convenient analytical properties and by arguing that all other sectors would conform to its results. Nevertheless a closer inspection of the linkages was clearly in order.

At a more general level of analysis the problem became less tidy. Outside agriculture, outputs were considerably more heterogeneous and their variety called for the aid of a device capable of reducing them to a common denominator. In short, statements about the division of the national revenue between the various income shares - when pursued in any depth - required a procedure for valuation.

In his search for a common factor linking all lines of production, it was not surprising that Ricardo should have hit upon labour as the crucial common denominator. In one form or another, a labour approach to value had already been built into the classical tradition. But that was not all. Labour, it could be plausibly maintained, did indeed provide a realistic link: it entered into all lines of production.

Ricardo approached the problem of value along a path somewhat different from the one his predecessors had taken and he emerged from his inquiries with a different solution. Smith, for example, had addressed himself to the issue for the primary purpose of measuring changes in total output between time intervals of considerable length. Ricardo, though not insensitive to the importance of this problem, was doubtful that labour could serve as a 'stable' and `invariant' measure. In any event, it was more pertinent to his concerns to analyse the consequences of changes in the relative prices of output for the distribution of income.

The tack Ricardo took was thus to come closer to the questions that were to dominate economic theorizing in a later stage - in particular, the analysis of price determination - than had Smith's. Even had he chosen to do so, Smith, with the tools he worked with, would have been precluded from offering a systematic account of relative price in labour terms. His procedure, it will be recalled, used labour as a `measure of value' by reducing income to labour units that could be `commanded'. On the input side, however, he lacked a basis for dissolving the nonlabour factors of production into labour units.

The Ricardian analysis of rent re-opened the labour input route to the analysis of value. Because he maintained that the price of corn was regulated by labour inputs on zero-rent land, the land factor of production could effectively be eliminated from the explanation of value. Capital, of course, was a different matter. But it appeared to be readily reducible to labour inputs. A machine, for example, could be viewed as embodied or accumulated labour, the productive powers of which would be transferred to current output over the course of its life. The value of a commodity could then be expressed in terms of labour inputs (both those applied directly and indirectly through embodiment in machines) required in its production.

At first glance it might appear that a satisfactory common denominator had been found. But, as Ricardo came increasingly to realize as he grappled with this issue, a labour-content interpretation of value became awkward precisely at the point where it was most needed - in the analysis of long period economic change. A crude labour-content explanation of relative price ran into heavy weather when important dynamic considerations were introduced into the analysis: e.g. changes in money wage rates and the accumulation of fixed capital.

With the accumulation of capital, Ricardo saw that a number of complications were introduced. After all, it could not be assumed that the fixed capital stock employed in an economy would have uniform durability; nor could it be assumed that fixed and circulating capital were allocated in identical proportions in all lines of production. Once these elements of diversity in the productive structure were allowed, there was no longer any basis for holding that prices would correspond to labour inputs in a growing economy. Divergent price results could be obtained, for example, if wage rates were altered, even though production processes themselves were unchanged. The basic point to which Ricardo wished to draw attention was that a production process dominated by direct labour inputs would be more vulnerable to an increase in money wage rates than would one in which indirect labour inputs (i.e. labour embodied in fixed capital) were used. If a uniform rate of profit were to be maintained in all branches of production, then relative prices would diverge from ratios of labour inputs in production. Moreover, a divergence might arise from inequalities in the time periods of production. Two commodities produced with identical quantities of labour input would differ in price if one required longer commitments of capital before revenues were realized through sales than the other.

In short, the strict labour interpretation of value broke down. Ricardo still maintained that the discrepancies would be constrained within narrow limits. At one point in his treatment of the divergence of price ratios from labour input ratios of two commodities produced with differing proportions of direct and indirect labour, he asserted: `The greatest effects which could be produced on the relative prices of these goods from a rise of wages, could not exceed six or seven per cent. . . .'9 Labour content was only a crude approximation or, as he later put it, the foundation of value'.10

This unsuccessful detour into value theory in a dynamic setting was not, however, devoid of significance. It produced a fresh insight into the relationships between increases in money wage rates and the accumulation of fixed capital, the phenomena responsible for undercutting his labour input approach. Both of these changes were expected to accompany economic expansion. But there was another important connexion between them. Rising wage rates would induce employers to substitute fixed capital for labour in order to reduce costs of production. Ricardo expected that the resulting economies would, at least in part, be passed on to consumers through price reductions, a result that competition was expected to assure. But what would be the consequence for the volume of employment? The Ricardo of the first two editions of Principles was confident that technological unemployment was an impossibility and that productivity gains brought by the introduction of machinery were an unmixed blessing. All classes of society would benefit from the ensuing reductions in prices of output, and profits would be higher than would otherwise have been the case. The rate of growth could thus be sustained and the total demand for labour enlarged to the benefit of the entire community.

In the third edition of Principles, Ricardo shifted his ground. After recounting his earlier opinions, he observed:

. . . I am convinced, that the substitution of machinery for human labour, is often very injurious to the interests of the class of labourers. My mistake arose from the supposition, that whenever the net income of a society increased, its gross income would also increase; I now, however, see reason to be satisfied that the one fund, from which landlords and capitalists derive their revenue, may increase, while the other, that upon which the labouring class mainly depend, may diminish, and therefore it follows, if I am right, that the same cause which may increase the net revenue of the country, may at the same time render the population redundant, and deteriorate the condition of the labourer.11

At base, Ricardo's worry about the possibly detrimental effects of machinery on employment stemmed from the view that the volume of circulating capital available to hire labour would be reduced by the purchase of fixed capital. This finding, of course, touched a sensitive nerve in contemporary controversy. The Luddites, dispensing with the qualifications Ricardo added to his conclusion, were convinced that the machine was inimical to the interests of working men and, acting on this premise, had sparked the machine-smashing riots in textile districts in 1811 and 1812.

Ricardo was still hopeful that unemployment in this form could be averted, arguing that technological discoveries were necessarily gradual and could thus be assimilated without sudden shock. Ricardo saw the danger, but played down its practical significance. Nevertheless, his argument conflicted sharply with Smith's faith in the 'harmony of interests' between the various classes of society. Marx was later to pick up this theme and to give it a central position in his theoretical system.

4. RICARDO AND THE LONG-PERIOD PROSPECTS
OF THE ECONOMY

Classical analysis of the problem of value underwent a subtle but profound change from Smith to Ricardo. Ricardo's approach, imperfect and approximate though it was, not only yielded fresh findings but buttressed a number of familiar ones. In his hands, the analysis of value provided an underpinning to the long-term prognosis of economic expansion. With its support, he could write: 'The reason then, why raw produce rises in comparative value, is because more labour is employed in the production of the last portion obtained, and not because rent is paid to the landlord. The value of corn is regulated by the quantity of labour bestowed on its production on that quality of land, or with that portion of capital, which pays no rent.'12

The implications of this conclusion extended far beyond their direct bearing on differential rates of change in the prices of agricultural and manufactured goods. Among other things this analysis pinned down the connexions between economic expansion and income distribution. As population growth was thought likely to accompany economic expansion, food requirements - which could only be satisfied at substantially higher cost - would grow. Higher money wages would be called for in order to maintain real wages at their conventional level. The profit share of income would thus be squeezed. Meanwhile, the distribution of income would shift in favour of rents. This outcome, however, was directly linked to `the increasing difficulty of making constant additions to the food of the country'. Conversely, Ricardo maintained, `if the necessaries of the workman could be constantly increased with the same facility, there could be no permanent alteration in the rate of profits or wages, to whatever amount capital might be accumulated'.13

The upshot of this argument was that the process of economic expansion might erode its own foundation - i.e. accumulation out of the profit share of income. Ultimately, as the rate of profit fell, the stationary state would emerge when further net accumulation would be halted. Nor was it necessary for profits to be eliminated altogether before growth was checked. Ricardo anticipated that a critical point might be reached earlier. As he put it:

The farmer and manufacturer -can no more live without profit, than the labourer without wages. Their motive for accumulation will diminish with every diminution of profit, and will cease altogether when their profits are so low as not to afford them an adequate compensation for their trouble, and the risk which they must necessarily encounter in employing their capital productively.14

The day when growth was halted could, however, be postponed by measures that reduced the labour costs involved in enlarging food supplies. The tendency of profits to fall, Ricardo noted, 'is happily checked at repeated intervals by the improvements in machinery, connected with the production of necessaries, as well as by 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 necessary of the labourer'.15 But relief via technological innovations could not be predicted with confidence. The upward pressure on the prices of subsistence goods and, in turn, on money wage rates, might be more reliably restrained through the importation of food stuffs from lower-cost producers abroad. This consideration figured prominently in Ricardo's hostile attitude toward the protection to home agriculture afforded by the Corn Laws.

5. RICARDO ON ECONOMIC POLICY

On most points of public controversy in his day Ricardo accepted and extended the mainstream of classical thinking. With respect to the Poor Laws he maintained that `every friend to the poor must ardently wish for their abolition',16 though, with Malthus, he recommended that relief payments should be withdrawn gradually. In general, he opposed government intervention in economic activity and endorsed the beneficence of a self-regulating market system, the virtues of which he defended against Malthus's doubts about the efficacy of Say's Law.17

His most important contribution to debates on policy focused on the issue that had originally inspired his investigations - the Corn Laws. Ricardo advocated repeal, but with a more powerful battery of arguments than had earlier been mustered. With the aid of his analytical model it could now be demonstrated that the Corn Laws were objectionable - not simply because they obstructed the free movement of resources - but, more importantly, because they tightened the squeeze on profits, the mainspring of sustained economic expansion.

In support of his arguments for free trade in agricultural products, Ricardo worked out the basic format of the doctrine that now enters introductory textbooks as the theory of comparative advantage. He formulated the problem in terms consistent with his general approach: by way of a comparison between the labour inputs required to obtain commodities from home production in different countries. If cost ratios of internationally tradeable commodities (measured in terms of labour inputs) differed in the home economies of two countries, each could benefit by specializing in the production of the good in which it held a comparative advantage (and offering part of the output for export) and by importing its requirements of the other. In this fashion, gains from trade would accrue to all parties. A greater quantum of output could be acquired than would have been possible through exclusive reliance on domestic resources.

But it was not simply the general gains from specialization and trade that Ricardo wished to emphasize. It was important that British trade should flow in channels that would arrest the erosion of profits. Thus it was not a matter of indifference which goods predominated in the trading pattern. On the contrary, the national interest was best served when imports were concentrated on foodstuffs, with British manufacturers supplying the exports to pay for them. Specialization along these lines would reduce pressures on money wage rates by making subsistence goods available at lower cost than would otherwise have been possible. As Ricardo argued the point:

If, therefore, by the extension of foreign trade, or by improvements in machinery, the food and necessaries of the labourer can be brought to market at a reduced price, profits will rise. If, instead of growing our own corn, or manufacturing the clothing and other necessaries of the labourer, we discover a new market from which we can supply ourselves with these commodities at a cheaper price, wages will fall and profits rise; but if the commodities obtained at a cheaper rate, by the extension of foreign commerce, or by the improvement of machinery, be exclusively the commodities consumed by the rich, no alteration will take place in the rate of profits.18

The realization of the full benefits of international trade required, however, a sound international financial system. Ricardo's views on monetary and financial questions - which left a formidable imprint on the thought of his time - were dominated by this concern. The domestic monetary system, he maintained, should be regulated to insure against disruption in the international division of labour. Conceivably, increases in the note issue at home might threaten a country's trading position should they lead to price increases that made its exports less competitive in foreign markets and imports more attractive in home markets. These considerations led Ricardo to adopt what was described as a 'bullionist' position in the debates of the time. He maintained that the domestic money supply should be directly tied to the country's gold supply. Under such an arrangement, the note issue of a country suffering a loss of gold through an unfavourable balance of trade would automatically be contracted. A reduced money supply would tend to depress the price level which, in turn, would encourage the desired adjustments in the international accounts. The deficit country's exports would become more attractive to foreigners while imports could compete less successfully in home markets as the prices of domestically-produced items declined. In embryonic form, Ricardo had sketched the theory of the nineteenth century gold standard.

Considerations of the problems of growth also informed Ricardo's basic strategy with respect to matters of taxation. Though he was at one with the mainstream of the classical tradition in his suspicion of government intervention in the economy, he recognized that some necessary functions could only be discharged on the public account. In the choice between various types of tax levies that might be used to finance these services, one consideration was paramount: that taxes falling on profits should be minimized, if not avoided altogether. He was aware, of course, that the impact of taxation could not always be easily ascertained. If wages were at the 'subsistence' level, for example, a tax on labourers would be shifted to capitalists; the latter would be obliged to increase money wage rates by an amount sufficient to maintain subsistence standards. From the point of view of the future expansion of the economy, taxes that threatened to choke accumulation from profits were undesirable. Far preferable were levies that fell on unproductive spenders and expenditures, particularly on the rent share of income and on luxury consumption.