WEBVTT NOTE 3. James Mill, Ricardo, and the Ricardian System (continued) 1 00:00:00.000 --> 00:00:09.320 4. RICARDO AND THE RICARDIAN SYSTEM 1. MACRO INCOME DISTRIBUTION 2 00:00:09.320 --> 00:00:14.760 While much of the Ricardian system turns out to be the creation of James Mill, perhaps 3 00:00:14.760 --> 00:00:22.040 most of it was due to Ricardo himself, who, of course, must, in any case, bear major responsibility 4 00:00:22.040 --> 00:00:29.640 for his own work. To continue the Marxian metaphor, in many ways the Mill-Ricardo relationship 5 00:00:29.640 --> 00:00:35.860 might be more of a Marx-Engels than a Lenin-Marx connection. 6 00:00:35.860 --> 00:00:41.600 Ricardo was born in London into a prosperous family of Spanish-Portuguese Jews who had 7 00:00:41.600 --> 00:00:48.780 settled in Holland after having been expelled from Spain at the end of the 15th century. 8 00:00:48.780 --> 00:00:55.360 Ricardo's father had moved to London, where he prospered as a stockbroker and had 17 children, 9 00:00:55.360 --> 00:00:58.240 of whom David was the third. 10 00:00:58.240 --> 00:01:04.240 At the age of 11, David was sent by his father to Amsterdam to attend orthodox Hebrew school 11 00:01:04.240 --> 00:01:06.360 for two years. 12 00:01:06.360 --> 00:01:13.080 At the age of 14, with only an elementary education, Ricardo began his business career, 13 00:01:13.080 --> 00:01:17.000 employed by his father's stockbroker house. 14 00:01:17.000 --> 00:01:22.480 It must be emphasized that with the exception of the quasi-governmental bank of England, 15 00:01:22.480 --> 00:01:27.700 there were no corporations or corporate stocks in that era. 16 00:01:27.700 --> 00:01:33.460 Government bonds were then called stocks, and so stockbrokers were what would now be 17 00:01:33.460 --> 00:01:37.300 called government bond dealers. 18 00:01:37.300 --> 00:01:43.060 Seven years later, however, David married a Quaker girl and left the Jewish faith, whereupon 19 00:01:43.060 --> 00:01:45.660 he was disowned by his parents. 20 00:01:45.660 --> 00:01:49.460 Eventually, he became a confirmed Quaker. 21 00:01:49.460 --> 00:01:55.140 A London bank, already impressed with young Ricardo, lent him enough money to set himself 22 00:01:55.140 --> 00:02:02.140 In 1799, at the age of 27, Ricardo, bored while wiling away time at a health resort, chanced upon a copy of The Wealth of Nations, and devoured it, becoming, like so many others of that era, a dedicated Smithian. 23 00:02:25.140 --> 00:02:32.940 As Schumpeter points out, Ricardo's principles can only be understood as a dialogue with 24 00:02:32.940 --> 00:02:40.900 and reaction to the wealth of nations. Ricardo's logical bent was offended at the basic confusion 25 00:02:40.900 --> 00:02:49.180 of mind, the chaos that J.B. Say also saw in the Smithian canon, and he, like Say before 26 00:02:49.180 --> 00:02:52.180 set out to clarify the Smithian system. 27 00:02:52.180 --> 00:02:56.180 Unfortunately, and in deep contrast to Say, 28 00:02:56.180 --> 00:03:02.180 Ricardo simplified by taking all the most egregious errors in Smith, 29 00:03:02.180 --> 00:03:05.180 throwing out all qualifications and contradictions, 30 00:03:05.180 --> 00:03:09.180 then building his system upon what was left. 31 00:03:09.180 --> 00:03:14.180 The worst of Smith was magnified and intensified. 32 00:03:14.180 --> 00:03:20.180 In his basic method, all of Smith's historical and empirical points were tossed out. 33 00:03:20.180 --> 00:03:29.180 This was not bad in itself, but it left a deductive system built on deep fallacy and incorrect macro models. 34 00:03:29.180 --> 00:03:37.180 In addition, while Ricardo's theoretical system might have been brutally oversimplified in relation to Smith, 35 00:03:37.180 --> 00:03:42.180 his writing style was inordinately crabbed and obtuse. 36 00:03:42.180 --> 00:03:56.180 The methodology of verbal mathematics is almost bound to be difficult and obscurantist, with blocks of words spelling out equilibrium mathematical relations in a highly cumbersome manner. 37 00:03:56.180 --> 00:04:09.180 But on top of that, Ricardo, in contrast to his mentor, Mill, was undoubtedly one of the worst and most turgid literary stylists in the history of economic thought. 38 00:04:09.180 --> 00:04:17.180 In contrast to Adam Smith, for whom the output or wealth of nations was of supreme importance, 39 00:04:17.180 --> 00:04:28.180 Ricardo neglected total output to place overriding emphasis on the alleged distribution of a given product into macro classes, 40 00:04:28.180 --> 00:04:35.180 specifically into the three macro classes of landlords, laborers and capitalists. 41 00:04:35.180 --> 00:04:42.420 Thus, in a letter to Malthus, who, on this question at least, was an orthodox Smithian, 42 00:04:42.420 --> 00:04:44.900 Ricardo made the distinction clear. 43 00:04:44.900 --> 00:04:51.540 Political economy, you think, is an inquiry into the nature and causes of wealth. 44 00:04:51.540 --> 00:04:57.100 I think it should rather be called an inquiry into the laws which determine the division 45 00:04:57.100 --> 00:05:04.380 of the produce of industry amongst the classes who concur in its formation. 46 00:05:04.380 --> 00:05:10.940 Since entrepreneurship could not exist in Ricardo's world of long-run equilibrium, he was left 47 00:05:10.940 --> 00:05:18.200 with the classical triad of factors. His analysis was strictly holistic in terms of allegedly 48 00:05:18.200 --> 00:05:25.980 homogeneous but actually varied and diverse classes. Ricardo avoided any say-type emphasis 49 00:05:25.980 --> 00:05:32.820 on the individual, whether he be the consumer, worker, producer or businessman. 50 00:05:32.820 --> 00:05:39.380 In Ricardo's world of verbal mathematics there were, as Schumpeter has astutely pointed out, 51 00:05:39.380 --> 00:05:41.140 four variables. 52 00:05:41.140 --> 00:05:48.340 Total output or income, and shares of income to landlords, capitalists and workers. 53 00:05:48.340 --> 00:05:54.500 That is, rent, profits, long run interest and wages. 54 00:05:54.500 --> 00:05:57.100 Ricardo was stuck with a hopeless problem. 55 00:05:57.100 --> 00:06:02.740 He had four variables, but only one equation with which to solve them. 56 00:06:02.740 --> 00:06:09.240 Total output or income equals rent plus profits plus wages. 57 00:06:09.240 --> 00:06:16.040 To solve, or rather pretend to solve, this equation, Ricardo had to determine one or 58 00:06:16.040 --> 00:06:24.500 more of these entities from outside his equation, and in such a way as to leave others as residuals. 59 00:06:24.500 --> 00:06:31.260 He began by neglecting total output, that is, by assuming it to be a given, thereby 60 00:06:31.260 --> 00:06:37.820 by determining output by freezing it on his own arbitrary assumptions. This procedure 61 00:06:37.820 --> 00:06:42.820 enabled him to get rid of one variable to his own satisfaction. 62 00:06:42.820 --> 00:06:51.820 Next, on to wages. Here, Ricardo took from Mill the hardcore or ultra-Malthusian view 63 00:06:51.820 --> 00:06:59.420 that wages, all wages, are always and everywhere pressing on the food supply to such an extent 64 00:06:59.420 --> 00:07:07.420 that they are always set and determined precisely at the level of the cost of subsistence. 65 00:07:07.420 --> 00:07:13.780 Labor is assumed to be homogeneous and of equal quality so that all wages can be assumed 66 00:07:13.780 --> 00:07:16.940 to be at subsistence cost. 67 00:07:16.940 --> 00:07:23.860 While briefly and dimly acknowledging that labor can have different qualities or grades, 68 00:07:23.860 --> 00:07:30.860 Ricardo, like Marx after him, drastically assumed away the problem by blithely postulating 69 00:07:30.860 --> 00:07:37.020 that they can all be incorporated into a weighted quantity of labor hours. 70 00:07:37.020 --> 00:07:44.080 As a result, Ricardo could maintain that wage rates were uniform throughout the economy. 71 00:07:44.080 --> 00:07:50.680 In the meanwhile, as we have seen, food, or subsistence generally, was assumed to be incorporated 72 00:07:50.680 --> 00:07:58.120 into one commodity, corn, so that the price of corn can serve as a surrogate for subsistence 73 00:07:58.120 --> 00:08:01.080 cost in general. 74 00:08:01.080 --> 00:08:06.780 Given these heroic and fallacious assumptions, then, the wage rate is determined instantly 75 00:08:06.780 --> 00:08:13.320 and totally by the price of corn, since the wage rate can neither rise above the subsistence 76 00:08:13.320 --> 00:08:19.280 level as determined by the price of corn, nor sink below it. 77 00:08:19.280 --> 00:08:26.400 The price of corn in its turn is determined according to Ricardo's famous theory of rent. 78 00:08:26.400 --> 00:08:30.500 Rent served as the linchpin of the Ricardian system. 79 00:08:30.500 --> 00:08:37.180 For according to Ricardo's rather bizarre theory, only land differed in quality. 80 00:08:37.180 --> 00:08:44.420 Labor, as we have seen, was assumed to be uniform, and therefore wage rates are uniform. 81 00:08:44.420 --> 00:08:50.860 And as we shall see, profits are also assumed to be uniform because of the crucial postulate 82 00:08:50.860 --> 00:08:56.740 of the economy's always-being and long-run equilibrium. 83 00:08:56.740 --> 00:09:02.860 Land is the only factor which miraculously is allowed to differ in quality. 84 00:09:02.860 --> 00:09:10.220 Next, Ricardo assumes away any discovery of new lands or improvements in agricultural 85 00:09:10.220 --> 00:09:12.100 productivity. 86 00:09:12.100 --> 00:09:17.760 This theory of history therefore concludes that people always begin by cultivating the 87 00:09:17.760 --> 00:09:20.180 most fertile lands. 88 00:09:20.180 --> 00:09:26.500 And as population increases, the Malthusian pressure on the food supply forces the producers 89 00:09:26.500 --> 00:09:30.180 to use ever more inferior lands. 90 00:09:30.180 --> 00:09:37.040 In short, as population and food production rise, the cost of growing corn must inexorably 91 00:09:37.040 --> 00:09:39.140 rise over time. 92 00:09:39.140 --> 00:09:48.140 Rent, in Ricardo's phrase, is payment for the use of the original and indestructible powers of the soil. 93 00:09:48.140 --> 00:09:59.140 This hints at a productivity theory, and, indeed, Ricardo did see that more fertile and productive lands earned a higher rent. 94 00:09:59.140 --> 00:10:05.140 But, unfortunately, as Schumpeter put it, Ricardo then embarks upon his detour. 95 00:10:05.140 --> 00:10:11.260 Remember, in the first place, Ricardo made the assumption that at any moment the poorest 96 00:10:11.260 --> 00:10:15.500 land in cultivation yields a zero rent. 97 00:10:15.500 --> 00:10:21.860 He concluded from that alleged fact that a given piece of land earns rent not because 98 00:10:21.860 --> 00:10:29.500 of its own productivity, but merely because its productivity is greater than the poorest, 99 00:10:29.500 --> 00:10:33.360 zero rent land under cultivation. 100 00:10:33.360 --> 00:10:40.760 Remember that for Ricardo, labor is homogeneous, and hence wages uniform and equal, and as 101 00:10:40.760 --> 00:10:46.120 we shall see, profits are also uniform and equal. 102 00:10:46.120 --> 00:10:54.120 Land is unique in its permanent long-run structure of differential fertility and productivity. 103 00:10:54.120 --> 00:11:01.900 Hence to Ricardo, rent is purely a differential, and land A earns rent solely because of its 104 00:11:01.900 --> 00:11:09.740 Differential Productivity compared to land B, the zero rent land in cultivation. 105 00:11:09.740 --> 00:11:14.660 To Ricardo, several important points followed from these assumptions. 106 00:11:14.660 --> 00:11:22.860 First, as population inexorably increases, and poorer and poorer lands are used, all 107 00:11:22.860 --> 00:11:25.660 the differentials keep increasing. 108 00:11:25.660 --> 00:11:33.620 Thus, say that at one point of time, corn lands, which sums up all land, range in productivity 109 00:11:33.620 --> 00:11:41.380 from the highest, land A, through a spectrum down to land J, which, being marginal, earns 110 00:11:41.380 --> 00:11:43.020 a zero rent. 111 00:11:43.020 --> 00:11:49.680 But now population increases, and farmers have to cultivate more and poorer lands, say 112 00:11:49.680 --> 00:11:59.360 Say, K, L and M. M now becomes the zero rent land, and land J now earns a positive rent, 113 00:11:59.360 --> 00:12:07.080 equal to the differential between its productivity and that of M. And all the previous inframarginal 114 00:12:07.080 --> 00:12:14.500 lands have their differential rents raised as well. It becomes ineluctably true, therefore, 115 00:12:14.500 --> 00:12:21.400 over time, as population increases, rents and the proportion of income going to rent 116 00:12:21.400 --> 00:12:31.500 increase as well. Yet, though rent keeps increasing, at the margin it always remains zero. And, 117 00:12:31.500 --> 00:12:38.940 as Ricardo put it in a crucial part of his theory, being zero rent does not enter into 118 00:12:38.940 --> 00:12:47.380 Put another way, quantity of labor cost, being allegedly homogeneous, is uniform for each 119 00:12:47.380 --> 00:12:54.340 product, and profits, being uniform and fairly small throughout the economy, form a part 120 00:12:54.340 --> 00:12:58.340 of cost that can be basically neglected. 121 00:12:58.340 --> 00:13:04.140 Since the price of every product is uniform, this means that the quantity of labor cost 122 00:13:04.140 --> 00:13:11.500 on the Highest Cost or Zero Rent Land uniquely determines the price of corn and of every 123 00:13:11.500 --> 00:13:20.500 other agricultural product. Rent, being inframarginal in Ricardo's assumptions, cannot enter into 124 00:13:20.500 --> 00:13:29.180 cost. Total rental income is a passive residual determined by selling prices and total income, 125 00:13:29.180 --> 00:13:35.540 And selling prices are determined by quantity of labor cost and, to a small extent, the 126 00:13:35.540 --> 00:13:38.340 uniform rate of profit. 127 00:13:38.340 --> 00:13:44.140 And since the quantity of labor needed to produce corn keeps rising as more and more 128 00:13:44.140 --> 00:13:50.620 inferior lands are put into production, this means that the cost of producing corn and 129 00:13:50.620 --> 00:13:55.260 hence the price of corn keep rising over time. 130 00:13:55.260 --> 00:14:02.480 And paradoxically, while rent keeps rising over time, it remains zero at the margin, 131 00:14:02.480 --> 00:14:06.860 and therefore without any impact on costs. 132 00:14:06.860 --> 00:14:09.720 There are many flaws in this doctrine. 133 00:14:09.720 --> 00:14:15.960 In the first place, even the poorest land in cultivation never earns a zero rent, just 134 00:14:15.960 --> 00:14:23.220 as the least productive piece of machinery or worker never earns a zero price or wage. 135 00:14:23.220 --> 00:14:29.880 It does not benefit any resource owner to keep his resource or factor in production unless 136 00:14:29.880 --> 00:14:32.700 it earns a positive rent. 137 00:14:32.700 --> 00:14:40.200 The marginal land or other resource will indeed earn less of a rent than more productive factors, 138 00:14:40.200 --> 00:14:46.940 but even the marginal land will always earn some positive rent, however small. 139 00:14:46.940 --> 00:14:57.940 Second, apart from the zero-rent problem, it is simply wrong to think that rent or any other factor return is caused by differentials. 140 00:14:57.940 --> 00:15:04.940 Each piece of land or unit of any factor earns whatever it produces. 141 00:15:04.940 --> 00:15:15.940 Differentials are simple arithmetic subtractions between two lands or other factors, each of which earns a positive rent of its own. 142 00:15:15.940 --> 00:15:30.940 The assumption of zero rent at the margin allows Ricardo to obscure the fact that every piece of land earns a productive rent, and allows him to slip into the differential as cause. 143 00:15:30.940 --> 00:15:47.940 We might just as well turn Ricardo on his head and apply the differential theory to wages and say with Schumpeter that one pays more for good than for bad land exactly as one pays more for a good than a bad workman. 144 00:15:47.940 --> 00:15:55.940 Third, in discussing the rise in cost of producing corn, Ricardo reverses cause and effect. 145 00:15:55.940 --> 00:16:03.820 Ricardo states that increasing population obliges farmers to work land of inferior quality, 146 00:16:03.820 --> 00:16:07.220 and then causes a rise in its price. 147 00:16:07.220 --> 00:16:14.900 But as any utility theory analyst would realize, the causal chain is precisely the reverse. 148 00:16:14.900 --> 00:16:21.660 When the demand for corn increases, its price would rise, and the higher price would lead 149 00:16:21.660 --> 00:16:25.820 farmers to grow corn on higher-cost land. 150 00:16:25.820 --> 00:16:31.540 But this realization, of course, eliminates the Ricardian theory of value, and with it, 151 00:16:31.540 --> 00:16:34.880 the entire Ricardian system. 152 00:16:34.880 --> 00:16:41.040 And fourth, as numerous critics have pointed out, it is certainly not true historically 153 00:16:41.040 --> 00:16:47.940 that people always start using the highest quality land and then sink gradually and inevitably 154 00:16:47.940 --> 00:16:52.220 down to more and more inferior land. 155 00:16:52.220 --> 00:16:59.860 Historically, there have always been advances and enormous ones in the productivity of agriculture, 156 00:16:59.860 --> 00:17:05.700 in the discovery and creation of new lands, and in the discovery and application of new 157 00:17:05.700 --> 00:17:11.820 and more productive agricultural techniques and types of products. 158 00:17:11.820 --> 00:17:17.540 Defenders of Ricardo counter that this is a purely historical argument, ignoring the 159 00:17:17.540 --> 00:17:21.060 logical beauty of the Ricardian theory. 160 00:17:21.060 --> 00:17:28.660 But the whole point is that Ricardo was, after all, advancing a historical theory, a law 161 00:17:28.660 --> 00:17:35.180 of history, and he certainly claimed historical accuracy for past and future predictions for 162 00:17:35.180 --> 00:17:36.960 his theory. 163 00:17:36.960 --> 00:17:44.160 And yet, it is all a purely arbitrary, and hence largely untrue, assumption of his logical 164 00:17:44.160 --> 00:17:52.800 Doctrine in the guise of what was making cavalier and untrue historical or empirical generalizations 165 00:17:52.800 --> 00:17:59.320 the building blocks of his logical system, from which he drew self-confident and seemingly 166 00:17:59.320 --> 00:18:04.600 apodictically true empirical and political conclusions. 167 00:18:04.600 --> 00:18:11.480 Yet from false assumptions only false conclusions can be drawn, regardless how imposing the 168 00:18:11.480 --> 00:18:22.360 Ricardo's differential rent theory has been widely hailed as the precursor of the neoclassical 169 00:18:22.360 --> 00:18:29.360 law of diminishing returns, which the neoclassicals were supposed to have generalized from land 170 00:18:29.360 --> 00:18:32.260 to all factors of production. 171 00:18:32.260 --> 00:18:39.280 But this is wrong, since the law of diminishing returns applies to increasing doses of a factor 172 00:18:39.280 --> 00:18:47.440 to Homogeneous Units of Other Logically Fixed Factors, in this case, land. 173 00:18:47.440 --> 00:18:53.240 But the whole point of Ricardo's differential rent theory is that his areas of land are 174 00:18:53.240 --> 00:19:00.760 not homogeneous at all, but varying in a spectrum from superiority to inferiority. 175 00:19:00.760 --> 00:19:07.600 Therefore, the law of diminishing returns, as grasped by Turgot and rediscovered by the 176 00:19:07.600 --> 00:19:15.240 of the neoclassicals simply does not apply. Rent, though increasing, is then effectively 177 00:19:15.240 --> 00:19:23.800 zero and not part of expenses or costs. Rent is disposed of in the Ricardian equation, 178 00:19:23.800 --> 00:19:30.640 but we have not yet finished the determination of wages, which so far we have said is precisely 179 00:19:30.640 --> 00:19:33.680 fixed at the subsistence level. 180 00:19:33.680 --> 00:19:38.360 What will happen to the costs of subsistence over time? 181 00:19:38.360 --> 00:19:45.200 They will rise as the cost of production of corn rises with the increasing population, 182 00:19:45.200 --> 00:19:49.720 forcing the cultivation of ever more inferior lands. 183 00:19:49.720 --> 00:19:57.400 Over time, in the slow-moving, long-run, Ricardian equilibria, the cost of food will rise, and 184 00:19:57.400 --> 00:20:04.920 Since wages must always be at the subsistence level, wages will have to rise to maintain 185 00:20:04.920 --> 00:20:09.720 real wage rates equal to the cost of subsistence. 186 00:20:09.720 --> 00:20:13.980 Now we begin to close the Ricardian Circle. 187 00:20:13.980 --> 00:20:21.000 Rents are in effect zero, and wage rates, always at subsistence, must rise over time 188 00:20:21.000 --> 00:20:27.300 as the cost of food increases, in order to keep precise pace with the rising cost of 189 00:20:27.300 --> 00:20:29.100 of Subsistence. 190 00:20:29.100 --> 00:20:31.300 But then, voila! 191 00:20:31.300 --> 00:20:38.960 We have finally determined all the variables except profits, at least to Ricardo's satisfaction. 192 00:20:38.960 --> 00:20:45.980 And since total income is given or kept frozen, this means that profits are the residual from 193 00:20:45.980 --> 00:20:48.040 total income. 194 00:20:48.040 --> 00:20:54.400 With rents out of the picture, if wage rates have to keep rising over time, this necessarily 195 00:20:54.400 --> 00:21:00.880 Theory means that profits or profit rates have to keep falling, hence the Ricardian 196 00:21:00.880 --> 00:21:08.280 doctrine of the ever-falling rate of profit, that is, long-term rate of interest. 197 00:21:08.280 --> 00:21:14.440 Note that this is not the same as Adam Smith's view that the profit rate falls over time 198 00:21:14.440 --> 00:21:20.840 because and in so far as capital continues to accumulate. 199 00:21:20.840 --> 00:21:26.520 was supposed to be an inverse function of the stock of capital. 200 00:21:26.520 --> 00:21:32.440 Ricardo's doctrine of the falling rate of profit follows by triumphant tautology from 201 00:21:32.440 --> 00:21:38.180 his attempt to determine the other factor shares of total income. 202 00:21:38.180 --> 00:21:44.880 When profits fall to zero, or at any rate to a low level, capital will cease to accumulate 203 00:21:44.880 --> 00:21:50.340 and we arrive at Ricardo's stationary state. 204 00:21:50.340 --> 00:21:55.540 So even more than Smith totally leaves out the entrepreneur. 205 00:21:55.540 --> 00:22:01.540 There can be no role for the entrepreneur, after all, if everyone is always in long-run 206 00:22:01.540 --> 00:22:06.100 equilibrium and there is never risk or uncertainty. 207 00:22:06.100 --> 00:22:13.820 His profits, as in Smith, are the long-run rate of return, that is, the rate of interest. 208 00:22:13.820 --> 00:22:20.480 In long-run equilibrium, furthermore, all profits are uniform, since firms rapidly move 209 00:22:20.480 --> 00:22:28.340 out of low-profit industries and into high-profit ones, until equalization takes place. 210 00:22:28.340 --> 00:22:35.740 We then have profits at a uniform rate throughout the economy at any given time. 211 00:22:35.740 --> 00:22:43.380 A plausible insight into Ricardo's habitual confusion of long-run equilibrium and instantaneous 212 00:22:43.380 --> 00:22:55.980 Fetter points out that Ricardo's practical familiarity was not with business and industry, 213 00:22:55.980 --> 00:23:03.400 as was, we might note, J.B. Say, but with the bond and foreign exchange markets. 214 00:23:03.400 --> 00:23:09.480 Ricardo usually assumed that even in industry and agriculture adjustment took place on the 215 00:23:09.480 --> 00:23:16.560 The basis of his small price differences and almost as quickly as did arbitrage in government 216 00:23:16.560 --> 00:23:21.020 securities and in foreign exchange. 217 00:23:21.020 --> 00:23:27.220 To return to the Ricardian world, note that Ricardo does not say that the cost of corn 218 00:23:27.220 --> 00:23:33.240 rises over time because rents keep rising on corn land. 219 00:23:33.240 --> 00:23:39.520 He must get rid of the rent variable, and he can only do so by assuming that rent is 220 00:23:39.520 --> 00:23:47.520 zero at the margin, and therefore never forms any part of costs. Rent, then, is effectively 221 00:23:47.520 --> 00:23:55.120 zero. Why, then, does the cost of corn rise? As we have indicated, because the quantity 222 00:23:55.120 --> 00:24:01.200 The theory of labor needed to produce corn, and hence the cost of producing corn, rises 223 00:24:01.200 --> 00:24:03.400 over time. 224 00:24:03.400 --> 00:24:08.120 This brings us to Ricardo's theory of cost and value. 225 00:24:08.120 --> 00:24:10.480 Rents are now out of it. 226 00:24:10.480 --> 00:24:16.620 Wages are not costs either because a key to Ricardo's system is that rising wages lead 227 00:24:16.620 --> 00:24:21.780 only to lower profits and not to higher prices. 228 00:24:21.780 --> 00:24:28.660 If rising wages meant that costs increased, then Ricardo, who as we shall see had a cost 229 00:24:28.660 --> 00:24:35.340 theory of value and price, would have to say that prices rose rather than that profits 230 00:24:35.340 --> 00:24:38.460 would necessarily fall. 231 00:24:38.460 --> 00:24:44.500 Wages he treated as uniform, since Ricardo, like Marx after him, maintained that labor 232 00:24:44.500 --> 00:24:47.740 was homogeneous in quality. 233 00:24:47.740 --> 00:24:53.580 Not only did that mean that wages were uniform, but Ricardo could then treat, as the crucial 234 00:24:53.580 --> 00:25:00.300 part of its labor cost, the quantity of labor embodied in any product. 235 00:25:00.300 --> 00:25:06.300 Differences in quality or productivity of labor could then be dismissed as simply trivial 236 00:25:06.300 --> 00:25:12.620 and as a slightly more complex version of the quantity of labor hours. 237 00:25:12.620 --> 00:25:18.860 has been quickly and magically transformed into quantity. 238 00:25:18.860 --> 00:25:24.780 We have reached the edge of the Ricardian and Marxian labor theory of value. 239 00:25:24.780 --> 00:25:30.060 So far we just have a labor quantity theory of cost. 240 00:25:30.060 --> 00:25:37.140 Ricardo vacillated at this point between a strict labor theory of cost and a labor quantity 241 00:25:37.140 --> 00:25:41.060 theory plus the uniform rate of profit. 242 00:25:41.060 --> 00:25:47.960 But since the uniform rate of profit, presumably around three to six percent, is small compared 243 00:25:47.960 --> 00:25:54.240 to the quantity of labor hours, Ricardo may be pardoned for dismissing the profit rate 244 00:25:54.240 --> 00:25:58.140 part of cost as of trivial importance. 245 00:25:58.140 --> 00:26:04.700 And since all profit rates are assumed to be uniform, and as we shall see, Ricardo had 246 00:26:04.700 --> 00:26:12.420 a Cost Theory of Value or Price, he could easily dismiss the uniform and small proportion 247 00:26:12.420 --> 00:26:18.260 profit as of no account in explaining relative prices. 248 00:26:18.260 --> 00:26:25.300 It is, of course, peculiar to consider profits, even profits as long-run interest, as part 249 00:26:25.300 --> 00:26:28.260 of the costs of production. 250 00:26:28.260 --> 00:26:36.260 Again, this usage stems from eliminating any consideration of entrepreneurial profits and losses, 251 00:26:36.260 --> 00:26:45.260 and focusing on interest as a long-run cost of inducing savings and the accumulation of capital. 252 00:26:45.260 --> 00:26:52.260 If profits for Ricardo are always uniform, how is this uniform profit determined? 253 00:26:52.260 --> 00:27:00.460 Curiously, profits are in no way related to savings or capital accumulation. 254 00:27:00.460 --> 00:27:06.700 For Ricardo, they are only a residual left over after paying wages. 255 00:27:06.700 --> 00:27:14.020 In short, to hark back to our original equation of Ricardian distribution, total output or 256 00:27:14.020 --> 00:27:18.700 income equals rent plus profits plus wages. 257 00:27:18.700 --> 00:27:27.700 Remarkably, Ricardo has attempted to determine all the variables with only one variable explicitly determined. 258 00:27:27.700 --> 00:27:35.700 Output, as we have seen, was assumed as mysteriously given from outside the Ricardian system. 259 00:27:35.700 --> 00:27:45.380 Wages, the uniform wage throughout the economy, is the only explicitly determined variable, 260 00:27:45.380 --> 00:27:51.620 determined completely to equal the cost of subsistence, embodied in the cost of producing 261 00:27:51.620 --> 00:27:52.720 corn. 262 00:27:52.720 --> 00:27:59.240 But that leaves two residuals, rents and profits, to be determined. 263 00:27:59.240 --> 00:28:05.160 The way Ricardo tries to get around that problem is to dispose of rents. 264 00:28:05.160 --> 00:28:13.440 Rents are the differential between the lands in cultivation and the least productive zero-rent land in use. 265 00:28:13.440 --> 00:28:20.880 The cost of producing corn is equal to the quantity of labor hours embodied in its production. 266 00:28:20.880 --> 00:28:27.920 Since rents are zero at the margin, they do not enter into costs and are passively determined. 267 00:28:27.920 --> 00:28:33.860 At the no-rent margin, labor and capital shares exhaust output. 268 00:28:33.860 --> 00:28:39.480 And since wages are supposedly determined by the cost of raising corn, this means that 269 00:28:39.480 --> 00:28:44.940 profit can only be a truistic residual of wages. 270 00:28:44.940 --> 00:28:52.060 Otherwise the variable would be over-determined and the system would evidently collapse. 271 00:28:52.060 --> 00:28:56.260 The alleged historical laws follow from the model. 272 00:28:56.260 --> 00:29:02.880 Since increasing population forces more and more inferior land into cultivation, the cost 273 00:29:02.880 --> 00:29:11.880 The cost of labor in producing corn, that is, the quantity of labor hours needed to produce it, must keep rising. 274 00:29:11.880 --> 00:29:20.880 And since price is determined by cost, supposedly boiled down into the quantity of labor hours to produce the good, 275 00:29:20.880 --> 00:29:25.880 this means that the price of corn must keep rising over time. 276 00:29:25.880 --> 00:29:32.320 But since real wage rates are fixed always at the cost of subsistence, and this is assumed 277 00:29:32.320 --> 00:29:40.040 to be the price of corn, money wage rates must keep rising over time while workers remain 278 00:29:40.040 --> 00:29:48.040 at the subsistence level, and therefore profits must keep falling in the course of history. 279 00:29:48.040 --> 00:29:53.960 Adam Smith believed that the rate of profit, or the long-run rate of interest return, is 280 00:29:53.960 --> 00:30:00.040 is determined by the quantity of accumulated capital, so that more capital will lead to 281 00:30:00.040 --> 00:30:03.040 a falling rate of profit. 282 00:30:03.040 --> 00:30:09.240 While this theory is not fully correct, it at least understands that there is some connection 283 00:30:09.240 --> 00:30:16.100 between saving, capital accumulation and long-run interest or profit. 284 00:30:16.100 --> 00:30:20.760 But to Ricardo, there is no connection whatever. 285 00:30:20.760 --> 00:30:24.040 Based on capital is only a residual. 286 00:30:24.040 --> 00:30:30.640 By a series of fallacies and holistic locked in assumptions, trivial conclusions are at 287 00:30:30.640 --> 00:30:38.060 last ground out, all with a portentous air, allegedly telling us conclusive insights about 288 00:30:38.060 --> 00:30:40.240 the real world. 289 00:30:40.240 --> 00:30:47.080 As Schumpeter scornfully puts it, propositions such as, profits depend upon wages and the 290 00:30:47.080 --> 00:30:53.840 The Falling Rate of Profit are excellent examples of that art of triviality that ultimately 291 00:30:53.840 --> 00:31:00.680 connected with the Ricardian vice leads the victim step by step into a situation where 292 00:31:00.680 --> 00:31:07.720 he has got either to surrender or to allow himself to be laughed at for denying what, 293 00:31:07.720 --> 00:31:14.080 by the time that situation is reached, is really a triviality. 294 00:31:14.080 --> 00:31:23.280 5. Ricardo and the Ricardian System 2. The Theory of Value 295 00:31:23.280 --> 00:31:30.560 This brings us to Ricardo's theory of value, or price. While Ricardo formally admitted 296 00:31:30.560 --> 00:31:37.120 that supply and demand determine day-to-day market pricing, he tossed that aside as of 297 00:31:37.120 --> 00:31:45.200 of No Consequence and concentrated solely on long-run equilibrium, that is, natural price 298 00:31:45.200 --> 00:31:53.240 and the alleged macro distribution of income in that equilibrium. Utility Ricardo brusquely 299 00:31:53.240 --> 00:32:01.920 disposed of as ultimately necessary to production but of no influence whatever on value or price. 300 00:32:01.920 --> 00:32:09.320 In the value paradox, he embraced exchange value and abandoned utility completely. 301 00:32:09.320 --> 00:32:16.120 Not only that, he frankly and boldly discarded any attempt to explain the prices of goods 302 00:32:16.120 --> 00:32:22.120 that are not reproducible, that could not be increased in supply by the employment of 303 00:32:22.120 --> 00:32:23.120 labor. 304 00:32:23.120 --> 00:32:30.720 Hence, Ricardo simply gave up any attempt to explain the prices of such goods as paintings, 305 00:32:30.720 --> 00:32:35.040 which are fixed in supply and cannot be increased. 306 00:32:35.040 --> 00:32:42.360 In short, Ricardo abandoned any attempt at a general explanation of consumer prices. 307 00:32:42.360 --> 00:32:50.360 We have arrived at the full-fledged Ricardian and Marxian labor theory of value. 308 00:32:50.360 --> 00:32:53.640 The Ricardian system is now complete. 309 00:32:53.640 --> 00:32:59.800 Prices of goods are determined by their costs, that is, by the quantity of labor hours embodied 310 00:32:59.800 --> 00:33:04.800 in them, trivially, plus the uniform rate of profit. 311 00:33:04.800 --> 00:33:10.940 Specifically, since the price of each good is uniform, it will equal the cost of production 312 00:33:10.940 --> 00:33:18.720 on the highest cost, that is, zero rent or marginal land in cultivation. 313 00:33:18.720 --> 00:33:25.160 In short, price will be determined by cost, that is, the quantity of labor hours on the 314 00:33:25.160 --> 00:33:29.860 and the zero-rent land used to work on the product. 315 00:33:29.860 --> 00:33:36.500 As time goes on then and population increases, poorer and poorer soils must be brought into 316 00:33:36.500 --> 00:33:42.640 use so that the cost of producing corn continues to increase. 317 00:33:42.640 --> 00:33:49.480 It does so because the quantity of labor hours needed to produce corn keeps increasing, since 318 00:33:49.480 --> 00:33:54.020 labor must be employed on ever poorer soil. 319 00:33:54.020 --> 00:34:01.040 As a result, the price of corn keeps increasing. Since wage rates are always kept precisely 320 00:34:01.040 --> 00:34:08.080 at the subsistence level, the cost of growing corn, by population pressure, this means that 321 00:34:08.080 --> 00:34:15.160 money wage rates must continue to increase over time in order to keep real wage rates 322 00:34:15.160 --> 00:34:23.520 in pace with the ever-rising price of corn. Wage rates must increase over time, and hence 323 00:34:23.520 --> 00:34:31.120 Profits must keep falling until they are so low that the stationary state is reached. 324 00:34:31.120 --> 00:34:38.720 To return to the idea of rent as not entering into cost, if we focus, as we should, on the 325 00:34:38.720 --> 00:34:45.800 micro, on the individual farmer or capitalist, it should be clear that the individual must 326 00:34:45.800 --> 00:34:52.960 pay rent in order to gain use of any particular plot of land in the productive process. To 327 00:34:52.960 --> 00:35:00.200 To do so, he must outbid other firms in his own as well as other industries. 328 00:35:00.200 --> 00:35:07.040 Ricardo's refusal to even consider the individual firm and his focus on holistic aggregates 329 00:35:07.040 --> 00:35:13.760 enables him to overlook the fact that rents, even if differentials, enter into costs the 330 00:35:13.760 --> 00:35:19.320 way every expense on factors of production enters into them. 331 00:35:19.320 --> 00:35:25.440 This is the only way that is real and that counts in the real world, the point of view 332 00:35:25.440 --> 00:35:29.560 of the individual firm or entrepreneur. 333 00:35:29.560 --> 00:35:38.040 There is, in fact, no social point of view since society as an entity does not exist. 334 00:35:38.040 --> 00:35:44.300 Ricardo's system is both gloomy and rife with allegedly inherent class conflict on the free 335 00:35:44.300 --> 00:35:45.300 market. 336 00:35:45.300 --> 00:35:57.300 First, there is tautological conflict, because given the fixed total, the income shares of one macro group can only increase at the expense of another. 337 00:35:57.300 --> 00:36:07.300 But the point of the free market in the real world is that generally production increases, so that the total pie tends to keep rising. 338 00:36:07.300 --> 00:36:14.460 Banking, and, second, if we focus on individual factors and how much they earn, as does the 339 00:36:14.460 --> 00:36:22.180 later marginal productivity theory, and as did J.B. say, then each factor tends to earn 340 00:36:22.180 --> 00:36:29.140 its marginal product, and we need not even concern ourselves with the alleged but nonexistent 341 00:36:29.140 --> 00:36:34.980 laws and conflicts of macro class income distribution. 342 00:36:34.980 --> 00:36:43.340 Ricardo kept his eye unerringly on the radically wrong problem, or rather, problems. 343 00:36:43.340 --> 00:36:49.380 But there is even more class conflict here than implied by Ricardo's tautological macro 344 00:36:49.380 --> 00:36:51.180 approach. 345 00:36:51.180 --> 00:36:57.820 For if value is the product solely of labor hours, then it becomes easy for Marx, who 346 00:36:57.820 --> 00:37:05.660 who was, after all, a neo-Ricardian, to call all returns to capital exploitative deductions 347 00:37:05.660 --> 00:37:09.220 from the whole of labor's product. 348 00:37:09.220 --> 00:37:15.660 The Ricardian socialist call for turning over all of the product to labor follows directly 349 00:37:15.660 --> 00:37:22.260 from the Ricardian system, although Ricardo and the other orthodox Ricardians did not, 350 00:37:22.260 --> 00:37:25.140 of course, make that leap. 351 00:37:25.140 --> 00:37:31.220 Mario would have countered that capital represents embodied or frozen labor. 352 00:37:31.220 --> 00:37:38.420 But Marx accepted that point and simply reposted that all labor producers of capital or frozen 353 00:37:38.420 --> 00:37:42.560 labor should obtain their full return. 354 00:37:42.560 --> 00:37:45.920 In fact, neither was right. 355 00:37:45.920 --> 00:37:51.840 If we wish to consider capital goods as frozen anything, we would have to say, with the great 356 00:37:51.840 --> 00:37:59.600 and Austrian Boehm-Bawerk that capital is frozen labor and land and time. 357 00:37:59.600 --> 00:38:06.240 Labor then would be earning wages, land would earn rent, and interest or long-run profits 358 00:38:06.240 --> 00:38:09.760 would be the price of time. 359 00:38:09.760 --> 00:38:15.000 Recent analysts in an attempt to mitigate the crude fallacy of Ricardo's labor theory 360 00:38:15.000 --> 00:38:21.920 of Value, have maintained, as in the case of Smith, but even more so, that he was attempting 361 00:38:21.920 --> 00:38:30.080 not so much to explain the cause of value and price, but to measure values over time, 362 00:38:30.080 --> 00:38:35.200 and labor was considered an invariable measure of value. 363 00:38:35.200 --> 00:38:38.480 But this hardly mitigates Ricardo's flaws. 364 00:38:38.480 --> 00:38:45.040 Instead, it adds to the general fallacies and vagaries of the Ricardian system, another 365 00:38:45.040 --> 00:38:52.400 important one, the vain search for a non-existent chimera of invariability. 366 00:38:52.400 --> 00:38:59.880 For values always fluctuate, and there is no invariable fixed base of value from which 367 00:38:59.880 --> 00:39:03.120 other value changes can be measured. 368 00:39:03.120 --> 00:39:09.720 Thus, in rejecting Say's definition of the value of a good as its purchasing power of 369 00:39:09.720 --> 00:39:18.080 other goods in exchange, Ricardo sought the invariable entity, the unmoved power. 370 00:39:18.080 --> 00:39:24.360 A franc is not a measure of value for any thing, but for a quantity of the same metal 371 00:39:24.360 --> 00:39:30.640 of which francs are made, unless francs, and the thing to be measured, can be referred 372 00:39:30.640 --> 00:39:37.840 to some other measure which is common to both. This I think they can be, for they are both 373 00:39:37.840 --> 00:39:44.440 the result of labor, and therefore labor is a common measure by which their real as well 374 00:39:44.440 --> 00:39:51.560 as their relative value may be estimated. It might be noted that both products are the 375 00:39:51.560 --> 00:39:59.920 result of capital, land, savings and entrepreneurship as well as labor, and that in any case their 376 00:39:59.920 --> 00:40:06.520 Their values are incommensurable except in terms of relative purchasing power, as Say 377 00:40:06.520 --> 00:40:09.920 had in fact maintained. 378 00:40:09.920 --> 00:40:16.600 Part of Ricardo's impassioned quest for an invariable measure of values undoubtedly stemmed 379 00:40:16.600 --> 00:40:20.200 from his deep-dyed scientism. 380 00:40:20.200 --> 00:40:25.360 Ricardo was almost as interested in the natural sciences as in economics. 381 00:40:25.360 --> 00:40:32.480 From his early youth, Ricardo was keenly interested in the natural sciences, in mathematics, chemistry, 382 00:40:32.480 --> 00:40:35.720 mineralogy and geology. 383 00:40:35.720 --> 00:40:41.560 He joined the Geological Society in his thirties shortly after it was founded. 384 00:40:41.560 --> 00:40:47.440 It is probable that Ricardo's quest for an invariable measure of values was based on 385 00:40:47.440 --> 00:40:49.960 the physical science model. 386 00:40:49.960 --> 00:40:56.160 If scientific in the physical sciences meant measurement, then surely this would be required 387 00:40:56.160 --> 00:40:59.280 in the human sciences as well. 388 00:40:59.280 --> 00:41:05.560 As Emil Couter wrote, I venture to say that Ricardo and his contemporaries believed that 389 00:41:05.560 --> 00:41:11.520 economics could only reach the dignity of a science if it could be based on objective 390 00:41:11.520 --> 00:41:15.800 measures like the Newtonian physics. 391 00:41:15.800 --> 00:41:22.280 An even stronger and more direct class struggle than that implied by the labor theory of value 392 00:41:22.280 --> 00:41:28.680 stemmed from Ricardo's approach toward landlords and land rent. 393 00:41:28.680 --> 00:41:33.920 Landlords are simply obtaining payment for the powers of the soil, which, at least in 394 00:41:33.920 --> 00:41:39.560 the hands of many of Ricardo's followers, meant an unjust return. 395 00:41:39.560 --> 00:41:47.560 Furthermore, Ricardo's gloomy vision of the future held that labor must be kept at subsistence level. 396 00:41:47.560 --> 00:41:58.560 Capitalists must see their profits inevitably falling, these two classes doing as badly as ever, labor, or always worse, capital, 397 00:41:58.560 --> 00:42:06.560 while the idle and useless landlords keep inexorably adding to their share of worldly goods. 398 00:42:06.560 --> 00:42:16.560 The productive classes suffer, while the idle landlords charging for the powers of nature benefit at the expense of the producers. 399 00:42:16.560 --> 00:42:22.560 If Ricardo implies Marx, he implies Henry George far more directly. 400 00:42:22.560 --> 00:42:32.560 The specter of land nationalization, or the single tax absorbing all land rent, follows straight from Ricardo. 401 00:42:32.560 --> 00:42:43.060 One of the greatest fallacies of the Ricardian theory of rent is that it ignores the fact that landlords do perform a vital economic function. 402 00:42:43.060 --> 00:42:51.060 They allocate land to its best and most productive use. Land does not allocate itself. 403 00:42:51.060 --> 00:42:59.560 It must be allocated, and only those who earn a return from such service have the incentive, or the ability, 404 00:42:59.560 --> 00:43:07.560 to allocate various parcels of land to their most profitable and hence most productive and economic uses. 405 00:43:07.560 --> 00:43:14.560 Ricardo himself did not go all the way to government expropriation of land rent. 406 00:43:14.560 --> 00:43:23.560 His short-run solution was to call for lowering of the tariff on corn or even repeal of the corn laws entirely. 407 00:43:23.560 --> 00:43:31.120 The tariff on corn kept the price of corn high, and ensured that inferior, high-cost 408 00:43:31.120 --> 00:43:35.200 domestic corn land would be cultivated. 409 00:43:35.200 --> 00:43:41.560 Repeal of the corn laws would enable England to import cheap corn, and thereby postpone 410 00:43:41.560 --> 00:43:46.600 for a time the use of inferior and high-cost land. 411 00:43:46.600 --> 00:43:49.900 Corn prices would for a while be lower. 412 00:43:49.900 --> 00:43:56.060 Any wage rates would therefore immediately be lower, and profits would rise, adding to 413 00:43:56.060 --> 00:43:58.700 the accumulation of capital. 414 00:43:58.700 --> 00:44:05.380 The dread stationary state would be put further off onto the horizon. 415 00:44:05.380 --> 00:44:09.440 Ricardo's other anti-landlord action was political. 416 00:44:09.440 --> 00:44:14.820 By entering parliament, by joining Mill and the other Benthamite radicals in calling for 417 00:44:14.820 --> 00:44:22.260 for Democratic Reform, Ricardo hoped to swing political power from the grip of the aristocracy, 418 00:44:22.260 --> 00:44:28.380 which meant in practice the landlord oligarchy to the mass of the people. 419 00:44:28.380 --> 00:44:35.260 But if Ricardo was too individualistic or too timorous to embrace the full logical consequence 420 00:44:35.260 --> 00:44:40.940 of the Ricardian system, James Mill characteristically was not. 421 00:44:40.940 --> 00:44:47.500 James Mill was the first prominent Georgist, calling frankly and enthusiastically for a 422 00:44:47.500 --> 00:44:54.640 single tax on land rent. In his high office in the East India Company, Mill felt able 423 00:44:54.640 --> 00:45:02.220 to influence Indian government policies. Before obtaining this post, Mill had characteristically 424 00:45:02.220 --> 00:45:10.100 presumed to write and publish A Massive History of British India, 1817, without ever having 425 00:45:40.100 --> 00:45:46.260 Land rent would have no bad effect on production. It would only have the effect of eliminating 426 00:45:46.260 --> 00:45:53.300 the ill-gotten gains of the landlords. In effect, a tax on land rent would be no tax 427 00:45:53.300 --> 00:46:02.300 at all. The land tax could be up to and including 100% of the social product caused by the differential 428 00:46:02.300 --> 00:46:09.420 fertility of the soil. The State, according to Mill, could then use this costless tax 429 00:46:09.420 --> 00:46:16.940 for Public Improvement, and largely for the function of maintaining law and order in India. 430 00:46:16.940 --> 00:46:23.300 We see now the pernicious implications of the fallacious view that any part of the expense 431 00:46:23.300 --> 00:46:30.960 of production is in some way, from a holistic or social point of view, really not a part 432 00:46:30.960 --> 00:46:32.720 of cost. 433 00:46:32.720 --> 00:46:39.180 For if an expense is not part of cost, it is in some sense not necessary to the factors 434 00:46:39.180 --> 00:46:47.180 Richard's Contribution to Production, and therefore this income can be confiscated by the government with no ill effect. 435 00:46:47.180 --> 00:46:54.180 Despite the deep pessimism of Ricardo about the nature and consequences of the free market, 436 00:46:54.180 --> 00:47:01.180 he oddly enough cleaved strongly, and more firmly than Adam Smith, to laissez-faire. 437 00:47:01.180 --> 00:47:10.180 Probably the reason was his strong conviction that virtually any kind of government intervention could only make matters worse. 438 00:47:10.180 --> 00:47:21.180 Taxation should be at a minimum, for all of it cripples the accumulation of capital and diverts it from its best uses, as do tariffs on imports. 439 00:47:21.180 --> 00:47:29.180 Poor laws, welfare systems, only worsen the Malthusian population pressures on wage rates. 440 00:47:29.180 --> 00:47:38.180 and, as an adherent of Say's law, he opposed government measures to stimulate consumption as well as the national debt. 441 00:47:38.180 --> 00:47:46.180 In general, Ricardo declared that the best thing that government can do to stimulate the greatest development of industry 442 00:47:46.180 --> 00:47:52.180 was to remove the obstacles to growth which government itself created. 443 00:47:52.180 --> 00:48:07.180 While Adam Smith's free-market views concentrated on the sinister nature of predatory government action, Ricardo was particularly struck by government's pervasive ineptness and counter-productivity. 444 00:48:07.180 --> 00:48:16.180 A typical and charming note was struck in a letter from Germany by Ricardo to James Mill in 1817. 445 00:48:16.180 --> 00:48:26.180 We were very much delayed by the dilatoriness of the German post, which being a monopoly is, of course, very much mismanaged. 446 00:48:26.180 --> 00:48:43.180 The paradox of Ricardo's gloom about the alleged class conflict on the free market and his determined opposition to virtually all government intervention was best and most wittily described by Alexander Gray. 447 00:48:43.180 --> 00:48:55.180 Such is the Ricardian scheme of distribution. In the place of the old harmony of interest, he has placed dissension and antagonism at the heart of things. 448 00:48:55.180 --> 00:49:01.180 The interest of the landlord is always opposed to that of the consumer and manufacturer. 449 00:49:01.180 --> 00:49:08.180 So also the interests of the worker and the employer are eternally and irreconcilably opposed. 450 00:49:08.180 --> 00:49:18.680 When one gains, the other loses. Further, the outlook for all except the landlord is a process of continual pejoration. 451 00:49:18.680 --> 00:49:23.680 Yet Ricardo remains immovably non-interventionist. 452 00:49:23.680 --> 00:49:28.680 These then, he says, are the laws by which wages are regulated. 453 00:49:28.680 --> 00:49:37.680 And, he adds, inconsequently, like all other contracts, wages should be left to the fair and free competition of the market, 454 00:49:37.680 --> 00:49:42.440 and should never be controlled by the interference of the legislature. 455 00:49:42.440 --> 00:49:49.040 In a world of Ricardian gloom, one might ask, and did in effect ask, why there should not 456 00:49:49.040 --> 00:49:51.080 be interference. 457 00:49:51.080 --> 00:49:57.280 An optimist caroling that God's in his heaven and that all's right with enlightened self-interest 458 00:49:57.280 --> 00:50:01.500 has a right to nail the laissez-faire flag to the mast. 459 00:50:01.500 --> 00:50:07.400 But a pessimist, who merely looks forward to bad days and worse times, ought not in 460 00:50:07.400 --> 00:50:14.080 principle to be opposed to intervention, unless his pessimism is so thorough going as to lead 461 00:50:14.080 --> 00:50:20.980 to the conviction that, bad as all diseases are, all remedies for all diseases are even 462 00:50:20.980 --> 00:50:21.980 worse. 463 00:50:21.980 --> 00:50:29.640 Finally, a fundamental and fatal flaw in Ricardo's whole approach in his system was that he started 464 00:50:29.640 --> 00:50:31.760 at the Wrong End. 465 00:50:31.760 --> 00:50:37.880 He began with his overriding focus on the laws of macro-income distribution. 466 00:50:37.880 --> 00:50:45.040 His theory of value and price was only a subsidiary appendage, enabling him to maintain that wages 467 00:50:45.040 --> 00:50:51.740 are not a part of cost, and therefore that the only influence of rising wages was to 468 00:50:51.740 --> 00:50:54.040 cause profits to fall. 469 00:50:54.040 --> 00:51:08.040 Ricardo, in short, never grasped the crucial point understood by his continental counterpart, J.B. Say, that there are no laws of macro-income distribution. 470 00:51:08.040 --> 00:51:18.040 Economics only establishes micro-laws determining price, including the prices of the various factors of production. 471 00:51:18.040 --> 00:51:43.040 In a sense, of course, the distribution of income in practice is a spin-off of market-determined factor prices, but this distribution also depends on entrepreneurial profits and losses, in short, on entrepreneurial responses to risk and uncertainty, and on the supplies at any time of the respective factors. 472 00:51:43.040 --> 00:51:47.040 None of the latter can be determined by economic theory. 473 00:51:47.040 --> 00:51:55.600 Once again, David Ricardo was pursuing a chimera, and in doing so took British economic theory 474 00:51:55.600 --> 00:52:00.520 off on a detour, or rather, into a dead end. 475 00:52:00.520 --> 00:52:08.240 Put another way, the French Catillon-Tourgaux-Say analysis of the free market demonstrated 476 00:52:08.240 --> 00:52:16.240 that on the market there is no separate distribution of income process, as there indeed would be 477 00:52:16.240 --> 00:52:20.240 under a State-controlled or socialist economy. 478 00:52:20.240 --> 00:52:29.240 Distribution is the indirect consequence of free production, exchange and price determination. 479 00:52:29.240 --> 00:52:35.700 All of this escaped David Ricardo, who had little or no conception of the economy as 480 00:52:35.700 --> 00:52:44.200 a web of micro-relations linking together individual utilities, exchanges and prices. 481 00:52:44.200 --> 00:52:50.640 As Frank Knight has pointed out, Ricardo, in a letter to his disciple McCullough, denied 482 00:52:50.640 --> 00:52:57.080 that the great questions of macro-income distribution were essentially connected with the theory 483 00:52:57.080 --> 00:52:58.820 of value. 484 00:52:58.820 --> 00:53:04.520 And further, Ricardo and his followers gave practically no hint of a system of economic 485 00:53:04.520 --> 00:53:10.260 organization worked out and directed by price forces. 486 00:53:10.260 --> 00:53:16.100 There is another point that needs to be made about Ricardo's basic economic goal. 487 00:53:16.100 --> 00:53:22.760 Chiding Adam Smith for being primarily interested in the total wealth of the nation rather than 488 00:53:22.760 --> 00:53:30.140 in the macro distribution of income, Ricardo pursues his Malthusian hostility to population 489 00:53:30.140 --> 00:53:36.980 growth by asking what is the point of looking at gross rather than net income. 490 00:53:36.980 --> 00:53:41.880 As Ricardo puts it in a famous and astonishing passage, 491 00:53:41.880 --> 00:53:47.180 What would be the advantage resulting to a country from the employment of a great quantity 492 00:53:47.180 --> 00:53:54.660 of productive labor, if, whether it employed that quantity or a smaller, its net rent and 493 00:53:54.660 --> 00:53:57.980 profits together would be the same? 494 00:53:57.980 --> 00:54:03.740 To an individual with a capital of twenty thousand pounds, whose profits were two thousand 495 00:54:33.740 --> 00:54:36.040 Inhabitants. 496 00:54:36.040 --> 00:54:42.360 The difference between 10 and 12 million may not make any difference to David Ricardo, 497 00:54:42.360 --> 00:54:46.800 but it makes a considerable difference, I should think, to the two million who would 498 00:54:46.800 --> 00:54:52.060 not have been around, and to their parents, friends and relations. 499 00:54:52.060 --> 00:54:59.420 There is no better example of the aggregative utilitarian economist looking upon the economy 500 00:54:59.420 --> 00:55:05.020 from the holistic viewpoint of a social slave master, rather than from the point of view 501 00:55:05.020 --> 00:55:08.620 of individuals on the market. 502 00:55:08.620 --> 00:55:15.200 As Alexander Gray, in his witty and perceptive way, puts it, Ricardo's logic would lead 503 00:55:15.200 --> 00:55:22.120 to the desirability of the population being reduced to one, and that last remnant producing 504 00:55:22.120 --> 00:55:28.440 a vast net surplus with the aid of sorcery and mechanical contrivances. 505 00:55:28.440 --> 00:55:34.200 The repellent doctrine that man exists for the production of wealth, rather than that 506 00:55:34.200 --> 00:55:41.840 wealth exists for the use of man, here finds its classical utterance. 507 00:55:41.840 --> 00:55:44.900 6. 508 00:55:44.900 --> 00:55:49.260 The Law of Comparative Advantage. 509 00:55:49.260 --> 00:55:55.260 Even the most hostile critics of the Ricardian system have granted that at least David Ricardo 510 00:55:55.260 --> 00:56:02.500 made one vital contribution to economic thought and to the case for freedom of trade, the 511 00:56:02.500 --> 00:56:05.620 law of comparative advantage. 512 00:56:05.620 --> 00:56:10.960 In emphasizing the great importance of the voluntary interplay of the international division 513 00:56:10.960 --> 00:56:17.780 of labor, free traders of the 18th century, including Adam Smith, based their doctrines 514 00:56:17.780 --> 00:56:21.200 on the law of absolute advantage. 515 00:56:21.200 --> 00:56:27.760 That is, countries should specialize in what they are best or most efficient at, and then 516 00:56:27.760 --> 00:56:33.440 exchange these products, for in that case the people of both countries will be better 517 00:56:33.440 --> 00:56:35.220 off. 518 00:56:35.220 --> 00:56:38.380 This is a relatively easy case to argue. 519 00:56:38.380 --> 00:56:43.360 It takes little persuasion to realize that the United States should not bother to grow 520 00:56:43.360 --> 00:56:50.720 bananas or rather to put it in basic micro-terms that individuals and firms in the United States 521 00:56:50.720 --> 00:56:57.280 Bananas should not bother to do so, but rather produce something else, for example, wheat, 522 00:56:57.280 --> 00:57:03.400 manufactured goods, and exchange them for bananas grown in Honduras. 523 00:57:03.400 --> 00:57:09.200 There are, after all, precious few banana growers in the United States demanding a protective 524 00:57:09.200 --> 00:57:10.600 tariff. 525 00:57:10.600 --> 00:57:17.260 But what if the case is not that clear-cut, and American steel or semiconductor firms 526 00:57:17.260 --> 00:57:20.360 are demanding such protection? 527 00:57:20.360 --> 00:57:26.640 The law of comparative advantage tackles such hard cases, and is therefore indispensable 528 00:57:26.640 --> 00:57:29.460 to the case for free trade. 529 00:57:29.460 --> 00:57:36.800 It shows that even if, for example, country A is more efficient than country B at producing 530 00:57:36.800 --> 00:57:45.080 both commodities X and Y, it will pay the citizens of country A to specialize in producing 531 00:57:45.080 --> 00:57:53.600 Making X, which it is most best at producing, and by all of Commodity Y from Country B, 532 00:57:53.600 --> 00:57:59.280 which it is better at producing but does not have as great a comparative advantage as in 533 00:57:59.280 --> 00:58:07.480 making Commodity X. In other words, each country should produce not just what it has an absolute 534 00:58:07.480 --> 00:58:15.560 Advantage in Making, but what it is most best at, or even least worst at, that is, what 535 00:58:15.560 --> 00:58:20.440 it has a comparative advantage in producing. 536 00:58:20.440 --> 00:58:26.880 If then, the government of country A imposes a protective tariff on imports of commodity 537 00:58:26.880 --> 00:58:34.040 Y, and it forcibly maintains an industry producing that commodity, this special privilege 538 00:58:34.040 --> 00:58:40.240 Advantage will injure the consumers in country A, as well as, obviously, injuring the people 539 00:58:40.240 --> 00:58:47.300 in country B. For country A, as well as the rest of the world, loses the advantage of 540 00:58:47.300 --> 00:58:53.380 specializing in the production of what it is most best at, since many of its scarce 541 00:58:53.380 --> 00:59:01.300 resources are compulsorily and inefficiently tied up in the production of commodity Y. 542 00:59:01.300 --> 00:59:07.300 The Law of Comparative Advantage highlights the important fact that a protective tariff 543 00:59:07.300 --> 00:59:14.220 in country A wreaks injury on the efficient industries in that country, and the consumers 544 00:59:14.220 --> 00:59:20.940 in that country, as well as on country B and the rest of the world. 545 00:59:20.940 --> 00:59:26.660 Another implication of the Law of Comparative Advantage is that no country or region of 546 00:59:26.660 --> 00:59:33.380 of the Earth is going to be left out of the international division of labor under free trade. 547 00:59:33.380 --> 00:59:40.300 For the law means that even if a country is in such poor shape that it has no absolute 548 00:59:40.300 --> 00:59:47.020 advantage in producing anything, it still pays for its trading partners, the people 549 00:59:47.020 --> 00:59:53.860 of other countries, to allow it to produce what it is least worst at. 550 00:59:53.860 --> 00:59:59.760 In this way, the citizens of every country benefit from international trade. 551 00:59:59.760 --> 01:00:06.700 No country is too poor or inefficient to be left out of international trade, and everyone 552 01:00:06.700 --> 01:00:13.960 benefits from countries specializing in what they are most best or least bad at. 553 01:00:13.960 --> 01:00:19.820 In other words, in whatever they have a comparative advantage. 554 01:00:19.820 --> 01:00:25.500 Until recently it has been universally believed by historians of economic thought that David 555 01:00:25.500 --> 01:00:32.660 Ricardo first set forth the law of comparative advantage in his Principles of Political Economy 556 01:00:32.660 --> 01:00:35.500 in 1817. 557 01:00:35.500 --> 01:00:41.580 Recent researches by Professor Thwait, however, have demonstrated not only that Ricardo did 558 01:00:41.580 --> 01:00:47.780 not originate this law, but that he did not understand and had little interest in the 559 01:00:47.780 --> 01:00:52.780 in the law, and that it played virtually no part in his system. 560 01:00:52.780 --> 01:00:57.780 Ricardo devoted only a few paragraphs to the law and his principles. 561 01:00:57.780 --> 01:01:01.780 The discussion was meager, and it was unrelated to the rest of his work 562 01:01:01.780 --> 01:01:06.780 and to the rest of his discussion of international trade. 563 01:01:06.780 --> 01:01:12.780 The discovery of the law of comparative advantage came considerably earlier. 564 01:01:12.780 --> 01:01:22.780 The problem of international trade sprang into public consciousness in Britain when Napoleon imposed his Berlin decrees in 1806, 565 01:01:22.780 --> 01:01:28.780 ordering the blockade of his enemy, England, from all trade with the continent of Europe. 566 01:01:28.780 --> 01:01:39.780 Immediately, young William Spence, 1783-1860, an English physiocrat and under-consumptionist who detested industry, 567 01:01:39.780 --> 01:01:59.780 published his Britain Independent of Commerce in 1807 advising Englishmen not to worry about the blockade since only agriculture was economically important and if English landlords would only spend all their incomes on consumption, all would be well. 568 01:01:59.780 --> 01:02:08.780 Spence's tract caused a storm of controversy, stimulating early works by two noteworthy British economists. 569 01:02:08.780 --> 01:02:16.780 One was James Mill, who critically reviewed Spence's work in the Eclectic Review for December 1807, 570 01:02:16.780 --> 01:02:23.780 and then expanded the article into his book, Commerce Defended, the following year. 571 01:02:23.780 --> 01:02:32.780 It was in rebuttal of Spence that Mill attacked under consumptionist fallacies by bringing Say's Law to England. 572 01:02:32.780 --> 01:02:47.780 The other work was the first book of young Robert Torrens, 1780-1864, an Anglo-Irish officer in the Royal Marines, in his The Economists Refuted, 1808. 573 01:02:47.780 --> 01:02:55.100 It has long been held that Torrens first enunciated the law of comparative advantage, and that 574 01:02:55.100 --> 01:03:02.420 then, as Schumpeter phrased it, while Torrens baptized the theorem, Ricardo elaborated it 575 01:03:02.420 --> 01:03:05.700 and fought for it victoriously. 576 01:03:05.700 --> 01:03:11.840 It turns out, however, that this standard viewpoint is wrong in both its crucial parts. 577 01:03:11.840 --> 01:03:19.080 That is, Torrens did not baptize the law, and Ricardo scarcely elaborated or thought for 578 01:03:19.080 --> 01:03:20.200 it. 579 01:03:20.200 --> 01:03:27.180 For first, James Mill had a far better presentation of the law, though scarcely a complete one, 580 01:03:27.180 --> 01:03:32.480 in his Commerce Defended, than did Torrens later the same year. 581 01:03:32.480 --> 01:03:39.400 Moreover, in his treatment, Torrens, and not Mill, committed several egregious errors. 582 01:03:39.400 --> 01:03:50.400 First, he claimed that trade yields greater benefits to a nation that imports durable goods and necessities as against perishables or luxuries. 583 01:03:50.400 --> 01:03:58.400 Second, he claimed also that advantages of home trade are more permanent than those of foreign trade, 584 01:03:58.400 --> 01:04:03.400 and also that all advantages of domestic trade remain at home, 585 01:04:03.400 --> 01:04:09.480 in Rome, whereas part of the advantages of foreign trade are siphoned off for the benefit 586 01:04:09.480 --> 01:04:11.480 of foreigners. 587 01:04:11.480 --> 01:04:18.040 And finally, following Smith and anticipating Marx and Lenin, Torrens asserted that foreign 588 01:04:18.040 --> 01:04:24.920 trade, by extending the division of labor, creates a surplus over domestic requirements 589 01:04:24.920 --> 01:04:30.320 that must then be vented in foreign exports. 590 01:04:30.320 --> 01:04:36.360 Six years later, James Mill led Robert Torrens again in presenting the rudiments of the Law 591 01:04:36.360 --> 01:04:38.920 of Comparative Advantage. 592 01:04:38.920 --> 01:04:46.680 In the July 1814 issue of the Eclectic Review, Mill defended free trade against Malthus support 593 01:04:46.680 --> 01:04:50.920 for the Corn Laws in his observations. 594 01:04:50.920 --> 01:04:57.320 Mill pointed out that labor at home will, by engaging in foreign trade, procure more 595 01:04:57.320 --> 01:05:03.320 or by buying imports than by producing all goods themselves. 596 01:05:03.320 --> 01:05:10.320 Mill's discussion was largely repeated by Torrens in his Essay on the External Corn Trade, 597 01:05:10.320 --> 01:05:13.320 published in February of the following year. 598 01:05:13.320 --> 01:05:20.320 Furthermore, in this work, Torrens explicitly hailed Mill's essay. 599 01:05:20.320 --> 01:05:26.320 Meanwhile, at the very time when this comparative cost ferment was taking place 600 01:05:26.320 --> 01:05:32.960 and his friends and colleagues, David Ricardo displayed no interest whatever in this important 601 01:05:32.960 --> 01:05:34.880 line of thought. 602 01:05:34.880 --> 01:05:41.280 To be sure, Ricardo weighed in to second his mentor Mill's attack on Malthus' support 603 01:05:41.280 --> 01:05:49.040 for the Corn Laws in his Essay on Profits, published in February 1815, but Ricardo's 604 01:05:49.040 --> 01:05:56.800 His line of argument was exclusively Ricardian, that is, based solely on the distinctive Ricardian 605 01:05:56.800 --> 01:05:58.240 system. 606 01:05:58.240 --> 01:06:04.180 In fact, Ricardo displayed no interest in free trade in general, or in the arguments 607 01:06:04.180 --> 01:06:05.480 for it. 608 01:06:05.480 --> 01:06:13.200 His reasoning was solely devoted to the importance of lowering or abolishing the tariff on corn. 609 01:06:13.200 --> 01:06:19.180 This conclusion, as we have noted, was deduced from the distinctive Ricardian system, which 610 01:06:19.180 --> 01:06:24.360 was to be fully set forth two years later in his principles. 611 01:06:24.360 --> 01:06:31.140 For Ricardo, the key to the stifling of economic growth in any country, and especially in developed 612 01:06:31.140 --> 01:06:38.340 Britain, was the land shortage, the contention that poorer and poorer lands were necessarily 613 01:06:38.340 --> 01:06:41.800 being pressed into use in Britain. 614 01:06:41.800 --> 01:06:47.720 In consequence, the cost of subsistence kept increasing, and hence the prevailing, which 615 01:06:47.720 --> 01:06:53.360 must be the subsistence money wage, kept increasing as well. 616 01:06:53.360 --> 01:07:00.200 But this inevitable secular increase of wages must lower profits in agriculture, which in 617 01:07:00.200 --> 01:07:03.320 turn brings down all profits. 618 01:07:03.320 --> 01:07:11.400 In that way, capital accumulation is increasingly dampened, finally to disappear altogether. 619 01:07:11.400 --> 01:07:17.880 Abolishing or abolishing the tariff on corn or other food was, for Ricardo, an ideal way 620 01:07:17.880 --> 01:07:21.580 of postponing the inevitable doom. 621 01:07:21.580 --> 01:07:28.360 By importing corn from abroad, diminishing fertility from corn land is deferred. 622 01:07:28.360 --> 01:07:34.940 The cost of corn, and therefore of subsistence, will fall sharply, and therefore money wage 623 01:07:34.940 --> 01:07:42.120 Large rates will fall pari passu, thereby raising profits and stimulating capital investment 624 01:07:42.120 --> 01:07:44.620 and economic growth. 625 01:07:44.620 --> 01:07:51.260 There is no hint in any of this discussion of the doctrine of comparative cost or anything 626 01:07:51.260 --> 01:07:53.300 like it. 627 01:07:53.300 --> 01:07:58.420 But how about the mature Ricardo, the Ricardo of the principles? 628 01:07:58.420 --> 01:08:04.420 Once again, except for the three paragraphs on comparative advantage, Ricardo displays 629 01:08:04.420 --> 01:08:11.920 is no interest in it, and he instead repeats the Ricardian system argument for repeal of the Corn Laws. 630 01:08:11.920 --> 01:08:21.920 Indeed, his discussion in the rest of the chapter on international trade is couched in terms of the Smithian theory of absolute advantage, 631 01:08:21.920 --> 01:08:28.920 rather than of the comparative advantage found in Torrens and especially in Mill. 632 01:08:28.920 --> 01:08:44.920 The three paragraphs on comparative advantage, furthermore, were not only carelessly worded and confused, they were the only account, brief as they were, that Ricardo would ever write on comparative advantage. 633 01:08:44.920 --> 01:08:50.920 Indeed, this was his only mention at any time of this doctrine. 634 01:08:50.920 --> 01:08:57.120 Even Ricardo's sudden reference to Portugal and his absurd hypothesis that the Portuguese 635 01:08:57.120 --> 01:09:03.060 had an absolute advantage over Britain in the production of cloth seemed to indicate 636 01:09:03.060 --> 01:09:08.440 his lack of serious interest in the theory of comparative cost. 637 01:09:08.440 --> 01:09:15.200 Furthermore, Ricardo's views on foreign trade in the principles received almost no comment 638 01:09:15.200 --> 01:09:16.920 at that time. 639 01:09:16.920 --> 01:09:22.440 Richard's concentrated on his labor theory of value and his view that wage rates and 640 01:09:22.440 --> 01:09:29.240 profits always move inversely with the former determining the latter. 641 01:09:29.240 --> 01:09:35.120 If Ricardo had no interest in the theory of comparative advantage and never wrote about 642 01:09:35.120 --> 01:09:42.920 it except in this single passage in the principles, what was it doing in the principles at all? 643 01:09:42.920 --> 01:09:48.760 Another Thwaites convincing hypothesis is that the law was injected into the principles 644 01:09:48.760 --> 01:09:55.340 by Ricardo's mentor, James Mill, whom we know wrote the original draft as well as the 645 01:09:55.340 --> 01:10:02.740 revisions for many parts of Ricardo's magnum opus. We know also that Mill prodded Ricardo 646 01:10:02.740 --> 01:10:10.600 on including a discussion of comparative cost ratios. As we have seen, Mill originated the 647 01:10:10.600 --> 01:10:16.800 The Doctrine of Comparative Cost and led in developing it eight years later. 648 01:10:16.800 --> 01:10:23.400 Not only that, while Ricardo dropped the theory as soon as he enunciated it in the principles, 649 01:10:23.400 --> 01:10:29.880 Mill fully developed the analysis of comparative advantage further, first in his article on 650 01:10:29.880 --> 01:10:37.400 Colonies for the Encyclopedia Britannica, 1818, and then in his textbook, The Elements 651 01:10:37.400 --> 01:10:46.760 of Political Economy, 1821. Once again, Robert Torrens tailed after Mill, repeating his discussion 652 01:10:46.760 --> 01:10:55.120 with no additional insights in 1827 in the fourth edition of his 1815 essay on the external 653 01:10:55.120 --> 01:11:04.200 corn trade. Meanwhile, George Grote, a devoted million disciple, wrote in 1819 an important 654 01:11:04.200 --> 01:11:10.840 un-published essay setting forth the million view on comparative advantage. 655 01:11:10.840 --> 01:11:18.280 And so, once again, James Mill, by the force of his mind as well as his personal charisma, 656 01:11:18.280 --> 01:11:25.240 was able to foist an original analysis of his own onto the Ricardian system. 657 01:11:25.240 --> 01:11:31.400 It is true that Mill was every bit a fan of the Ricardian system, as Ricardo himself, 658 01:11:31.400 --> 01:11:37.280 But Mill was a man of far broader scope and erudition than his friend, and was interested 659 01:11:37.280 --> 01:11:41.640 in far more aspects of the disciplines of human action. 660 01:11:41.640 --> 01:11:47.840 It seems possible that Mill, the inveterate disciple and number two man, was number one 661 01:11:47.840 --> 01:11:51.840 One man far more often than anyone has suspected.