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"Understanding the Economic Basics & Modern Capitalism: Market Mechanisms and Administered Alternatives"
by Dan Blatt - Publisher of FUTURECASTS online magazine.

Smith: Wealth of Nations.   Ricardo: Principles.
Marx: Capital (Das Capital).   Keynes: General Theory.
Schumpeter: Capitalism, Socialism and Democracy.

Economics is the miracle science. Even imperfect capitalist markets routinely raise billions out of poverty.

Table of Contents & Chapter Introductions

ON THE PRINCIPLES OF
POLITICAL ECONOMY & TAXATION
by
David Ricardo

Page contents

Value

Rent, Prices, Wages & Profits

International Trade & Comparative Advantage

Money

Say's Law & Inadequate Demand

Taxes & War Debts

FUTURECASTS online magazine
www.futurecasts.com
Vol. 6, No. 12, 12/1/04

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  In this review, modern terminology is frequently used for the sake of clarity.
The word "corn," however,  is often used to refer to the subsistence grains of England.

Introduction

The processes of market directed commerce:

 

&

  David Ricardo's  "On The Principles of Political Economy and Taxation" is concerned to a large extent with the intellectual discourse on the subject of economics during the first decades of the 19th century. Ricardo essentially follows and expands upon the concepts of Adam Smith. The concepts of Malthus and Say also appear prominently, and there are numerous references to the works of other contemporaries.
 &

It is the least fertile ground under cultivation - the least fertile mines in production - the subsistence wages of labor - that dictate prices, wages and the rent of landlords.

   While in general agreement with Smith with respect to basic principles, Ricardo has many differences with respect to particular market impacts and market adjustment sequences. Serious students thus must read the two treatises together. See, Adam Smith, "The Wealth of Nations (I)," and Adam Smith, "The Wealth of Nations (II)." Ricardo's agreements and differences with his other contemporaries - both as to matters of basic principle and particular impact - permeate this book. Much of this discourse is of only historic interest. Only the points of most current interest are covered in this article.
 &
  The market adjustment process in relation to various economic factors is what Ricardo emphasizes. His numerous disagreements with Smith and others are generally over the particulars in this adjustment process. Consistently, he emphasizes how prices are set at the margins of supply and demand, but insists that in the long haul, it is the costs of supply that dictate market prices. It is the least fertile ground under cultivation - the least fertile mines in production - the subsistence wages of labor - that dictate prices, wages and the rent of landlords.
 &

Population increases would always drive the wages of ordinary laborers back towards subsistence levels, no matter how productive and wealthy the rest of the economy should become.

 

Capital flows tend to equalize profit rates - subject to factors of risk and other difficulties. The rate of profits depends on the cheapness of labor, which depends on the cheapness of corn and other subsistence goods. However, with vast accumulations of capital, the amount of profits can increase even as the rate of profits declines.

  Ricardo was an ardent Malthusian. He expressed great admiration for Malthus' "Essay on Population," but had several disagreements with Malthus' work on rent.
 &
  Thus, population increases would always drive the wages of ordinary laborers back towards subsistence levels, no matter how productive and wealthy the rest of the economy should become. Capital flows tend to equalize profit rates - subject to factors of risk and other difficulties. The rate of profits depends on the cheapness of labor, which depends on the cheapness of corn and other subsistence goods. However, with vast accumulations of capital, the amount of profits can increase even as the rate of profits declines.

  "I make profits and wealth to depend on the real cheapness of labor."

  This put the interests of labor in direct conflict with the interests of capital and even of the nation - a profound error. It gravely underestimated the ability of capitalism to thrive - increasing both real wages and wealth.
 &
  The most obvious weaknesses in this book and the works of the other economists of the classical era flow from Malthusian expectations. Malthusian limits on economic possibilities must have seemed quite reasonable during the Napoleonic Wars - a two decade period when Great Britain was wracked with inflation and swamped with vast debts.
 &
  In fact, human fertility declines - rapidly - with modern prosperity. There are few broom pusher - totally unskilled - jobs in a modern economy. For that reason, along with reasons of modern education and labor productivity, wages and benefits tend to rise to absorb over 60% of the benefits of productivity gains.
 &
  Thus, many of the particulars of the market adjustment process that fill so many pages of the works of Ricardo and his contemporaries simply don't apply to modern conditions. Moreover, the pessimism of all the classical economists with respect to labor and wages is shown to be in gross error.
 &
  Yet, more than three decades earlier, Smith was already able to discern that over the course of the previous century, British labor had been able to appreciably increase the level at which it was "subsisting."

All economies that are directed by competitive markets have comparative advantages - even if they have no absolute advantages in the goods they produce.

  Ricardo is a worthy follower of Adam Smith.

  • Ricardo provided the theoretical tools for analyzing economic problems and devising practical solutions for dealing with them. His analyses emphasized the law of diminishing returns - the phenomenon that puts the curve in the standard supply and demand curves. 

  • Currency inflation and the national debt - problems recently arising from the Napoleonic Wars - are of particular interest to Ricardo;

  • as is agricultural protectionism - the Corn Laws.

  Ricardo's analyses would be a powerful factor in the reinstatement of the gold standard and the repeal of the Corn Laws and the establishment of free trade in the decades after his death. These economic reforms played a prominent role in the great surge of economic power and wealth enjoyed by 19th century Great Britain.

  • International trade theory was the subject of Ricardo's greatest contribution.

  Smith had argued simply that it was foolish to produce goods that others could produce and deliver more efficiently. Nations should concentrate on that which they could produce with an absolute advantage.
 &
  Ricardo broadened this concept immensely - proving the profitability of production for which there is a "comparative advantage." All economies that are directed by competitive markets have comparative advantages - even if they have no absolute advantages in the goods they produce.

  • Ricardo also analyzed economic distribution between rent, wages, and profits and interest;

  • the impacts of economic growth; and,

  • the impacts of various forms of taxation.

Value

Theories of value:

  The inherent conundrum of value is explained by Ricardo.
 &

Abundant items like air and water can have infinite value in use but no value in exchange, while scarce items like gold or diamonds can - in the beginning of the 19th century - have little value in use but great value in exchange.

 

Scarcity and labor embodied in commodities determine the levels around which exchange values fluctuate.

  He begins with Adam Smith's observations about the differences between value in use and value in exchange. Abundant items like air and water can have infinite value in use but no value in exchange, while scarce items like gold or diamonds can - in the beginning of the 19th century - have little value in use but great value in exchange. However, some utility in gratifying human wants is essential for value in exchange.

  "Utility then is not the measure of exchangeable value, although it is absolutely essential to it."

  Scarcity and labor embodied in commodities determine the levels around which exchange values fluctuate.
 &
  The labor theory of value
invoked by Ricardo is the same as that of Smith. This "labor" involves all the labor required to bring the commodity to the consumer - not just that required to produce it. However, unlike Smith, Ricardo persuasively asserts that even subsistence labor embodied in commodities fails to provide a precise method of calculating the "value" of those commodities.

  Karl Marx would produce 1800 tedious pages trying to establish the nonsensical proposition that only industrial and agricultural labor creates value. See six articles beginning with Karl Marx, "Capital" ("Das Kapital") (vol. 1)(I).

A precise method of calculating the "value" in commodities is impossible, but the embodied labor is the best general measure.

  "Value in exchange" is distinguished from "value in use" by equating "riches" and "wealth" solely with use values, and economic "values" solely with exchange values. Ricardo's explanations of  these distinctions are a part of his disputes with the views of contemporary writers.
 &
  Ricardo, like Smith, sees no purpose in actually trying to determine use value. He concludes that a precise method of calculating the "value" in commodities is impossible, but the embodied labor is the best general measure. Again referring to Smith, he explains that in a barter economy, labor determines value. If it took twice the labor to kill a beaver than to kill a dear, one beaver would exchange for two dear.

  Use values are inherently subjective and infinitely variable with each consumer - and absent fraud or mistake - always greater than exchange value for those who purchase commodities in the market. Part of the magic of the market is that everyone almost always gets a bargain - almost always receives more in terms of use values than they give up. Economists call this "the producer surplus" and "the consumer surplus" - both surpluses existing together in the market.

There is no basic constant value for labor based on subsistence commodities.

 

Like Smith, Ricardo concentrates on exchange values, although he constantly emphasizes the ways in which labor values constrain exchange value fluctuations.

  Basic unskilled labor is itself a variable value, Ricardo points out. It can only be measured "comparatively" at any given moment - in proportion to other things - all of which are also in constant flux. He rejects Smith's view that, regardless of momentary fluctuations above and below subsistence levels, basic labor can be viewed as a constant because of its essential relationship to subsistence levels.
 &
  There is no basic constant value for labor based on subsistence commodities, Ricardo emphasizes. Although there have been powerful mutual relationships, in fact, the market prices of labor and corn have a long history of divergent movements. Labor remains a variable, even though subsistence commodities and basic labor generally fluctuate roughly together as a unit.

  Marx, with obvious futility, tried to demonstrate otherwise - but only for basic industrial and agricultural labor. His propaganda myth depended on establishing basic industrial labor as a determinable constant value against which the value of all other commodities could be calculated. That this is a practical impossibility was proven during the almost two hundred years of futile efforts by many types of  non-market socialist systems.

  Skill and intensity of labor are also variables, as are labor factors like hardship and ingenuity and training. Such labor factors are impossible to evaluate in the abstract, but are roughly reflected in market adjustments that respond to their intrinsic values "with sufficient precision for all practical purposes." Thus, like Smith, Ricardo concentrates on exchange values, although he constantly emphasizes the ways in which labor values constrain exchange value fluctuations.

  Ricardo and Smith simply recognize that economics is a practical art - emphasis on the word "practical." Theories of value that are indeterminate are of no use in the essential economic task of allocating scarce resources. Exchange values are always determinable no matter how violently they fluctuate, and they automatically balance a vast array of variable factors in allocating scarce resources with substantial precision. Thus, exchange values are what drive the competitive market economic world.

All valuable items are constantly in flux absolutely and relative to each other - whether gold or corn or labor itself - due to flux in factors of supply and demand - long term and short term.

 

Exchange values in competitive markets fluctuate in response to shifts in the factors of supply and demand - albeit with some delay.

  There is no fixed measure of exchange values, either. All valuable items are constantly in flux absolutely and relative to each other - whether gold or corn or labor itself - due to flux in factors of supply and demand - long term and short term.
 &
  Supply and demand interact to determine exchange values. Ricardo takes note of monopoly commodities, but confines his analysis to the factors involved under competitive conditions. Exchange values in competitive markets fluctuate in response to shifts in the factors of supply and demand - albeit with some delay.
 &
  However, Ricardo believes that it  is the factors of supply that ultimately dictate the natural price of commodities around which market exchange values fluctuate. This is especially true of subsistence goods. If production costs are reduced, prices will adjust - ultimately low enough to reduce profit rates to the usual level, even if demand doubles or trebles. He argues that the impacts of shifts in demand exist only in the period required for the supply to adjust. Demand factors play their essential role only in the adjustment process.

  This is not wrong, but is an unfortunate overstatement. It is perhaps due to concentration too much on subsistence commodities that do not fluctuate much on the demand side. For discretionary goods, demand, too, can increase or decrease sufficiently to permanently affect prices - and even subsistence commodities generally compete with potential substitutes. Examples are not hard to find.
 &
  Today, rising demand for energy pushes up prices, bringing less productive wells back into production as well as bringing alternative energy sources - wind, liquid natural gas, and coal - increasingly on line. This is changing not only the amount, but the character, of the production process. Ricardo recognizes similar impacts for corn and natural commodities as less fertile lands and mines are brought into production.
 &
  The availability of a mass market for autos enabled a shift from custom production to mass production in the early years of the 20th century that permanently reduced costs and prices. A lack of mass market demand limits the production processes for large pleasure boats. That mass production techniques are possible for large vessels was amply demonstrated during WW-II.
 &
  Both demand and supply play essential roles in establishing production levels and prices. Yes, production costs - including the usual rate of profit - establish a "normal" price level, but it is demand characteristics that dictate production levels and their attendant cost characteristics. Any concentration on one to the exclusion of the other is like an analysis of clapping that concentrates on the actions of just one hand.
 &
  Marx, in particular, would rely heavily on this one-hand clapping mode of reasoning to establish his narrow labor use-value theory of value limited to industrial and agricultural labor. He would thus describe a rigid economic system that would lack most of the flexibility characteristic of real capitalist systems.

The production of durable capital - of fixed capital - is what permits economic growth, whereas production of immediate consumables does not - but fine distinctions at the margins are of little consequence.

  The value of physical capital assets is a part of the value of the commodities produced by use of capital implements and facilities. This, too, is related to the value of the labor expended in furnishing that capital, and the rate at which those capital assets are expended.
 &
  Capital that is used up quickly and has to be repeatedly replaced may be classified as circulating capital, while that which lasts longer can be classified as fixed capital. Even though the dividing line is fuzzy, that is of little consequence since the classification itself is of little consequence. It is of accounting use only to differentiate maintenance and depreciation expenses from inventory replacement expenses. Ricardo notes that the production of durable capital - of fixed capital - is what permits economic growth, whereas production of immediate consumables does not. However, fine distinctions at the margins are of little consequence. (Human capital is, of course, a form of "durable" capital.)

  Marx's propaganda myth views all value as derived solely from industrial and agricultural labor. Thus, it is of basic importance for Marx to distinguish the fixed industrial capital that he considers productive from capital in circulation that he ridiculously must insist is unproductive.

  Ricardo states the obvious:

  "[Value], comparatively with other things, depends on the total quantity of labour necessary to manufacture [commodities] and bring them to market."

  The rate of profits is calculated against all capital used - whether for wages, fixed capital or circulating capital or financial capital. This is a fact so obvious that Ricardo just assumes it - it requires no further elaboration - and is noted just in a footnote. Profits are an ordinary and necessary expense of production. See, "Profits and Capitalist Productivity."
 &
  Exchange value is divided among wages, profits and rent. If there is no change in labor expended, than an increase in profits or rent must cause a decrease in the other.
 &

  Exchange values are measured in money terms. Ricardo explains this at some length with reference to changes in relative valuations between two commodities and between them and a third commodity - a money commodity - which is presumably a commodity of stable valuation. Money - to the extent that it is a commodity of stable valuation - permits calculation of the extent to which value relationship changes are due to each of the other commodities.
 &
  Of course, no commodity - not even gold - is itself immune from value fluctuations. Acknowledging the limitations of gold as a standard of measure, Ricardo assumes that it is the best available standard, and uses it for the rest of his analysis. However, he does not neglect consideration of inflation and deflation. Wage increases caused by inflation have different impacts from those caused by other economic factors. For example, wages and commodity values all fluctuate together as money decreases or increases in purchasing power, regardless of capital intensity of production.
 &
  Thus, in analyzing fluctuations of exchangeable value and price, a distinction must be drawn between changes attributable to particular commodities and changes in the purchasing power of the monetary unit. Inflation and deflation cause all prices to rise and fall roughly together.

  This is only true in the short run. Inflation that is substantial and chronic has inherent adverse impacts on capital accumulation and maintenance - and on risks and nominal interest rates - that impact profits, rents and wages and capital values in varying degrees - and that depress the real value of them all. When Ricardo discusses inflation, he assumes all other factors remain equal - a normal mode of economic analysis - but clearly not valid when discussing inflation.

  Reliance on gold as his standard of measure is supported by the fact that - in spite of the vast influx in gold and silver from the new mines in America during the previous three centuries - the declines in purchasing power were slow enough to be practically imperceptible to those involved in the economy. This, and their other suitable qualities - hardness, malleability, divisibility - make gold and silver ideal as monetary units.

  Paper money is much more unstable. All modern economic statistics are thus calculated against a ruler drawn on a stretched rubber band. See, "Economic Statistics: The Figures Lie."
 &
  Until the Great Depression, when the pound ceased to be tied to the value of gold, records on British agricultural commodities markets running back to the end of the 16th century demonstrate the stability of gold as the monetary unit. Although there were constant fluctuations - some of them severe during wars or droughts - the fluctuations for over 300 years remained in an impressively level range. This is even more remarkable considering the constant influx of gold from the Americas on the supply side during the first half of this period, and the vast increase in population and economic activity on the demand side during the last half of this period.
 &
  In the seven decades of the age of unsupported paper money, grain price fluctuations have been in a consistently rising range - despite massive increases in productivity. That should be no surprise to anybody.

There is a time cost for commodities, physical capital assets and money. Time increases the value of commodities above the value attributable to labor, depending on the time costs of assets and money.

   Capital intensity determines how wage fluctuations impact the relative fluctuations of value and prices of different commodities. The distributional impact of a general change in wage rates in a particular industry will vary depending on whether production is or is not capital intensive. Production that relies more on capital is less affected by wage rate changes, and that which relies less on capital is more affected.
 &
  The extent of capital intensity is affected by both the extent and average durability or turnover of the capital implements, facilities and commodities used. Here, maintenance costs and depreciation rates act like reductions in capital intensity to the extent that they increase costs and thus increase the impacts of  wage fluctuations. Maintenance work is just a part of commodity production.
 &
  The impact of fluctuations in profit rates
can be analyzed in the same way as fluctuations in wage rates.
 &
  Time is a vital economic factor. The time it takes to produce and get goods to market is another obvious factor in valuation. There is thus a time cost for commodities, physical capital assets and money. Time increases the value of commodities above the value attributable to labor, depending on the time costs of assets and money. (These fluctuate with fluctuations in interest rates).

  Marx would be forced to stupidly deny this obvious fact to sustain the restricted view of value in his propaganda myth.

While increases in productivity can push basic wages somewhat above subsistence levels, the overall impact of increases in wealth and population is to drive wages back down towards and sometimes below subsistence levels.

  It is productivity increases that introduce the greatest normal variability in absolute and relative valuations. Changes in wages or profits can only have minimal impacts, but productivity increases can carve major percentages off costs of a particular product. Of course, losses of productivity - as when infrastructure breaks down - can substantially increase costs. Ricardo thus emphasizes productivity factors that decrease the amount of labor needed to get goods to market, rather than changes in wage rates.
 &
  Basic wages fluctuate around subsistence levels. While increases in productivity can push basic wages somewhat above subsistence levels, the overall impact of increases in wealth and population is to drive wages back down towards and sometimes below subsistence levels. (This fallacious view is the basic source of the pessimism about wage rates that afflicts classical economics.)
 &

Rent, Prices, Wages & Profits

Rent:

  Ricardo's concept of "rent" is confined to the "use of the indestructible power of the soil."
 &

"Rent" covers only the "use of the indestructible power of the soil."

  The capital invested in the land is a separate subject. Ricardo also distinguishes payments for mineral and timber rights. His definition of "rent" is thus considerably narrower than that of Smith, and permits a sharper analysis of the subject. He primarily discusses rents in relation to agricultural lands producing the staple grains.
 &

If capital improvements are permanent - such as the removal of trees or rocks or the draining of wetlands - rent will ultimately increase to absorb those benefits.

  Rent rises to absorb all the advantages of a particular piece of property over alternative properties. In this Ricardo agrees with Smith. Thus, the rate of profits remain equal - as widely observed - whether for operations based on the least favorable property, which can command no rent, or the most favorable, which commands substantial rents, or any of the parcels in between.
 &
  Of course, capital will be invested in the land whenever the return for capital is at least equal to that for the least favorable land in profitable use. "Rent" thus narrowly defined increases to absorb all the advantages provided by capital invested in the land over and above the normal rate of profit for capital. The rest - the return on capital - belongs to whomever provided the capital, whether the landlord or the tenant.
 &
  However, if the capital improvements are permanent - such as the removal of trees or rocks or the draining of wetlands - rent will ultimately increase to absorb those benefits, too. Thus, tenant farmers make few permanent improvements in the land. (This is a major reason why tenant farming would not dominate capitalist agriculture - something Marx was too stupid to understand.)
 &

It is the profitably cultivated land that is least fertile - and thus pays no rent - that sets the price of corn.

 

It is the least efficiently provided items - as long as they are accepted in the market - that set the price.

  Prices are set at the margin. Thus, it is the profitably cultivated land that is least fertile - and thus pays no rent - that sets the price of corn.

  "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 a rent is paid to the landlord."
 &
  "Corn is not high because a rent is paid, but a rent is paid because corn is high."

  The elimination of rent would not reduce the price of corn. It would just transfer wealth from landlords to tenant farmers.
 &
  The need to bring less productive lands into cultivation of the staple crop causes an increase in the value of all commodities produced. This is due to the increased labor required to produce the marginal commodities accepted in the market. It is the least efficiently provided items - as long as they are accepted in the market - that set the price.

  "When land of an inferior quality is taken into cultivation, the exchangeable value of raw produce will rise, because more labor is required to produce it."

  The "advantages of fertile over inferior lands - - - [is] transferred from the cultivator, or consumer, to the landlord, yet, since more labor is required on the inferior lands," and produce from the inferior lands is needed to meet market demand, "the comparative value" of that commodity will be set at the margin of that produced by the least efficient producer. Its value will rise in relation to other goods not similarly impacted.
 &
  This narrower definition of rent permits Ricardo to demonstrate that rent cannot be a component of price - something in which he disagrees with Smith. It is the unequal increase in costs that creates rents. However, he agrees with Smith that:

  "The rise of rent is always the effect of the increasing wealth of the country, and of the difficulty of providing food for its augmented population."

Profits of tenant farmers must remain equal whether they work more or less fertile lands, with rents absorbing the difference.

  Increases in productivity - by reducing the extent of the less fertile lands that have to be cultivated to meet demand - will reduce rents on the more fertile lands that remain in cultivation. However, as wealth and population increase in response to these lower costs, the extent of lands under cultivation and the amount of rents will be restored. An increase in productivity thus initially harms landlords by reducing rents, until wealth and population growth can respond and bring marginal lands back into production.

  As it turned out, the increase in productivity that brought cheap grains into Europe from overseas and Russia was ruinous for European landlords during the heyday of free trade - globalization - at the end of the 19th century. They became powerful advocates for the protectionist measures that ultimately brought that period of globalization to an end and - with WW-I - created the conditions responsible for the Great Depression.

  Whatever reduces or increases the inequality of lands under cultivation reduces or increases rent. Moreover, as the greater demand brings more marginal lands into cultivation, the price of grains rises. The landlords holding more fertile lands absorb all the benefits, including much of the increase in the value of the grains produced. Profits of tenant farmers must remain equal whether they work more or less fertile lands, with rents absorbing the difference.

The poorest mine that can be operated with the standard rate of profit pays no rent but regulates the rent chargeable on all the wealthier mines.

  The landlord interest today still benefits from the economic growth of the economy - but that is no different than for the ownership interests of most productive assets. Landlord interests today are purchased and taxed. They are no longer awarded as fiefs. However, subsidized and protected interests remain directly at odds with the broader national interest.
 &
  As a practical matter, it is impossible to distinguish rents as narrowly defined by Ricardo from returns on capital invested in the land. Because of the extent of the latter in modern times, the rents attributable to the raw land at most constitute just a minute fraction of the total land rents that include returns on capital. This heavy dependence on capital has greatly reduced the impacts of the rents narrowly defined by Ricardo.
 &
  The capital investment needs of modern farming have become very extensive and complex. Absentee landlords have no skill at managing such capital complexes. This has rendered the landlord-tenant farm uncompetitive with private or corporate owned and operated farms.
 &
  In industries where the landlord-tenant model still thrives, it is often because landlords employ specialized skills and advantages in managing the capital invested in the land. In such cases, their return is much more a return on capital and management services than on narrowly defined land rents.
 &
  Only where capital still involves fairly routine management does the absentee landlord still thrive.
 &
  God will make no more land in our time. Fortunately, there is no limit to the capital that can be invested in the land. Thus, real estate bubbles still occur.

  Rents charged for mining rights are analyzed along similar lines. The poorest mine that can be operated with the standard rate of profit pays no rent but regulates the rent chargeable on all the wealthier mines.
 &

Prices:

 

&

  Market prices are influenced by and fluctuate around the natural price. While labor generally determines this natural price, market prices adjust sensitively to applicable unstable factors to regulate the competitive market economic system.
 &

  Capital knows no geographic boundaries and will flow towards the most profitable uses in the system. By increasing and decreasing profits, price fluctuations balance the whole system. They provide the driving force that causes prices to tend to return towards their natural levels.
 &
  Of course, many other factors impact profits. Risk and hardship may deter the investment of capital until profits reach relatively higher levels. However, such differences should remain fairly stable over time until and unless there is change in the pertinent factors.
 &
  An obvious factor in Ricardo's time was the recently concluded Napoleonic Wars. Ricardo noted that war had so jumbled normal relationships, that they had not as yet had time to settle.
 &

Wages:

 

&

  The natural price of labor rises and falls only in line with fluctuations in the subsistence cost of living. This leaves the wages of labor stuck - fluctuating around subsistence levels.
 &

However, like Smith, Ricardo recognizes that English laborers during his times subsist at considerably higher levels than in previous periods.

  These subsistence levels are meager, indeed, according to Ricardo. They are sufficient only to reproduce a stable population.
 &
  Like Smith, Ricardo asserts that only an economic system that is constantly improving can support wages above subsistence levels for indefinite periods of time. During prosperous times, population growth will constantly increase the labor force and tend to depress wages back to subsistence levels, unless the economy keeps growing.
 &
  However, also like Smith, Ricardo recognizes that English laborers during his times subsist at considerably higher levels than in previous periods.

  "Many of the conveniences now enjoyed in an English cottage would have been thought luxuries at an earlier period of our history."

  Why, then, didn't it occur to him that his expectations concerning wage labor might be in error? Even though both Smith and Ricardo recognized the steadily rising living standards of labor in England, they could not bring themselves to question the pessimistic expectations that became identified with Malthus.

  Productivity increases are recognized by Ricardo as a natural phenomenon of capitalist market economies. This can provide the constant expansion of capital that supports persistently higher wages and continuous population growth.

  This provides a theoretical explanation for continuous labor prosperity above subsistence levels - but it still doesn't provide an explanation for the persistent increase in labor prosperity observed throughout the last 300 years.
 &
  As stated in the "Introduction," above, modern economic systems offer few jobs for the totally unskilled. Education and on-the-job training offer productivity and scarcity values above subsistence levels that are impossible to calculate abstractly, but that labor markets readily recognize and reward.

A "diminished rate of increase in population" can keep labor scarce and prosperous.

  Ricardo's long term outlook for labor is gloomy. The persistent population increase and the law of diminishing returns must ultimately drive wages back to subsistence levels. Productivity increases and capital expansion simply cannot indefinitely outrun population growth.

  That prosperity in modern times reduces fertility rates and population growth was, of course, not an observable phenomenon at the beginning of the 19th century.

  However, Ricardo actually did note the possibility. A "diminished rate of increase in population," he noted, can keep labor scarce and prosperous.
 &
  Wages, like rent, will tend to rise with the progress of wealth and population. However, the prices of wheat and other subsistence items will tend to increase faster. Whereas landlords benefit under such circumstances by rent increases that outrun cost increases, labor falls behind.
 &

The Poor Laws:

  Discussing the entitlement welfare program of his day, Ricardo perceptively pointed out the unintended consequences of such programs.
 &

Welfare entitlements must increase poverty and impoverish society.

 

Entitlement programs tend to create dependencies, making their withdrawal difficult, painful, and even dangerous.

  The Poor Laws were benevolently established for the relief of poverty. However, Ricardo explained, such efforts must increase poverty. They suffer from costs that rise rapidly and without limit, and ultimately can bankrupt an economy.

  "[Whilst] the present laws are in force, it is quite in the natural order of things that the fund for the maintenance of the poor should progressively increase, till it has absorbed all the net revenue of the country, or at least so much of it as the state shall leave to us, after satisfying its own never failing demands for the public expenditure."

  Experience with modern entitlements - with social security and Medicare and Medicaid - confirm this obviously correct analysis.

  Ricardo carefully notes that this should not be interpreted as criticism of efforts to relieve "temporary states of misery" such as may occur during periods of famine or economic recession. However, entitlement programs tend to create dependencies, making their withdrawal difficult, painful, and even dangerous. Fortunately, each local parish was responsible for its own Poor Law expenditures, giving each locality incentive to restrain program growth.

  Smith relates how these Poor Laws caused great harm by restraining labor mobility. They created a strong incentive for parishes to keep job-seekers away.
 &
  In modern times, incentives to restrain welfare cost increases have frequently been introduced by devolving responsibility for welfare programs to state and local governments, and by limiting the programs that are entitlements.

Profits:

 

&

  The profits of stock in different industries have been shown to maintain a proportionate relationship to each other and to fluctuate in the same degree and direction.
 &

Profits are an ordinary and necessary cost of production, so a reduction beyond certain limits will bring all economic progress to a halt.

 

Ricardo notes that the subsistence levels of English workers are substantially higher than those of Irish workers and those who live in similarly impoverished lands.

  Rent, as narrowly defined by Ricardo, is an add-on to the costs of wages and profits. It does not diminish either of them, but is passed on as an addition to consumer costs.
 &
  Thus - temporary fluctuations aside - a rise in wage costs will reduce profits. Even when the increased wages also cause or are caused by increased prices for wheat, the farmer's profits will still decline. The price increase will be more than absorbed  by the wage cost increases and - ultimately - by rent increases. If the profits of manufacturing declines, then the profits of agriculture must also decline, and any sustained increase in wheat costs must be the result of increased wages and rent. Ricardo provides examples demonstrating this principle, and concludes:

  "[A] rise in the price of corn, which increases the money wages of the labourer, diminishes the money value of the farmer's profits."

  However there is a natural limit to how far profit rates can decline. Profits are an ordinary and necessary cost of production, so a reduction beyond certain limits will bring all economic progress to a halt.
 &
  Land rent is like a business tax. The burden always falls on the consumer - never on the business owner or farmer. However, it prevents the tenant-farmer from reaping the benefits of sustained price increases, since it will rise to absorb those increases, leaving the farmer with just the standard rate of profit. In addition, it hurts him as a consumer.

  Of course, there are time lags. When the adjustment process involves population changes, the time lags can be measured in decades. In addition, this neat theoretical relationship between wages and the subsistence cost of living becomes looser as persistent prosperity permits wage levels to move permanently above subsistence levels.

  As Ricardo notes, the subsistence levels of English workers are substantially higher than those of Irish workers and those who live in similarly impoverished lands. This is substantial enough to provide some cushion during recession periods even during Ricardo's times. (However, this still does not lead him to doubt his essentially gloomy outlook for wage labor.)
 &
  Ricardo's analysis of profits is limited to the impacts of permanent price changes - not temporary fluctuations. His analysis covers only those increases in commodity costs attributable to increases in the amount of labor expended in their production and distribution. Increases in real wages - being unsustainable in his view - are but temporary fluctuations. Only nominal wage increases driven by increases  in the subsistence cost of living are analyzed here.
 &
  Price changes of discretionary goods - such as silks and furniture - do not permanently affect wages and thus do not permanently affect profits. They just reflect alterations in the amount of labor required to produce and distribute them, and have only temporary impacts on profits. Such impacts must soon be eliminated by capital flows attracted to higher profits or fleeing from lower profits.
 &

A small return on the vast capital in wealthy nations will far exceed in aggregate amount the high return on the meager capital in impoverished nations. However, the law of diminished returns always puts limits on capital accumulations. Thus, only productivity gains can provide prosperity at a constantly expanding rate.

  Because of diminishing returns, the constant increase in population and wealth tends to increase nominal wages and reduce profit rates. This is countered - (indeed, outweighed) - by rapid increases in productivity that push down all costs - including subsistence costs - and thus force down "natural" wage rates as well.
 &
  Capital expands and increases in value as population and wealth increase.  Even if profit rates decline because wages are rising to keep pace with rising costs of subsistence, total profits may increase - substantially - due to the employment of capital of increased value and extent.
 &
  A small return on the vast capital in wealthy nations will far exceed in aggregate amount the high return on the meager capital in impoverished nations. However, the law of diminished returns always puts limits on capital accumulations. Thus, only productivity gains can provide prosperity at a constantly expanding rate.
 &

International Trade and Comparative Advantage

The benefits of free trade:

  What are the economic benefits of an extension of foreign trade?
 &

"No country can long import, unless it also exports, or can long export unless it also imports."

  Foreign trade is a win-win proposition. Both exports and imports  bestow benefits on trading nations. Indeed, it is equally essential to engage in both. International monetary flows and fluctuations, and the processes of comparative advantage, dictate that the two must go together. The need to conduct import-substitution manufacturing or agriculture will withdraw capital from export manufacture - a nation's most efficient economic activity - and apply it to considerably less efficient import-substituting commerce.

  "No country can long import, unless it also exports, or can long export unless it also imports."

  The third world nations that have the least economic growth are the ones that have raised the greatest barriers to foreign trade and thus refuse to participate in globalization. 

Importation of subsistence foods from more fertile lands abroad can materially increase economic limits. The reduction of subsistence costs reduces wages and rents, increases profits and capital accumulation and wealth and population.

  Arguments that favor the Corn Laws - protectionist measures that shielded farmers from import competition - are easily shredded by the author. He repeatedly demonstrates how the importation of cheap grains - something that would require repeal of the Corn Law protectionist measures - would increase the wealth - the "riches" - of the nation.
 &
  Capital would be released from corn production without any reduction in grain supplies, and would be used elsewhere to increase supplies of various products. Some of this increase would go abroad in exchange for grain imports - but not all of it. What remains would be an increase in the wealth of the nation.
 &
  Absent productivity gains, it is the least fertile lands under cultivation that dictate the amount of profits, the natural wage rates, rents on more fertile lands, and the wealth and population of the nation. However, importation of subsistence foods from more fertile lands abroad can materially increase these economic limits. The reduction of subsistence costs reduces wages and rents, increases profits and capital accumulation and wealth and population.

  "However extensive a country may be where the land is of poor quality, and where the importation of food is prohibited, the most moderate accumulations of capital will be attended with great reductions in the rate of profit, and a rapid rise in rent; and on the contrary a small but fertile country, particularly if it freely permits the importation of food, may accumulate a large stock of capital without any great diminution in the rate of profits, or any great increase in the rent of land."

  Free trade - domestic and foreign - permits cities - and city states like Singapore - to prosper despite a total lack of fertile agricultural lands - or other natural resources.

  Of course, change - any change - always inconveniences some people. It is such people that support the Corn Laws against the broader interests of the nation.

  "[A man may have] erected machinery in his manufactory at a great expense, machinery which is afterwards so much improved upon by more modern inventions, that the commodities manufactured by him very much sink in value. It would be entirely a matter of calculation with him whether he should abandon the old machinery, and erect the more perfect, losing all the value of the old, or continue to avail himself of its comparatively feeble powers. Who, under such circumstances, would exhort him to forego the use of the better machinery, because it would deteriorate or annihilate the value of the old? Yet this is the argument of those who would wish us to prohibit the importation of corn, because it will deteriorate or annihilate that part of the capital of the farmer which is for ever sunk in land."

  This is a perfect explanation of the benefits of "outsourcing" and other aspects of modern globalization. Of course, all change causes some damage. However, the changes wrought by outsourcing and the other aspects of globalization are a small fraction of the constant flow of change occurring in a dynamic modern economy. Just as it would be ruinous to block all change, it is damaging to a nation's broader interests to protect the politically influential from changes arising from international trade.
 &
  The right to fail is as important as the right to succeed in capitalist market systems.

The benefits of foreign trade thus include an increase in living standards with an increase in the amount and variety of goods for consumption, and the ability to increase savings and capital accumulation without sacrificing consumption. These are the same impacts as for the domestic introduction of improved technology or infrastructure. It is the consumers that are the invariable beneficiaries.

  The benefits of free trade are profound but limited.

  • The amount of value in the economy will not experience any immediate increase. By definition, the purchase of foreign goods will exchange value for value - no matter how relatively advantageous the bargain may be. (The magic of the market is that all bargains can be advantageous to both seller and buyer.)

  • There will be no permanent increases in profit rates unless the trade brings subsistence goods to market at reduced prices.

  • For imports of discretionary goods - "commodities consumed by the rich" - the domestic rate of profit may increase because of the increased profits gained from the foreign trade. However, that increase will be only temporary, as the profits of foreign trade will attract capital flows and competition sufficient to bring profit rates back down to domestic levels. Ricardo disagrees with Smith's view that this equalization will be due to an increase in profit rates for domestic commerce.

  • For imports of subsistence goods, the reduction in subsistence costs will lead to a reduction in the natural price of labor. Population growth must eventually drive wages back down to this natural subsistence level, permitting a much longer term increase in profit rates, and an increase in the wealth of the nation.

  • By increasing economic efficiency - economic productivity - prices will decline and consumers will be able to procure more. Living standards will rise. Consumers are the primary beneficiaries of international trade.

  • Savings and thus economic growth may be increased during the period while the profits from foreign trade remain above domestic levels. Savings and economic growth may be increased longer term from the decline in the costs of consumer goods.

  Some of these conclusions are dependent on Ricardo's basic theory that "the rate of profits can never be increased but by a fall in wages, and there can be no permanent fall of wages but in consequence of a fall of the necessaries on which wages are expended."

  Obviously, this theory fails to explain the prosperity of wage labor - rising ever further above subsistence levels in capitalist market economies - and only in capitalist market economies. See, "Introduction," and "Wages," above, for some of the reasons.

  The benefits of foreign trade thus include an increase in living standards with an increase in the amount and variety of goods for consumption, and the ability to increase savings and capital accumulation without sacrificing consumption. However, it "has no tendency to raise the profits of stock" unless it involves the import of subsistence goods at reduced prices. These are the same impacts as for the domestic introduction of improved technology or infrastructure. It is the consumers that are the invariable beneficiaries.
 &

Comparative advantage:

  Ricardo then provides his explanation of comparative advantage - undoubtedly his most outstanding contribution to economic theory.
 &

  "Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole. By stimulating industry, by rewarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically: while, by increasing the general mass of productions, it diffuses general benefit, and binds together by one common tie of interest and intercourse, the universal society of nations throughout the civilized world. It is this principle that determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England."

  In international trade, there are obstructions to the rational flow of economic factors. Labor and even capital are obstructed at international borders. There are variations in risk factors affecting the security of peoples and their property. Climate and fertility characteristics vary in each nation. Sociological characteristics vary widely.
 &
  Thus, there are different products that each nation can produce most advantageously, and it is in their best interest to concentrate on those products and acquire the rest from the most efficient sources in the world in exchange for the products they produce. Portugal obtains more cloth by exchanging its wine for it than by producing cloth itself, while England similarly obtains more wine by exchanging its cloth for it than by producing wine itself.
 &

Even if Portugal could produce both wine and cloth more efficiently than England, it would still be more efficient for Portugal to concentrate on the product for which it has the greatest advantage - say, wine - and still procure its cloth from England in exchange for wine. Even if England had no absolute advantage, it would still have a comparative advantage in cloth with which it could engage profitably in foreign trade. By trade, both nations would wind up with more cloth and wine, and living standards would thus rise.

  Then, Ricardo takes this logic one step further. Even if Portugal could produce both wine and cloth more efficiently than England, it would still be more efficient for Portugal to concentrate on the product for which it has the greatest advantage - say, wine - and still procure its cloth from England in exchange for wine. Even if England had no absolute advantage, it would still have a comparative advantage in cloth with which it could engage profitably in foreign trade. By trade, both nations would wind up with more cloth and wine, and living standards would thus rise.

  "This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced there with less labour than in England. Though she could make the cloth with the labour of 90 men, she would import it from a country where it required the labour of 100 men to produce it, because it would be advantageous to her rather to employ her capital in the production of wine, for which she would obtain more cloth from England, than she could produce by diverting a portion of her capital from the cultivation of vines to the manufacture of cloth.
 &
  "Thus England would give the produce of the labour of 100 men, for the produce of the labour of 80. Such an exchange could not take place between the individuals of the same country. The labour of 100 Englishmen cannot be given for that of 80 Englishmen, but the produce of the labour of 100 Englishmen may be given for the produce of the labour of 80 Portuguese, 60 Russians, or 120 East Indians. The difference in this respect, between a single country and many, is easily accounted for, by considering the difficulty with which capital moves from one country to another, to seek a more profitable employment, and the activity with which it invariably passes from one province to another in the same country." (The "labor" referred to here as elsewhere by Ricardo is basic, subsistence labor, or more skilled labor expressed in terms of basic, subsistence labor equivalents.)

  Thus, a nation with the great technological advantages of England can be better off producing more manufactured items for sale abroad in exchange for corn even from nations with lower levels of agricultural fertility than in England.

  "Two men can both make shoes and hats, and one is superior to the other in both employments; but in making hats, he can only exceed his competitor by one-fifth or 20 per cent, and in making shoes he can excel him by one third or 33 per cent; - will it not be for the interest of both, that the superior man should employ himself exclusively in making shoes, and the inferior man in making hats?"

  Even in circumstances where there is no government interference in international trade - perfect globalization - such differences would persist due to differences of domestic law and culture. Capital feels more secure and workers feel more comfortable within familiar cultures, thus imposing natural limits on the mobility of capital and labor.
 &

  If a nation loses its advantage in its export commodities for some reason, it would have to exchange money - gold, in the 19th century - for its imports. This loss of gold would increase the domestic exchange value of gold - resulting in lower prices and labor costs - until sufficient comparative advantage should be reestablished so that it could again exchange goods for goods in international markets.

  Of course, this process requires flexible competitive markets. Also, the process involves a reduction in living standards that can be quite painful if sudden - as when a fixed exchange rate collapses.

  Ricardo goes into some detail about the commercial mechanics of this process. In the country that gains gold, gold loses value resulting in rising prices. This includes an increase in the prices for subsistence commodities and thus an increase for the natural wages of labor. However, this does not cause a reduction in profits as would an increase in corn costs attributable to domestic causes. When the supply of money increases, all prices rise together permitting domestic producers of all products to maintain profit margins.
 &

Capital shifts are not exact. There is inevitably waste and error involved. Adjustments can overshoot the mark, requiring expensive withdrawals of capital later on.

  The problem is that these adjustments are never totally smooth or without loss, Ricardo acknowledges. There are individual inertia and government impediments to deal with. The costs of shifting capital from one use to another may be such that some producers will continue in production for some time at lower than standard profit rates. This can impact the profits of a whole industry. Capital shifts are not exact. There is inevitably waste and error involved. Adjustments can overshoot the mark, requiring expensive withdrawals of capital later on.

  Monetary volatility itself increases risks and reduces capital accumulation. Markets in all nations have rigidities - some more than others. These things cause real difficulties that frequently induce governments to step in to limit the impact on politically powerful domestic interests. Unfortunately, this invariably increases market rigidities and the burdens imposed on the nation as a whole. The benefits of capital mobility cannot be realized without the costs of creative destruction.
 &
  The right to fail is as vital as the right to succeed in capitalist market economic systems. 

  Gold flows between nations tend to be gradual and self correcting in normal times.

  Wars and famines are not normal times, however, and inflation due to the "clipping of the coinage" or a substantial increase in paper currency or negotiable instruments will cause major disruptions. Rigidities introduced into capital and money markets disrupt the adjustment processes of international money markets. They can reduce volatility and risk in the short run until collapsing catastrophically when overwhelmed by market forces that tend to build to overwhelming proportions over time.

  The noxious impacts of various mercantilist policies - tariffs, quotas, trade prohibitions, trade subsidies - are extensively explained by Ricardo. While in general agreement with Smith with respect to basic principles, here, too, Ricardo expresses differences with respect to particular impacts.
 &

  In his opposition to the Corn Laws, Ricardo emphasizes that the increased prices of protected grains may be of benefit to the farmers - but only temporarily. Ultimately, market adjustments take these benefits away from the farmers as capital flows in to take advantage of the higher profits. Ultimately, all the benefits are transferred to the landlords. In the long run, only the landlords benefit from agricultural protectionist policies. And there is no benefit for the national interest from such benefits for landlords.
 &
    With respect to mercantilist policies, "the interest of the landlord is always opposed to that of the consumer and manufacturer."

  "All classes, therefore, except the landlords, will be injured by the increase in the price of corn. The dealings between the landlord and the public are not like dealings in trade, whereby both the seller and buyer may equally be said to gain, but the loss is wholly on one side, and the gain wholly on the other; and if corn could by importation be produced cheaper, the loss in consequence of not importing is far greater on one side, than the gain is on the other."

  A trade war - such as that in the 1920s and 1930s - has noxious impacts similar to those of enemy blockades - except that instead of trying to break the blockade, governments impose the blockades on their own people for the benefit of some politically influential groups. However, today, the worst culprits are the governments of Third World nations whose economic growth is thus stymied and whose peoples are thus kept in hopeless poverty. Today, it is the interests of politically powerful agricultural interests in the EU and U.S. for whom national interests are sacrificed.

  International monetary flows cause shifts in the terms of trade. An influx or loss of gold is not without consequences even if self limiting.
 &
  Gold loses value as it increases in volume, resulting in higher prices than in other countries, until the international system balances out at a level where the terms of trade have improved for the more productive system. By the time prices have risen enough to balance foreign trade accounts, the nation with the influx will be receiving more goods from abroad in exchange for less of its own and thus will be wealthier, while the opposite will occur in the nation that lost gold.

  "Foreign trade, then, whether fettered, encouraged, or free, will always continue, whatever may be the comparative difficulty of production in different countries; but it can only be regulated by altering the natural price, not the natural value, at which commodities can be produced in those countries, and that is effected by altering the distribution of the precious metals. [Thus], there is not a tax, a bounty, or a prohibition, on the importation or exportation of commodities, which does not occasion a different distribution of the precious metals, and which does not, therefore, every where alter both the natural and the market price of commodities."

  Thus, an increase in productivity that is relatively faster than in other nations is a double blessing. It not only increases wealth domestically, but it improves the terms of trade with an additional boost to productivity. As English industrial productivity advanced in the 19th century, it was able to procure more Portuguese wine for less of the labor embodied in English cloth.

  "Whenever the current of money is forcibly stopped, and when money is prevented from settling at its just level, there are no limits to the possible variations of the exchange. The effects are similar to those which follow, when a paper money, not exchangeable for specie at the will of the holder, is forced into circulation. Such a currency is necessarily confined to the country where it is issued: it cannot, when too abundant, diffuse itself generally amongst other countries. The level of circulation is destroyed, and the exchange will inevitably be unfavourable to the country where it is excessive in quantity: just so would be the effects of a metallic circulation, if by forcible means, by laws which could not be evaded, money should be detained in a country, when the stream of trade gave it an impetus towards other countries." (Adam Smith had a lot to say about the noxious impacts on Spain and Portugal of laws restricting the outflow of their gold - the mechanics of which Ricardo disagreed with.)

  The advent of paper money and negotiable instruments brings various advantages but also permits serious abuses. The Napoleonic Wars were financed by England with a vast expansion of paper notes that would no longer be redeemed with gold or silver. Massive amounts of government securities were issued that could be readily discounted.
 &
  The inevitable result was inflation. The weight of gold or silver that British pound notes could purchase in foreign markets dropped substantially, and all goods rose in price in terms of the pound both domestically and abroad. England suffered a major adverse shift in its terms of trade It also suffered the host of domestic problems that usually attend inflationary times. The price of corn rose dramatically throughout the two decades of the wars.

  Paper money is, of course, not self regulating. With the advent of paper money and private negotiable instruments, monetary discipline depends on human intervention. It depends on the monetary and financial regulatory authorities.
 &
  Human inadequacies and short term political imperatives frequently result in failures of discipline, resulting in inflation and financial bubbles that periodically afflict the vast majority of market economic systems. When prices rise only in terms of the local currency, the afflicted nation suffers an adverse shift in its terms of trade as well as a host of cyclical and inflation problems in its domestic economy.

Money

Money:

 

&

  The value of monetary gold and silver depends on the labor it takes to bring it into circulation. If gold is worth 15 times more than silver by weight, it is not because there is 15 times more silver available, but because it takes 15 times more labor to bring the gold into circulation.
 &

  Nevertheless, scarcity is still clearly a factor in value. Coins that have been worn or clipped do not lose value as long as they retain their relative scarcity. Paper money retains value almost entirely on the basis of scarcity alone.

  Marx would stupidly ignore scarcity as a factor creating value - for money as well as for other things. Even Smith did not fully appreciate it.

  "Though [paper money] has no intrinsic value, yet, by limiting its quantity, its value in exchange is as great as an equal denomination of coin, or of bullion in that coin. On the same principle, too, namely, by a limitation of its quantity, a debased coin would circulate at the value it should bear, if it were of the legal weight and fineness, and not at the value of the quantity of metal which it actually contained. In the history of the British coinage, we find, accordingly, that the currency was never depreciated in the same proportion that it was debased; the reason of which was, that it never was increased in quantity, in proportion to its diminished intrinsic value."

  The private banking system is part of a nation's monetary system. It is therefore the responsibility of the state to regulate banking. Unfortunately, governments, too, have a bad record at managing monetary systems. Thus, Ricardo asserts, the natural disciplines of a gold or silver standard seem like the best alternative. 

  "Experience, however, shews, that neither a State nor a Bank ever have had the unrestricted power of issuing paper money, without abusing that power: in all States, therefore, the issue of paper money ought to be under some check and control; and none seems so proper for that purpose, as that of subjecting the issuers of paper money to the obligation of paying their notes, either in gold coin or bullion."

  Almost 200 years later, nothing has changed. Governments - ever hungry for ways to milk more revenue from an economy - love monetary inflation as a means of stealth taxation. It has been determined by trial and error that monetary inflation that does not inflict more than 2% price inflation on a nation does not destroy economic growth and is tolerated by the public. So, 2% price inflation is what governments now aim for. See, "Understanding Inflation." If productivity gains are in excess of 3%, price inflation at a rate of 2% reflects about 5% monetary inflation - a huge source of additional revenues for government purposes.

  The great advantages of paper for monetary purposes are recognized by Ricardo. However, he also recognizes that the issuer labors under powerful temptations to issue increasing amounts of paper money. Like Smith, he was quite familiar with the periodic panics caused by undisciplined issuance of negotiable notes by the private banks. Ricardo also recognized that a gold standard works only in normal times. Financial panics would cause bank runs that could quickly exhaust gold reserves.
 &
  Ricardo favored issuance of Bank of England notes to deal with such problems. He argued that it was clearly better to ship paper notes than large quantities of gold to the various country banks. However, Bank of England notes, too, can be issued in excess. Were panic ever to undermine confidence even in the Bank of England and its notes, Ricardo offers no answer.

  The Bank of England was a private profit-making company, but one which bore a public responsibility for managing the nation's currency and financing its wars.

  Ricardo notes the temptations and political imperatives that lead to excess issuance of paper money, but he does not discuss the full consequences of chronic inflation.

  Considering England's experience with inflation during the Napoleonic Wars, Ricardo's discussion of paper money appears somewhat nave. He is also familiar with the failures of paper currency in North America, both before and after U.S. independence.
 &
  Nevertheless, he indicates no awareness of the characteristics of chronic rapid inflation. This is something impossible with currency pegged to gold or silver. English paper notes were pegged before the Napoleonic Wars - and would be again according to Ricardo's advice. Perhaps for that reason, in his discussion of paper monies, Ricardo stops short of dealing with the wide range of noxious impacts of a substantial rate of chronic inflation.

Say's Law and Inadequate Demand

Say's law:

The accumulation of capital cannot depress profits.

  There can't be too much capital accumulation in a competitive market economy. In thus supporting the pertinent views of Jean Babtiste Say, and opposing those of Smith, Ricardo again stresses the natural powers of adjustment of the markets. Only higher natural wages will depress profits, Ricardo insists. The accumulation of capital cannot do that.
 &

  The act of producing extra supply creates extra demand that tends to balance the system.

  "[No] accumulation of capital will permanently lower profits unless there be some permanent cause for the rise of wages."

  "There is no limit to demand," Ricardo emphasizes. When profits are too low to attract investment capital, there will be foreign investments. If profits on foreign investments are too low, money that otherwise would have been invested will be spent or saved, and interest rates will decline for consumer borrowing as well as investments, all of which will increase demand and profits sufficiently to restore balance.

  "It follows then for [Adam Smith's] admissions that there is no limit to demand - no limit to the employment of capital while it yields any profit, and that however abundant capital may become, there is no other adequate reason for a fall of profit but a rise of wages, and further it may be added, that the only adequate and permanent cause for the rise of wages is the increasing difficulty of providing food and necessaries for the increasing number of workmen."

  Of course, Ricardo recognizes the glitches and delays in the adjustment processes of real economic systems. He repeatedly brings them into his discussions. In this chapter, he discusses state interference with interest rates. Also, creative destruction and the redeployment of capital involve major capital expenditures and losses.
 &
  Both he and Smith take special note of government interference in domestic markets and foreign trade. They elaborate on the harm caused by such interference - in today's terminology, such "industrial policy."
 &
  Actual profit rates are very difficult to determine, Ricardo acknowledges. They are related to interest rates, but interest rates exist in a broad schedule of different rates for different risks - as do profits. Interest rates also frequently suffer from government interference - especially usury laws in those days - as well as fluctuating risks. Thus, it is hard to offer numerical proof of these concepts.
 &
  Inflation of credit instruments and paper money also cause periodic adjustment problems. The adjustment process is indeed far from rapid or smooth - and it is in those delays and irregularities that the business cycle lives. It is in those adjustment delays that government administered alternatives achieve their short term desirable results.

  The existence of the business cycle, thus, is no refutation of Say's law, as many of its critics contend. Periodic recessions are required to force rationalization of private business plans and collapse of the inevitable houses of cards that afflict investment markets, as Say recognized. However, any simplistic view of the adjustment process is untenable.
 &
  Major government blunders - like ongoing monetary inflation or unsustainable levels of government borrowing or trade war levels of protectionism, or regulatory strangulation of industry or markets as in India, or attempts to substitute administered alternatives for market mechanisms - will thwart the adjustment process. These can make economic difficulties permanent for as long as it takes the government to recognize and sufficiently reform such noxious policies.
 &
  It is such colossal blunders of government economic policy - rather than any failure of Say's law - that explains the decade long Great Depression in the 1930s and the decade long chronic inflation, instability and stagflation of the 1970s. See, "Great Depression, Depression Mythology," and Great Depression Chronology articles, beginning with "Great Depression, The Crash of '29."

Automation fears:

 

 &

  Ricardo falls prey to automation fears - a weakness that would afflict many economists right up to modern times. It is possible, he believes, for improved productivity to render some labor redundant. However, Ricardo at least is smart enough to view this as very unusual. It is in no way some inevitable fate of "mature" capitalism.
 &

  Even though he recognizes that there is no limit to demand, he fails to appreciate the extent of the economic ability to produce more, improved, and new goods and services. Like so many intellectuals, since he is incapable of imagining what those new products and services might be, he is blind to them. His powers of calculating economic adjustments thus fail him in this instance.

  Increases in productivity ALWAYS enable an economy to produce more as well as to produce new products that could not economically be provided before - providing more and better jobs and higher living standards in the process.

  However, he is not  totally blind in this matter. He notes that capital productivity gains proceed slowly, allowing time for adjustments so that unemployment due to productivity gains never occurs. Every increase in capital increases the demand for labor, even if at a diminishing rate.
 &
  Of courses, with the recent end of a great war, he is correct in noting that the sudden increase in workers due to the discharge of men from the military will for a time leave men unemployed and wages depressed.
 &

The savings gap:

 

&

  The savings gap stupidity that would afflict Marx and Keynes and their followers is given indirect support by Ricardo. After the wealthy buy all the furniture and other luxury goods that they want, some of their income will go unspent - will be saved - leaving demand short of levels sufficient to maintain full employment.

  This, of course, is impossible for any modern economic system with functioning money markets and financial systems that immediately make use of all savings. Only after an economy has collapsed for some other reasons do savings reside unused in bank vaults or mattresses. The English banking system in Ricardo's time was probably already adequate to make impossible the development of a Keynesian savings gap - the accumulation of excess savings as a result of prosperous times that provide too much income to spend or invest.
 &
  In fact, savings rates decline with economic development and wealth. The wealthy in modern economic systems tend to rely on their asset wealth for reserve purposes rather than bank savings.

  However, Ricardo is at least intelligent enough to realize that this insufficient demand at most could only occur in the short run - until market adjustments have brought matters back into balance. He thus rejects the notion of a chronic savings gap such as Marx and Keynes were stupid enough to believe in. Increased savings must lead to capital accumulation, Ricardo points out, and capital accumulation must result in increased demand and higher living standards. (Nevertheless, this segment of Ricardo's work is one of unconvincing and somewhat contradictory reasoning.)

Taxes and War Debts

Taxes:

 

 

 

&

  The burdens of all taxes fall on capital or revenue. Despite the vast expenses of the Napoleonic Wars, it is evident to Ricardo that the revenues of Great Britain were sufficient to cover them without unduly restricting public consumption or even preventing further capital accumulation. The wealth of the nation and its revenues increased noticeably during the two decades of the war.
 &

  Taxation methods are not viewed as critically as Smith views them, perhaps because of the experience during the wars. It is the rate of taxation rather than the particular methods used that is most important to Ricardo. No matter whether a tax be assessed against income or capital, it will burden just income if it can be paid from a similar deduction in expenses, and from capital to the extent that it is not.

  "Taxation under every form presents but a choice of evils."

  Taxes must always be kept low enough to be paid from revenues without reduction of capital. Taxes levied on capital asset transactions - including estate taxes - obstruct the logical flows of capital and reduce productivity. The result of taxation is a decrease in productivity the net effects of which depend on any offsetting productivity advantages bestowed by government activities - such as education, the maintenance of law and order, the maintenance of the freedom of the seas, and the construction of useful infrastructure.
 &
  Unfortunately, governments levy taxes on the basis of ease of collection rather than on the basis of the impact on economic productivity. Ricardo goes at considerable length - about a third of the book - into the impacts of various taxes. He reviews taxes on income, estates, property transfers, raw produce, rents, land, gold, houses, wages, and commodities - and parish taxes for poor relief. He generally agrees with Smith both as to principles and particulars, but does have some disagreements about particulars of impacts - especially concerning taxes on wages, subsistence goods, and interests in land.
 &

  The substantial ability of the market economy to adjust to various taxes limits their ultimate impacts, Ricardo repeatedly stresses. He at various times notes the inherent loss of overall productivity caused by taxation, but seldom includes that in his analysis of particular taxes. He also on a couple of occasions mentions the affects of government expenditure of tax revenues. This puts money back into circulation, but displaces private consumption to some degree with government consumption.
 &
  Of course, if tax revenues are spent abroad - as was likely for the government of the British Empire - then prices would fall as the value of the remaining monetary gold rose. Monetary gold and silver were the international currencies of those times.
 &
  Of course, falling prices would discourage imports and encourage exports, serving to bring more gold into the nation to replace that which was spent abroad. There had in fact been a great surge in English exports during the Napoleonic Wars that helped to finance the war. As Smith explained, wealthy nations with productive and flexible economic systems thus finance their wars with the produce of their economic systems. They need not rely on great hoards of precious metals. Ricardo - correctly - expects much of those exports to wither as the world gets back to normal with the end of the war - just as they did after prior major conflicts.
 &
  Ricardo explains that, when discussing the impacts of different taxes, it is assumed that the discussion is about permanent impacts, not the immediate impacts during the time it takes for the economic system to adjust - which for such things as housing and population adjustments, can be quite lengthy. During the adjustment periods, tax burdens can - to a declining degree - afflict producers and distributors, until the least productive are driven out of business, and sufficient pricing power is provided to make the consumers pay.
 &
  He emphasizes how successfully a free international trading system would adjust to bring trade back into balance after a nation imposes new taxes. (However, he here ignores the impacts on the nation's terms of trade.)
 &

Business taxes are a cost of production that is passed on to buyers and ultimate consumers as a part of the cost of goods sold.

 

Income taxes are particularly obnoxious because of the reporting requirements and necessary enforcement procedures.

  Businesses don't pay taxes. They collect taxes. Business taxes are a cost of production that is passed on to buyers and ultimate consumers as a part of the cost of goods sold. The only businesses hurt are the marginal producers who are driven out of production by the increased costs imposed by taxes. For those who survive, business taxes cost little or nothing, since the reductions in the production of failed businesses permit a rise in prices sufficient to cover the costs of taxation.
 &
  Taxes on subsistence goods increase their price and thus the natural wages of labor. This depresses profit rates and capital accumulation and employment. Ricardo agrees with Smith that income taxes are particularly obnoxious because of the reporting requirements and necessary enforcement procedures.
 &
  Taxes on wages, profits and raw produce spread the burden most widely. They push up prices and are passed on to consumers. However, such taxes are viewed by Ricardo as the most equitable, because they are passed on to consumers in proportion to their consumption, and the wealthy clearly consume the most.
 &
  If "a tax in proportion to profits were laid on all trades, every commodity would be raised in price," and the burden would thus be passed on to the consumers, Ricardo states at one point. However, at another point he states that "if a tax were general, and affected equally all profits, whether manufacturing or agricultural, it would not operate either on the price of goods or raw produce, but would be immediately, as well as ultimately, paid by the producers."

  "All trades" in the first line in the preceding paragraph apparently doesn't include agriculture, so trades would be reduced in favor of agriculture and consumers would pay higher prices for the produce of those trades. Otherwise, these two assertions appear contradictory - or perhaps victims of a typographical error. Wouldn't the profits and prices of agriculture fall somewhat from such a massive shift of capital? Perhaps not, if much of the capital could flee abroad.
 &
  Of course, it is impossible to so finely calculate - much less collect - a profits tax in an equally proportional manner, so much of the cost would be passed on to consumers in any event. In accounting, "profits" are just a matter of professional opinion, not a statement of fact - as recent accounting shenanigans at Enron and similar entities in the U.S. and Europe amply demonstrate.

  A tax on monetary gold is the only commodity tax that may not affect the broader economy. If there is less monetary gold, then the remainder simply rises in value sufficiently to perform the same monetary purposes. Ultimately, the people who pay out some of their gold to the tax gatherer gain much of their loss back from the increase in value of the rest.
 &
  However, this adjustment process becomes far less precise if there is paper money in circulation. There will also be impacts on international trade accounts and the terms of trade unless the nation is a monopoly producer of gold. (Also, the deflationary adjustment process may not be without significant pain.)
 &
  Profits taxes distort commercial relationships.
They alter the relative prices and value of commodities depending on the average durability of the capital - the mix of fixed and circulating capital - used in production and distribution. They even cause the impacts of monetary inflation or deflation to differ for different commodities. (All taxes cause various degrees of distortion that impact productivity.) Taxes on particular profits are passed on to consumers similarly to general taxes on profits. Capital flees the industry until supply is reduced sufficiently to permit a suitable increase in prices.
 &

  The impacts of a tax on wages are exactly the same as a tax on profits. "Taxes on wages will raise wages, and therefore will diminish the rate of profits of stock."

  "A tax on wages is wholly a tax on profits, a tax on necessaries is partly a tax on profits, and partly a tax on rich consumers."

  Anybody earning above subsistence wages falls into the category of "rich consumers." Workers earning above subsistence wages - comprising the vast majority of workers in modern advanced nations - will share the burden of wage and payroll taxes.

  Taxes on subsistence goods increase their price and thus increase the natural wages of subsistence labor. This depresses profit rates and capital accumulation, but the economic adjustments prevent the impacts from being as severe as presented by Smith. Taxes on discretionary items fall only on those that consume them. Luxury taxes have many additional advantages, but produce uncertain revenues. They may collapse demand - and collapse the producing industry - yielding little revenue.

  "A country whose financial situation has become extremely artificial by a mischievous enormous taxation, is particularly exposed to the inconvenience attendant on this mode of raising taxes. After visiting with a tax the whole round of luxuries; after laying horses, carriages, wine, servants, and all the other enjoyments of the rich, under contribution; a minister is induced to have recourse to more direct taxes, such as income and property taxes, neglecting the golden maxim of M. Say, 'that the very best of all plans of finance is to spend little, and the best of all taxes is that which is the least in amount.'"

  A heavy tax on new power boats and yachts collapsed the industry in the U.S. and yielded little revenue. The tax was ultimately abandoned, and the industry recovered.

  Ricardo explains in detail why Smith and others were in error in their analyses of the extent of the impacts of taxes on wages and subsistence goods. Taxes reduce productivity and wealth in many ways - through a rise in costs to consumers and a general reduction in profit rates and capital accumulation. After the economy has had time to fully adjust, taxes on wages and subsistence goods actually  have essentially the same impacts as most other taxes. 

  However, since these adjustments necessarily include population changes, the adjustment period can be quite lengthy - extending over several decades.

  Tithes - percentage taxes on gross produce - are passed on to consumers. Taxes on particular commodities reduce their production. However, the economic impact is not the direct reduction in production, since capital is simply redirected elsewhere. The impact is in this distortion - shifting production and consumption to less efficient uses and to channels deemed less desirable by the public.
 &
  By taxing exports, part of the expense of government can be imposed on foreigners. However, this applies only to items for which the demand is relatively inelastic and the exporting nation's comparative advantage is substantial over all other nations in the world (a very rare commodity, indeed, in the modern world). Ricardo suggests that this would apply to a tax on tea by China. (Revenue derived from oil exports by efficient producers would be a modern equivalent.)
 &

  With respect to rent taxes, Ricardo has some disagreements with Smith. He denigrates the landlord interest almost as much as does Smith, and agrees that a tax on rent is peculiarly attractive since its impact falls only on the landlord - an unproductive class of people.
 &
  Of course, he's talking about rent narrowly defined - the rent on raw land - not the part of rent that includes the return on capital invested in land - "the landlord's stock" - (which today comprises the vast majority of rent). Taxes on the returns of capital invested in land, like all business taxes, are passed on to consumers. Similarly, land taxes assessed on value regardless of rent will be passed on to consumers.
 &
  Although Smith does recognize the distinction, Ricardo notes that Smith did not sufficiently distinguish raw land interests from the interests from capital invested in the land, and so made several errors in his analysis of rents and other applicable taxes.
 &

War debts:

 

 

&

  The great war debts of the Napoleonic Wars are a primary concern of Ricardo. He sets forth all the well known impacts of these war debts. Ricardo concludes that it would be best if these debts were paid off as quickly as possible - even at the expense of a one time reduction in capital. After all, what would happen if the debt burden were still in existence when the next war - or the next unexpected major emergency - came along.?
 &

  Similar worries had occupied Adam Smith, concerning the war debts of the 18th century wars. The two great worldwide conflicts that included the French and Indian War and the American Revolution in North America left debts of about 170 million. Yet, when the Napoleonic Wars came along, they dwarfed all the previous wars in financial costs and debt burdens assumed, leaving debts of almost 500 million. However, Ricardo notes that England was able to cope - and even to finance its allies and to expand its economic wealth.

  So, what's to worry?
 &
  In the event, Great Britain was to enjoy a glorious century of prosperity and freedom from major conflict between 1815 and 1914. However, the two great wars of the 20th century did indeed impose financial burdens and debts on Great Britain that were truly crippling.
 &
  The major difference was not the heavy debts, but England's economy in the 20th century - increasingly laboring under unsustainable welfare policies and, after WW-II, socialist policies and other administered alternatives. Such an economy simply no longer could adjust and grow its way out of the financial problems imposed by these wars - or even the financial problems imposed by its welfare and socialist policies.

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Copyright 2004 Dan Blatt