Ricardo: The Intellectual Contributor

The aim of this paper is to point out how the great thinker David Ricardo continued or answered some of the unresolved questions in Adam Smith’s theories. David Ricardo started off as a stockbroker then turned to an economist. He was a man who contributed to numerous areas of economic theory, including methodology, diminishing returns, rent, theories of value, and international trade. Ricardo began studying economics around 1799 at age 28, and published his first pamphlet “The High Price of Bullion” in 1810. His book (which is also his major work) “The Principles of Political Economy and Taxation” replaced Adam Smith’s “Wealth of Nations” with regard to economic questions. When it came to political economy, Adam Smith had two ways of dealing with the questions. The first was through deductive theory, which he would use for his economic analysis. The second, he would present a well described, informative narrative of present and historical organizations. Ricardo, however, absorbed from his present economy and used the deductive method as a base to build an analysis. Thus, he represented “the pure theorist at work”. It is worthy to note that Ricardo had a firm position on the fact that “theory was a prerequisite to concrete analysis of the policy issues of the real world.” With the brief bibliography presented, and the different (yet brief) methods of each economic scholar explained, the three topics this paper will cover are the Labor Theory of Value, Distribution of Income over Time, and International Trade.
Labor Theory of Value: Before any explanation done by David Ricardo regarding this thought, one must understand that Adam Smith kept asking questions till his death without giving a proper answer. Smith had contradicting ideas in his writings when discussing this theory. Smith believed that there were two meanings of value. The first, he called value in use, which are basically useful goods like clothing and food. This type of good gave the satisfaction received from consuming this item. The second, he would call, value in exchange. These goods according to Smith weren’t useful but could be exchanged for other useful items. This is what led Adam Smith to develop the Water-Diamond Paradox (The Paradox of Value). On the other hand, David Ricardo was more concerned with what economic forces cause changes in relative prices over time. In his book, he clearly distinguished his views from Adam Smith. Unlike Adam Smith’s position, Ricardo mentions that the value of a good depends on the total amount of labor required to produce that good. With this, Ricardo turns to the confusion in the water-diamond paradox and explains that value in use is essential for the existence of value in exchange; however, it is not its measure. According to Ricardo, the price of goods that return satisfaction is done from two sources: their scarcity and the amount of labor required to produce them. He did note that some commodities prices’ are determined by their scarcity and he excluded these from his theory of value. In the making of his theory, he encountered some difficulties but Ricardo did think of solutions for five problems. The first problem was to measure the quantity of labor. Smith believed that the value of skill and hardship were up to the market and that wages would reflect the laborers skills and hardship in accordance with their jobs. Ricardo strongly disagreed with this thinking and emphasized on the fact that the total amount of labor is what determines relative prices, not wages. Thus, his solution was to measure the total amount of labor by the amount of time it takes to produce a good, hence, by “clock hours alone.” The second problem was to realize that labor skills vary. Here, Ricardo fell in a skilled-labor problem. To solve this, he used wages paid to laborers to measure their production. Thus, the wage of one laborer producing more than the other would be twice that of the other less productive laborer. It is worthy to note that this is not circular reasoning because Ricardo’s main purpose was to make a theory explaining the changes in relative prices over time. The third problem was regarding capital goods. Ricardo’s solution to this problem wasn’t convincing, however, he answered the question: “What is the influence of capital on the prices of final goods under a labor cost theory?” by labeling capital as labor that was applied earlier in time. The fourth problem was the question of land rent. Adam Smith turned to the cost of production theory when land became an economic good and thus didn’t quite answer this. Hence, Ricardo proposed the solution to this problem through his theory of land rent. Although there will be two lands with different fertility, the price of the item depends on the marginal cost of the item that was least efficiently produced. Thus, price will be determined on the margin and at the margin there is no rent. This leads to the fact that rent is not a part of price, it is price-determined, and different rents on different fertilities of land won’t have an effect on changes in relative prices over time. Basically, rent is not labor and it is not time. The final problem Ricardo faced in developing his theory was determining the role of profits. He analyzed and examined the existence of profits and concluded that the effect of the rate of profits isn’t important.
Distribution of Income over Time:
When it comes to this theory, Smith predicted that the rate of profits will fall over time because of the competition in labor, commodity markets, and investment. Ricardo agreed with Smith on the fact that the rate of profits will fall over time but he did not agree with the reasons put forward by Smith. As for the first reason, Ricardo refuted Smith’s thought by using the Malthusian Population Doctrine. Ricardo’s argument was that people were going to reproduce, thus increasing population, which in turn would increase the labor force’s size in the long run. Thus, wages will be pushed down to the cost of reproduction (the cost of reproducing labor). The wage will go down to the subsistence wage in the long run. This basically means that total wages will be low and rent will be maximized. Thus, in the long run laborers will get very little wages and the landlords will get the rent. Ricardo rejected the second and third reasons done by Smith through an argument that is known as Say’s Law. Say’s Law basically states that supply will make its own demand. Thus, if we create a supply, demand will increase automatically. Ricardo argued that Smith’s second and third reasons of profits falling inferred a presence of general overproduction. Falling profits in the competitive investment markets will happen only if it’s impossible to sell at earlier prices the improved output that resulted from new investment. Hence, he stood firm on the thought that increased or improved output from new investment could be sold at previous prices, concluding that profit rates won’t fall. He also used this same argument to disprove Smith’s third reason. He pointed out the fact that the competitive commodity markets’ general prices won’t fall. Keep in mind that Ricardo believed and agreed with Smith that profits would fall. He just disagreed with Smith’s reasons.
International Trade: When it comes to this topic, David Ricardo strengthened Adam Smith’s analysis on the gains of trade that result from free trading internationally. Smith believed in abolishing all trade barriers and that by importing and exporting freely, production and wealth will increase. His theory states that each country should specialize in the production of the item that it produces best. If, for example, country X can produce a good at a lower cost than the country Y, and the country Y can produce another good at a lower cost than country X, then both country X and country Y will benefit from specialization and free trade. This theory became known as the theory of Absolute Advantage. David Ricardo took this theory and tackled the question: “What happens if one country enjoys Absolute Advantage in most items over the other country?” His solution to this was his theory of Comparative Advantage. Comparative Advantage is basically a measure of Absolute Advantage, and according to Ricardo, the countries should specialize and export the goods they have the greatest Absolute Advantage in. Thus, the item that the country has less Absolute Advantage in will be produced by the other country. To measure how large the Absolute Advantage of one country is, one must divide the labor required to produce the good in the other country by the labor required in the country of Absolute Advantage. Thus, Ricardo proved that the influential factor for gains from international trade is Comparative Advantage and not Absolute Advantage.
Conclusion:
In conclusion, the three topics chosen to be discussed in this paper that David Ricardo has dealt with were: The Labor Theory of Value, The Distribution of Income over Time, and International Trade. First, Ricardo disagreed with Smith and openly stated in the first chapter of his book that value depends on the total amount of labor necessary for production, and not on the wages paid to the labor. To prove this, he decided to develop his own theory of value and made five solutions to the fundamental problems that came his way. Second, when it came to the Distribution of Income Theory, Ricardo agreed with Smith on the fact that profits will not fall but strongly disagreed with Smith’s reasons. To prove this fact (and to somewhat strengthen Smith’s claim) he used the Malthusian Population Doctrine to refute the first reason (competition in labor markets) put up by Smith, and further went on to use Say’s Law to rebut the second and third reason (competition in investment and commodity markets). Finally, when it came to International Trade, Ricardo strengthened Adam Smith’s view on Free Trade internationally (without barriers) by introducing the concept of Comparative Advantage. Hence, we can say that David Ricardo is in fact “the continuation of Adam Smith”. However, I’d like to think of him as “Smith’s Intellectual Contributor”.
References:
* History of Economic Thought Book * On The Concept of Ricardo and Rent: https://www.youtube.com/watch?v=ZIY7hdJ3sVQ&list=PLEyOHk9v89u3j-IwGx7IJulrolWJKHqGx&index=65 * Distribution Theory Help: http://www.policonomics.com/ricardian-distribution-theory/ * Say’s Law Brief Explanation and Definition: https://www.youtube.com/watch?v=blVDRSL9dpk