Classical Economics, Lecture 2

Bentham and Ricardo

Rothbard and Ricardo

• The discussion of David Ricardo is crucial for Rothbard’s approach to the history of economics.

• In the standard view that Rothbard challenges, Ricardo’s Principles of Political Economy and Taxation (1817) is the next great book in economics after The Wealth of Nations (1776). The standard view says Ricardo established economics as a rigorous science. David Friedman takes this view. He regards Ricardo’s book as one of the all time great books.

Rothbard and Ricardo Continued

• Rothbard rejects this. It is part of the Whig Interpretation of economics. To Rothbard, Ricardo made disastrous mistakes. Ricardian economics is almost all wrong.

• One of Ricardo’s fundamental mistakes was a way in which he differed from Adam Smith. Smith was concerned with how economies grow--- “the wealth of nations.” Ricardo wasn’t. He wanted to find out how income is distributed, assuming that the economy is static.

Another Mistake

• In Austrian economics, there aren’t separate laws of distribution. Once all the individuals make their production and consumption decisions, there isn’t a remaining question about distribution.

• This leads to another of Ricardo’s mistakes. He wasn’t much concerned with individual prices or factors. He talked about aggregates---what determined wages, e.g., not an individual wage.

Ricardo’s Method

• Rothbard thus objects to the question Ricardo asked, how is income distributed among rent, wages, and profit or interest, taking these as aggregates?

• He also objected to way Ricardo tried to answer his question. Ricardo set up a system of mathematical identities. These are tautologies that don’t tell us anything about real causal relations.

Method Continued

• Ricardo started from this identity:

• Total Income = Rent + Wages + Profit

• If you assume that Income and Rent are constants, then if wages go up, profits will go down. This is an arithmetic identity and doesn’t tell us anything about causation.

Austrian Method

• Before we go into the details of Ricardo’s system, there is an objection to consider.

• Rothbard objects to the deductive way in which Ricardo reasons. But doesn’t Austrian praxeology reason in the same way?

• No: Austrian economics uses axioms that are true. It doesn’t rely on arbitrary axioms. Also, it is interested in casual relations, not mathematical tautologies.

Ricardo’s System

• To understand Ricardo’s equation, we have to understand what he thinks determines rent, wages, and profits.

• For wages, Ricardo accepts Malthus on population. ( Malthus was a friend of his). Malthus thought that population tends to increase until no more people can be supported at the level of food production that prevails.

Wages

• Ricardo accepted this. He drew the consequence that if wages rise, population will increase. This will drive down wages. Wages cannot go below subsistence.

• Thus, for Ricardo wages in his equation are fixed.• By “subsistence”, Ricardo didn’t mean bare

physical survival. There is an element of social custom involved.

• Rothbard doesn’t accept the mechanical relation between population and wages that Ricardo does.

Wages Continued

• Because population depends on food supply, the wage rate depends on the cost of food. Workers have to be able to buy enough food for subsistence; but their wages won’t rise much higher than that.

• Because Ricardo aggregates commodities, he talks about the price of corn when he discusses the cost of food. (This refers to wheat, in American usage).

More Wages

• If the price of corn rises, then wages also have to rise.

• Remember, in Ricardo’s equation, Total Income is constant. If wages rise, something else has to go down.

• As we’ll see, Ricardo thought that rent would not go down. Only profit is left. If wages rise, profits fall. Wages and profits are in an inverse relation. This is an arithmetic identity, if neither Total Income nor rent changes.

Rent

• Probably the most distinctive element in Ricardo’s system is his account of rent.

• The land in a given economic system varies in how productive it is. People will first use the most productive land. When that is all taken, they will go on to the next most productive, etc.

• As population increases, less and less productive land is used.

Rent Continued

• If a type of land is more productive than another, all the gains go to the landlord. The user of more productive land, if he is not the owner, gets no net benefit from using it.

• Land is always used until the point of zero surplus to the landlord. In other words, marginal land earns zero rent.

Profit

• Once rent and wages are taken out, what is left is profit. Again, this is an arithmetic identity.

• As more and more land comes under cultivation, it becomes harder to grow corn. Because workers cannot get a wage below subsistence, wages rise---wages must cover the cost of subsistence, which has gone up.

More Profit

• The increase in wages comes entirely at the expense of the capitalist. The landlords don’t give up anything.

• Profit and wages are inversely related, and there is a tendency for wages to rise.

• It follows that there is a long term trend for profit to fall.

Criticisms

• Rothbard argues that Ricardo’s ideas about distribution rest on arbitrary assumptions.

• Ricardo’s theory of rent is especially vulnerable: why does the amount of rent for land A consist solely of its differential productivity from other land ? Related to this, its wrong to assume that land would be cultivated that had zero return.

• Also, for land of superior productivity, why does all the benefit go to the landlord?

Ricardo on Prices

• So far, we have been explaining Ricardo’s views about the distribution of income.

• This doesn’t account for the price of individual goods.• Changes in supply and demand could cause prices to

fluctuate temporarily. But in the long run, the price of something is determined by the number of labor hours required to make it. This amount could be converted into a money price, depending on the quantity of money. To this, the profit rate would be added.

Prices Continued

• This theory requires some way to equate labor of different kinds of skill. E.g., how is the labor of a surgeon to be equated with the labor of a ditch digger?

• This would later be a problem for Marx.• Ricardo acknowledged that if a good didn’t have

utility, it couldn’t command a positive price. But utility was a necessary condition for economic value: it didn’t determine price.

Is There Anything Good About Ricardo?

• Ricardo accepted Say’s Law. Total production can’t exceed total spending and saving because this total just is total production. The introduction of money doesn’t change this.

• Ricardo really got this from James Mill.

Comparative Cost

• Usually, the law of comparative cost or advantage is taken to be one of Ricardo’s greatest achievements.

• It’s obvious that if A is better at growing oranges than B, and B is better than A in growing apples, A and B together will produce more oranges and apples combined if each specializes in what he can do best. The can then trade with each other.

• But what happens if A is better than B at growing both apples and oranges?

Comparative Cost

• The law of comparative cost says that trade is still advantageous if one party is absolutely better at producing everything than the other. The better producer should concentrate on producing the product in which he enjoys the greatest amount of superiority. The worse producer should concentrate on producing the product where is margin of inferiority is least.

Comparative Cost Concluded

• Although Ricardo was right about this, Rothbard thinks he didn’t really care much about the subject.

• It was really James Mill who developed the law. Mill was a very tough personality, primarily an organizer. Rothbard calls him a cadre type. Mill’s own contributions to economic theory haven’t been emphasized enough.

• Rothbard does give Ricardo credit for his opposition to taxes and government.intervention

Mises on Association

• Mises generalized Ricardo’s law into the Law of Association.

• This says that everyone benefits through social cooperation on the free market.

Why Bentham?

• Why does Rothbard include a chapter about Jeremy Bentham in the book? Although Bentham wrote about economics, he wasn’t a major theorist.

• Rothbard discusses him because he thinks that Bentham’s utilitarianism was basic to classical economics.

Utilitarianism

• The utilitarianism that Rothbard attacks is different from the views of Mises and Hazlitt. They simply contend that rules of morality aim to promote human welfare.

• The free market is the best way to promote welfare.• Bentham wanted to add up pleasures and pains.

“The greatest happiness of the greatest number.” This view has many problems, e.g., what if people’s pleasures and pains depend in part on their moral views?