InsightsEconomic

This helped to cement in the pub-lic’s mind the idea that Ricardo was aneconomist of some standing. That sta-tus brought him into contact with otherfamous political economists of his time,notably James Mill and Thomas RobertMalthus. Mill became Ricardo’s mentor,coaching him and inspiring him to writemore in their shared field.

In 1814, Ricardo retired from busi-ness life and bought an estate in Glou-cestershire. A year later, he publishedhis next major work in economics,Essay on the Influence of a Low Price ofCorn on the Profits of Stock. In thatwork, Ricardo laid out what was tobecome a key idea in neoclassical eco-

David Ricardo was born in Londonin 1772, one of 17 children. His parentswere Sephardic Jews who had emi-grated to England. His father, Abraham,was a successful stockbroker. Ricardo’sbusiness career started when he beganworking for his father at age 14, but at21 he married a Quaker, which createda family rift that sent Ricardo into theworld completely on his own. He none-theless prospered as a stockbroker andleft a vast estate at his death.

Having no money problems,Ricardo could afford to spend a greatdeal of time in intellectual pursuits, andhe became interested in many subjects.Besides political economy, which hetook up after reading Adam Smith’sWealth of Nations in 1799, he also stud-ied mathematics, mineralogy, chemistryand geology. His career as an activepolitical economist lasted but 14 years.1

Ricardo’s first major work in thefield of economics, The High Price ofBullion, a Proof of the Depreciation ofBank Notes, was published in 1810.This pamphlet became very influential,making Ricardo’s name familiar to thosein government who sought economicadvice. A parliamentary inquiry into thehigh bullion price may have been thedirect result of the pamphlet’s publica-tion, but that’s speculative. In any case,the government report’s conclusion—that the inflation then occurring inEngland was the result of too manypaper banknotes being created—wasRicardo’s own claim in his pamphlet.

FEDERAL RESERVE BANK OF DALLAS VOLUME 9, NUMBER 2

David RicardoTheory of Free International Trade

Few ideas have been as widely accepted

by economists and as roundly rejected by

many other people as the doctrine of free

international trade. Economists base their

acceptance of the mutual benefits from such

trade on a concept called comparative

advantage. The theory is most closely associ-

ated with the writings of the great English clas-

sical school economist David Ricardo.

Although his career in the field of political

economy was brief, Ricardo became one

of the most influential—and financially

successful—practitioners the discipline has

ever known.

Today, world trade agreements are

under increasing attack. Many people are

deeply concerned about such issues as out-

sourcing and the physical location—and

relocation—of firms doing business across

national borders. In light of these develop-

ments, we offer this latest Economic Insights

on the life and ideas of one of free trade’s most

ardent theoretical defenders. Anyone inter-

ested in this issue should become familiar with

Ricardo’s work. We hope this short piece pro-

vides a useful starting point.

— Bob McTeerPresidentFederal Reserve Bank of Dallas

David Ricardo

nomics: the so-called law of diminish-ing returns as it applied to labor andcapital. Generally, as it applies to culti-vation of crops, this law states thatincreasing the quantities of inputs willincrease total production up to a point,but then output must decline, giventhat the land used is fixed in size.Although increasing production is pos-sible, and perhaps common at first, atsome point the marginal returns toadditional inputs must decline, fol-lowed by their average returns and,thus, total output must decline as well.

Ricardo’s purpose in exploring theissue of land rents was British legisla-tion called the Corn Laws. Passed in1815, these laws forbade the importa-tion into England of food grown else-where and sought to maintain the rising prices for British agriculturalproducts that had occurred during theNapoleonic wars, when the French navyhad embargoed British ports. Facingthe loss of food imports, Britain had touse more of its own land to feed itspopulation. This caused crop prices,and hence, land rents to rise at rapidrates during the war period. The pro-tectionist Corn Laws were an attempt tomaintain the agricultural status quo afterNapoleon’s defeat and a return to peace-ful conditions.

Ricardo, himself a landowner whowas profiting from the rising rents, nev-ertheless argued that the Corn Lawsshould not be enacted and, after theywere, continued to argue strenuouslyfor their repeal. Beyond that, the ob-served rent increases suggested to Ri-cardo a general theory of land rent.The reason rent exists, he argued, wasthat as more and more land of dimin-ishing fertility was applied to growingfood, the better lands commanded apremium. This was an argument forrent on the extensive margin, that is, asmore land was cultivated. But Ricardoalso argued for rent on the intensivemargin, that is, where similar landsexperienced different diminishing returnsto capital and labor. In Ricardo’s view,the Corn Laws generated rents both ex-

Under a system of perfectly free com-merce, each country naturally devotes itscapital and labour to such employments as are most beneficial to each. This pursuitof individual advantage is admirably con-nected with the universal good of thewhole. By stimulating industry, by reward-ing ingenuity, and by using most effica-ciously the peculiar powers bestowed by nature, it distributes labour most effec-tively and most economically: while, by in-creasing the general mass of productions,it diffuses general benefit, and binds to-gether by one common tie of interest andintercourse, the universal society ofnations throughout the civilized world. It isthis principle which determines that wineshall be made in France and Portugal, thatcorn shall be grown in America and Poland,and that hardware and other goods shall bemanufactured in England.

In one and the same country, profitsare, generally speaking, always on thesame level; or differ only as the employ-ment of capital may be more or less secureand agreeable. It is not so between differ-ent countries. If the profits of capital em-ployed in Yorkshire should exceed those ofcapital employed in London, capital wouldspeedily move from London to Yorkshire,and an equality of profits would be ef-fected; but if in consequence of the dimin-ished rate of production in the lands ofEngland, from the increase of capital andpopulation, wages should rise, and profitsfall, it would not follow that capital andpopulation would necessarily move fromEngland to Holland, or Spain, or Russia,where profits might be higher. n

—On the Principles of Political Economyand Taxation (Cambridge, UK:

Cambridge University Press, 1983),133–34

The Beneficent Effects of Free Trade and National

Profit Equalization

There are no taxes which have not atendency to lessen the power to accumu-late. All taxes must either fall on capital orrevenue. If they encroach on capital, theymust proportionably diminish that fund bywhose extent the extent of the productiveindustry of the country must always beregulated; and if they fall on revenue, theymust either lessen accumulation, or forcethe contributors to save the amount of thetax, by making a corresponding diminutionof their former unproductive consumptionof the necessaries and luxuries of life.Some taxes will produce these effects in amuch greater degree than others; but thegreat evil of taxation is to be found, not somuch in any selection of its objects, as inthe general amount of its effects taken col-lectively.

Taxes are not necessarily taxes oncapital because they are laid on capital; noron income because they are laid on in-come…. The desire which every man has to keep his station in life, and to maintainhis wealth at the height which it has onceattained, occasions most taxes, whetherlaid on capital or on income, to be paid from income; and therefore as taxation pro-ceeds, or as government increases itsexpenditure, the annual enjoyments of the people must be diminished, unless theyare enabled proportionally to increase their capitals and income. It should be thepolicy of governments to encourage a dis-position to do this in the people, and neverto lay such taxes as will inevitably fall oncapital; since by so doing, they impair thefunds for the maintenance of labour, andthereby diminish the future production ofthe country. n

—On the Principles of Political Economyand Taxation, 152–53

Taxation Impedes Growth, and Its Incidence Falls Not Necessarily Where

the Law Says

One of the ideas for which Ricardois most remembered is the theory ofcomparative advantage. Ricardo demon-strated that for two nations withoutinput factor mobility, specialization andtrade could result in increased totaloutput and lower costs than if eachnation tried to produce in isolation.Since Ricardo’s exposition, the distinc-tion between absolute and comparativeadvantage has been taught as one ofthe field’s most brilliant insights.Nations will export not only what theyhave an absolute advantage in produc-ing, but also what they have a compar-ative cost edge in producing. Some his-torians of economic thought havesought to show that others, specificallyJames Mill and Robert Torrens, statedthe idea, or something close to it, priorto Ricardo. Such writers tend to dis-count Ricardo’s version of the theory asvery short and possibly even incorrect.6

tensively and intensively. His analysis ofthe effects of the Corn Laws producedthe famous Ricardian theory of rent.2

In 1817, he expanded his pamphleton rent and retitled it On the Principlesof Political Economy and Taxation. By1819, he had been elected to the Houseof Commons, where he continued tobe an active participant in the policydiscussions of his time.

Ricardo died suddenly of an earinfection in 1823, leaving an estate esti-mated at $126 million (current dollars).As Mark Blaug comments: “Ricardo mayor may not have been the greatesteconomist that ever lived, but he wascertainly the richest.”3

Ricardo’s Contributionsand System

Ricardo’s approach to economicsdiffered markedly from that of AdamSmith. Ricardo was a pure theoretician,an architect of a simple, highly abstractmodel from which he drew policy con-clusions. His most important assump-tion was that economic growth mustdecline and end due to the scarcity ofland and its falling marginal productiv-ity. In this, we see the origin of JohnStuart Mill’s later contention that eco-nomic stagnation would flow from theworking out of the capitalist productiveprocess. It also is very suggestive of laterarguments by John Maynard Keynes ofthe continuing potential macrostagnationthat, according to Keynes and many ofhis followers, flows from a chronicinsufficiency of aggregate demand inany relatively closed-market economy.

Ricardo’s foremost contemporarycritic was Malthus, author of the famouspamphlet An Essay on the Principle ofPopulation. It was from Malthus thatRicardo took the argument of an ever-growing population that pressedagainst all economic expansions, anassumption that lay at the heart ofRicardo’s model. His central considera-tion in his Principles was to show howdistributional changes between wages,rent, interest and profit affected theprospects for long-run capital accumu-

lation and economic growth.4 Becausehis model produced a falling rate ofprofit and an ever-rising price for corn(grains), Ricardo favored an end to theCorn Laws, arguing that Britain oughtto import corn from countries betterequipped to produce it at lower cost.He hated the rising rents he attributedto the laws, since they came, in hisview, at the expense of the drivingforce of the economy—profits.

Twenty-three years after his death,the laws were repealed and Ricardo’sinternational free trade agenda becameone with British public policy. Ricardohad provided an answer to Britain’slong-term growth problems, and Britainbecame the “workshop of the world,”importing most of its food and “out-sourcing” most of its agricultural employ-ment. Ricardo’s ideas became “thefountainhead of all nineteenth-centuryfree trade doctrine!”5

There is no point more important in issuing paper money, than to be fully impressed with theeffects which follow from the principle of limitation of quantity. It will scarcely be believed fiftyyears hence, that Bank directors and ministers gravely contended in our times, both in parliament,and before committees of parliament, that the issue of notes by the Bank of England, uncheckedby any power in the holders of such notes, to demand in exchange either specie, or bullion, hadnot, nor could have any effect on the prices of commodities, bullion, or foreign exchanges. Afterthe establishment of Banks, the State has not the sole power of coining or issuing money. The cur-rency may as effectually be increased by paper as by coin; so that if a State were to debase itsmoney, and limit its quantity, it could not support its value, because the Banks would have an equalpower of adding to the whole quantity of circulation. On these principles, it will be seen that it isnot necessary that paper money should be payable in specie to secure its value; it is only neces-sary that its quantity should be regulated according to the value of the metal which is declared tobe the standard. If the standard were gold of a given weight and fineness, paper might beincreased with every fall in the value of gold, or, which is the same thing in its effects, with everyrise in the price of goods…. Experience, however, shows, that neither a State nor a Bank ever havehad 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 seemsso proper for that purpose, as that of subjecting the issuers of paper money to the obligation ofpaying their notes, either in gold coin or bullion. n

—On the Principles of Political Economy and Taxation, 353–54, 356

The Potential Pitfalls for Paper Monies

money change prices instead of realfactors.

Ricardo’s theory of rent was tieddirectly to the marginal productivity ofland, his theory of value was tieddirectly to labor costs, and his theory ofdistribution stood atop both concepts,with Malthusian economic stagnationas a major assumption. Ricardo was notso naive as to attempt to explain allmarket prices by labor costs. He recog-nized the importance of “nonreproduc-ible” commodities whose value wassolely determined by their rarity in themarket. However, he considered thesethings—rare paintings, fine wines—tobe a small portion of overall marketconsumption. He also allowed a rolefor capital in determining value andargued that an increase in fixed (morepermanent) capital as opposed to cir-culating (perishable) capital would in-crease value. By allowing value to beinfluenced by capital, Ricardo indirectlysuggested that time played a major rolein value, a discovery later generallyattributed to other economists.8

Ricardo’s model, abstract and highlydeductive, became the means by whichhe advocated public policy. A freetrade enthusiast, he also was not a fanof public expenditure, believing mostsuch spending to be at worst wastefulor at best incapable of changing aggre-gate well-being and output. His influ-ence should not be underestimated,especially in Great Britain, for as Keyneswrote, “Ricardo conquered England ascompletely as the Holy Inquisition con-quered Spain.”9 n

— Robert L. FormainiSenior Economist

Notes1 “David Ricardo,” by G. de Vivo, in The New

Palgrave: A Dictionary of Economics, ed.

John Eatwell, Murray Milgate and Peter Newman, vol. 4, London: Macmillan Press, 1987, pp. 183–98.

2 See the general discussion in A History of Economic Theory and Method, by Robert B.

Ekelund, Jr., and Robert F. Hébert, 4th ed., New York: McGraw-Hill, 1997, pp. 144–46.

3 Great Economists before Keynes, by Mark Blaug, New York: Cambridge University Press, 1986, p. 201.

4 Ekelund and Hébert (1997), p. 147.5 Blaug (1986), p. 203.6 Classical Economics: An Austrian

Perspective on the History of Economic Thought, by Murray Rothbard, vol. 2, Hants, UK: Edward Elgar, 1995, pp. 96–98.

7 “David Ricardo’s Discovery of Comparative Advantage,” by Roy J. Ruffin, History of Political Economy, vol. 34, Winter 2002, pp. 727–48.

8 Ekelund and Hébert (1997), p. 148.9 The General Theory of Employment, Interest

and Money, by John Maynard Keynes, New York: Harcourt Brace, 1936, p. 32.

Other economic historians defendRicardo and argue the contrary.7

Regardless of ongoing academic dis-putes, it is unlikely that historians ofeconomic thought will reverse theirposition on Ricardo’s original author-ship of this idea.

Another major contribution Ricar-do made to economics was the doc-trine of fiscal equivalence, or, as it hascome to be known today, Ricardianequivalence. His argument, as put forthin Chapter 17 of his Principles, is as fol-lows: It doesn’t matter whether govern-ment finances itself through taxes or debt. They are equivalent and have no appreciable effect on house-hold consumption or capital formation.This is because either the public sector will save or run a deficit, orhouseholds will do likewise and at thesame rate. Further, expectantly, taxpay-ers view a deficit as a future taxincrease and will save to pay for it,while a surplus is viewed as a futuretax cut with an opposite result.Households will arrange their privateaffairs to frustrate the long-run effectsof either finance approach, as judgedfrom a macroeconomic policy perspec-tive. (To be sure, Ricardo did not wantgovernment to issue debt rather thanraise tax revenue, regardless of the truthof his equivalence insight.)

Other concerns that Ricardo de-voted himself to were monetary re-form, the distribution of national in-come and the determination of aninvariant measure of value. Ricardofavored redemption of paper money ingold bullion, argued for decoupling the Bank of England from that nation’smoney supply creation and contendedthat labor costs were the best long-run invariant measure of the value ofgoods and services—a labor cost the-ory of value not unlike what Smithhad also proposed in Wealth ofNations. Ricardo was a believer in thestrict quantity theory of money,whereby the price level is directly pro-portional to the quantity of money cir-culating and changes in that quantity of

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