18 April 2018

Ricardo’s ideas are as indispensable today as they were 200 years ago


It’s David Ricardo’s birthday. Or at least it would have been were he still alive. The classical economist has been dead for nearly 200 years, but his insights and theories remain immeasurably valuable today.

Yet Ricardo was, in many ways, an unlikely economist.

Born into a large Sephardic Jewish family, he received little formal education, instead joining his father on the London Stock Exchange at the age of 14. Ricardo is rare amongst economists in amassing a vast personal fortune, largely due to a series of canny speculations on the stock market. His interest in economics was sparked by a chance reading of The Wealth of Nations during his late twenties. Compared with Smith, his near-contemporary, Ricardo’s life and works remain relatively obscure, but his contribution to economics was immense.

What is perhaps most remarkable about Ricardo’s work is his ability to articulate nuanced and elegant concepts in an entirely theoretical way, anticipating the complex equations and modelling that now dominate economics. As Professor David Friedman puts it, the modern economist reading Ricardo’s Principles of Political Economy “feels rather as a member of one of the Mount Everest expeditions would feel if, arriving at the top of the mountain, he encountered a hiker clad in T-shirt and tennis shoes.”

Ricardo was an early proponent of a Land Value Tax, one of those rare ideas which finds favour with economists across the political spectrum. Himself a landlord, Ricardo’s “Law of Rent” explained how landowners are able to monopolise the gains from economic growth. Ricardo understood that much of the value of land exists due to conditions that have nothing to do with the landowner’s effort or expense — often, far more to do with other people’s labour, and the good fortune of where it happens to be situated. He viewed unearned income derived from land as a harmful anomaly: “that portion of the produce of the earth which is paid to the landlord for the use of the original and indestructible powers of the soil”.

Surprisingly little has changed in some ways, and we can see contemporary examples of this inequity all around us. For example, it has been estimated that extending the Jubilee Line in the 1990s increased residential land values within 1000 yards of stations by £13 billion, at a cost of £3.3 billion. In other words, taxpayers from across the UK contributed to these costs but only a select group of homeowners benefited from the gains. The presence of high-quality public services also has a significant impact on house prices. A home in the UK near a top-performing school can be worth anything from 5 to 20 percent more than one near a bad school.

Ricardo understood that the economic principles behind land value tax offer a unique solution to some of these problems; being a levy that, if properly implemented, could harness some of the unearned wealth of land and location value, and channel it back into the community that helped create it.

Ricardo may have anticipated some of the policy questions of today, but he is of course best known for his attacks on the prevailing economic doctrine of his time – mercantilism, embodied in the early 19th century by the notorious “Corn Laws”.

Mercantilists held that the amount of wealth in the world was finite and fixed — and argued that the only way to prosper was to hoard gold, impose tariffs on products from abroad and eliminate trade imbalances between nations. Unsurprisingly, countries fell into bouts of retaliatory tariffs which hampered free exchange.

Ricardo’s counterintuitive theory of comparative advantage offered a powerful rebuttal to this understanding of trade. He held that both countries benefit from trading with each other, even when one has an absolute advantage in producing all the goods exchanged — so long as there are differences in the efficiencies of their own industries that give them an incentive to focus on areas where they enjoy the biggest comparative advantage.

For instance, few people know that Winston Churchill was a talented bricklayer, who single-handedly constructed a wall around Chartwell, his country estate. But, at the height of World War Two, it would surely have made more sense for Churchill to contract out this task, and focus instead on speech-making or strategising in the War Rooms — even if he might have built a better wall himself.

Likewise, if each country specialises in the products where it is comparatively more efficient, we enjoy better outcomes – total production is higher and consumers can access a wider range of products.

In arguing against protectionism and for comparative advantage and specialisation, Ricardo followed the example set by Adam Smith in arguing that mercantilism rewarded select groups of producers and the rich — all at the expense of ordinary consumers and the poor. Imports raise the collective standard of living by giving people what they want, at lower prices, they argued. With money to spare, consumers are then able to purchase more from producers, thereby creating jobs and driving prosperity.

Time has certainly vindicated Ricardo. Though he never lived to witness it, following the abolition of the Corn Laws in 1846, Britain flourished.

Yet although Mercantilism was seen off in the 18th and 19th centuries by Smith, Ricardo and their inheritors, John Bright and Richard Cobden, it is making a comeback on both sides of the pond — and has certainly found a powerful proponent in the White House. Neo-mercantilist noises are also growing as we gear up to our EU departure; with many arguing against the unilateral abolition of tariffs and other barriers for precisely the same reasons as the mercantilists – for the sake of protecting producers and special interest groups.

Likewise, the old mercantilist fallacy that wealth is a zero sum game abounds in contemporary politics, and in the work of economists like Ha-Joon Chang and Danny Dorling. The charity Oxfam seems to spend its time campaigning against wealth, as if there were a finite amount to be divvied up within human civilisation.

David Ricardo may have been dead for almost 200 years, but as we move towards a new juncture in the trade debate, and as the forces of protectionism loom large in domestic policy, his ideas seem more relevant than ever.

Madeline Grant is Digital Officer of the IEA.