The Principles of Political Economy and Taxation (Barnes & Noble Library of Essential Reading) by David Ricardo, Robert E. Wright (Introduction)

From the Publisher

Many of the problems of globalization confronting us today---including finding the right balance between economic growth, technological advance, and international trade, and human welfare---also troubled earlier generations. David Ricardo's Principles of Political Economy and Taxation represents an important early attempt to illuminate the problem and to offer viable policy solutions.

The book, like modern "principles of economics" textbooks, exposes readers to rigorous economic thinking and deductive reasoning, but does not contain advanced mathematics. Principles heavily influenced socialist thinkers such as Karl Marx as well as classical economists like John Stuart Mill and John R. McCulloch. In the economics of international trade, the book continues to be a major influence.

Product Details

• Forewords & Introductions

Forewords & Introductions

INTRODUCTION

Globalization has accelerated in recent years but it is not a new process. Many of the problems confronting us today---including finding the right balance between economic growth, technological advance, and international trade, on the one hand; and human welfare, particularly the living standards of the poor, on the other---also troubled earlier generations. David Ricardo’s Principles of Political Economy and Taxation represents an important early attempt to illuminate the problem and to offer viable policy solutions. Although it contains no advanced mathematics, the book, like modern “principles of economics” textbooks, exposes readers to rigorous economic thinking and deductive reasoning. Principles heavily influenced socialist thinkers such as Karl Marx as well as classical economists like James Mill, John Stuart Mill, and John R. McCulloch. Although superseded in most of its details, much of the text is still considered a correct first approximation by many economists. Especially in the economics of international trade, the book continues to be a major influence. For those reasons, many economists consider Principles the first “modern” economics text.

The author of this work, David Ricardo, is perhaps best described as Adam Smith with attitude. Born in 1772 to an orthodox Jewish stockbroker who had recently moved to London, Ricardo studied at the Talmud Torah attached to the Portuguese Synagogue in Amsterdam for two years. At age fourteen, he returned to London and joined his father’s counting house as an apprentice. Just four years later he horrified his parents by announcing his intentions to become a Unitarian and to marry a Quaker. Expelled from his parents’ house and discharged from his apprenticeship, Ricardo competed in business against his father. A member of the London Stock Exchange from 1793 to 1816, Ricardo made a living, and a very good one at that, buying and selling public securities. Thanks to the quickness of his mind and the coolness of his judgment, he soon “left all his contemporaries at the Stock Exchange far behind.” By the time he was twenty-six years old he was independently wealthy. After making a tidy sum by correctly deducing the outcome of the battle of Waterloo, he largely retired from active business worth between £500,000 and £1.6 million, a princely sum that he invested in both financial assets and real estate. Earnestly interested in weighty questions of public policy, Ricardo spent his remaining years expounding upon the economic lessons that he had learned in the City of London’s hyper-competitive securities markets.

Ricardo displayed some literary flair when composing polemical pamphlets and short op-ed pieces for newspapers. But when writing longer works for a sophisticated audience, like Principles, his exposition grew plodding yet terse, no doubt because he yearned for a degree of clarity and precision not easily attained with the English language. Indeed, historians of economic thought still ponder the intended meaning of some of his more opaque passages and Ricardo himself admitted that he was “but a poor master of language.” Yet for most people, Principles is more readily comprehended than the mathematical formulas that have supplanted words in most recent economic texts. And most contemporaries preferred reading even the most demanding passages of Ricardo’s prose over listening to his harsh, high-pitched speaking voice.

Utilitarian philosopher James Mill encouraged Ricardo to write Principles because he valued what critics of modern economic methodology would later dub “Ricardian Vice,” Ricardo’s deductive model-building. Moreover, Mill and others saw that the leading economic text of the day, Adam Smith’s seminal Wealth of Nations (1776), no longer adequately addressed the biggest problems facing the British economy---industrialization, urbanization, and the relative decline of the agricultural sector. Another great British scholar, Thomas Malthus, also befriended Ricardo. Although of diametrically different backgrounds and views, Malthus and Ricardo challenged each other to sharpen their respective interpretations by constructively criticizing each other’s ideas at every turn. “They hunted together,” contemporary Maria Edgeworth claimed, “in search of the Truth.” Malthus later admitted that, aside from members of his own family, he “never loved anybody” as much as he loved Ricardo though in the end they could do no more than agree to disagree.

In Principles, Ricardo exposed Adam Smith’s views as not so much wrong as woefully incomplete in certain particulars. Many of Ricardo’s difficulties with Smith’s views stemmed more from uncharitable readings of Wealth of Nations than from substantive differences. For instance, Ricardo incorrectly assumed that Smith also believed in the central importance of the law of diminishing returns, the view that output per worker will eventually decrease as more laborers are added to a production process. Similarly, Ricardo, who usually concerned himself with analyses of the long run, chided Smith for being too concerned with short-run changes. But clearly Ricardo modeled his Principles on Wealth of Nations, which he drew on extensively for ideas and organization as well as the occasional rhetorical foil. In short, Ricardo suckled at the intellectual teat of the father of capitalism.

It is therefore ironic that Ricardo influenced the intellectual father of communism, Karl Marx, who learned of Ricardo’s views directly from Principles and also indirectly through the writings of early British socialists. Socialists were drawn to Ricardo’s labor theory of value because it seemed to justify their notion that workers deserved a larger part of the economic wealth that they created. Unlike most socialist thinkers, however, Ricardo made clear that capital also helped to create wealth and hence should also receive its fair due.

Ricardo’s pessimistic view that population increases would likely erase the positive effects that productivity gains have on real wages was likewise music to Marx’s ears because it seemed to portend the end of capitalism. Again, however, only in a misunderstanding of the Ricardian system could socialists find succor. It was in fact German socialist Ferdinand Lassalle, not Ricardo, who strenuously argued that an “iron law” pinned real wages close to subsistence levels. Ricardo, by contrast, understood that “in an improving society” a rising demand for labor could outstrip its supply, leading to an increase in real wages above mere subsistence. Similarly, Ricardo deduced that “overproduction,” one of the main theoretical underpinnings for Marx’s belief in the inevitability of communism, was impossible.

Although Ricardo flirted briefly with the early Owenist movement, nobody has seriously argued that he was a socialist. Nevertheless, many classical economists never quite forgave him for insinuating the existence of a persistent conflict between labor and capital. For that and other politicized reasons, and the general faddishness of the academy, Ricardo’s reputation has vacillated over the years. Although lauded by most contemporaries, Principles suffered from abuse and disuse in the latter part of the nineteenth century, partly due to the admonition of British economist William Stanley Jevons, who proclaimed Ricardo an “able but wrongheaded man” who “shunted the car of economic science to a wrong line.” About the same time, with a vituperation rarely seen in the academic press, German economist Adolf Held accused Ricardo of defending the material interests of financiers!

Obviously, Ricardo could not have been both a socialist and a capitalist apologist. He was, in fact, a capitalist, but not an apologetic one. According to several of his contemporaries, Ricardo exhibited keen interest in the plights of the working poor and of pensioners of modest means. A “bullionist,” i.e., a critic of the Bank of England’s suspension of specie convertibility during the Napoleonic Wars, Ricardo helped to develop a plan that eased Britain back onto the gold standard, and price stability, by 1821. Like any good bond trader, Ricardo dreaded inflation because of its adverse effect on bond prices. But he also realized that inflation caused the purchasing power of annuities to decrease, much to the injury of widows, orphans, and others who lived on fixed incomes. So by backing a return to gold, Ricardo aided both rich and poor alike.

In addition to preventing pernicious increases in the price level, the gold standard aided international trade by decreasing transaction costs and foreign exchange rate uncertainty. Ricardo was a strong proponent of trade largely because he believed that it had a salubrious effect on the conditions of the working poor. For centuries, most economists and policymakers believed that wealth came at the expense of someone else. In such a “zero sum” world, exports were good because they appeared to increase wealth, particularly gold and silver, but imports were bad because they seemed to decrease the nation’s stock of precious metals. Many nations therefore implemented policies designed to decrease imports and increase exports. Great Britain, for example, passed laws, the so-called “Corn Laws,” that impeded the importation of grains.

Ricardo, like Smith before him, saw through such nonsense. People, he strenuously maintained, can be counted on to pursue their self-interest. They therefore trade only when they expect to get something out of the exchange, when they value the thing received (bought) more than the thing given (sold, or money). Whether examined at the individual or national level, both parties grow wealthier from trade, otherwise they would not bother making exchanges. Policies that limited trade therefore created poverty, not wealth. The Corn Laws were particularly bothersome in Ricardo’s view. To the extent that they dissuaded the importation of grains, the Corn Laws raised the domestic price of wheat, rye, barley, etc. Although high prices were a boon to British landlords, they injured consumers of bread, dairy products, and other goods sensitive to grain prices. The Corn Laws, in other words, came at a cost borne largely by industrialists and their workers. All trade restrictions, Ricardo deduced, helped some domestic interests (producers) while injuring others (consumers). His next insight, that the losses to consumers exceeded the gains to producers, sealed his conviction in favor of free trade and repeal of the Corn Laws.

Though he passed away in 1823, twenty-three years before the nation of his birth abolished the Corn Laws, Ricardo is widely credited with persuading British legislators that free trade would increase economic output. In Principles and in speeches in the Commons, where he served for four years, Ricardo made clear that nations were best served when they made the products that they were relatively good at producing and trading for the rest. That principle, “comparative advantage,” has been called the only concept in the social sciences that is both true and non-trivial. Its truth has been mathematically and empirically established; the depth of its profundity is demonstrated by the fact that almost no one intuits it and that few understand it at first.

Indeed, even Adam Smith stopped short of explicating the concept in full. All that he could muster was a special case of comparative advantage called absolute advantage. “If a foreign country can supply us with a commodity cheaper than we ourselves can make it,” Smith correctly argued, “better buy it of them with some part of the product of our own industry, employed in a way in which we have some advantage.” What Ricardo showed was that a nation was better off trading even when it could not produce anything more efficiently than its trading partner could. It should make and trade away whatever it was comparatively good at producing, even if the other country was absolutely better at making it. If the other country did likewise, total output would be maximized.

Suppose, for example, that workers in Germany can produce 1 yard of cloth with 4 hours of work or 1 bushel of wheat with 2 hours of work, and that workers in Britain can produce 1 yard of cloth with 1 hour of work or 1 bushel of wheat with 1.5 hours of work. In 10 hours, Britain can therefore produce 10 yards of cloth, or 6.7 bushels of wheat, or some combination thereof, at the cost of 2 yards of cloth per 3 bushels of wheat. In 10 hours, Germany can produce 2.5 yards of cloth, or 5 bushels of wheat, or a combination thereof, at the cost of 2 yards of cloth per 1 bushel of wheat. Britain in this example has an absolute advantage over Germany in the production of both cloth (10 > 2.5) and wheat (6.7 > 5). Yet, trade would still profit both parties. If Britain specializes in what it does comparatively better (cheaper) than Germany, producing cloth, and if Germany specializes in what it does comparatively better (cheaper) than Britain, producing wheat, total production (and consumption) of both wheat and cloth will be maximized.

Without trade, the price ratio of cloth to wheat in Britain, as noted above, will be 2 to 3, while in Germany it will be 2 to 1. With trade, merchant-arbitrageurs, people who buy low in one market to sell high in another, will ensure that the price ratio of cloth to wheat in both Britain and Germany will be (roughly) the same. What the new ratio will become depends on a variety of factors but obviously it will fall between the initial price ratios in both countries, i.e., somewhere between 2/3 and 2/1. For convenience sake, suppose the new price ratio ends up at 1/1. In that case, Britain could make 1.5 yards of cloth instead of 1 bushel of wheat, then trade 1 yard of the cloth to Germany for 1 bushel of wheat. Clearly, Britain has gained .5 yards of cloth from the trade. Moreover, Germany can now produce 1 less yard of cloth, turning those resources instead to the production of 2 bushels of wheat. One of those bushels goes to Britain in exchange for the yard of cloth; the other bushel is Germany’s net gain from trade.

Although obviously fictional, and a little complicated, neither this example nor Ricardo’s parallel example of trade between Britain and Portugal is achieved by mathematical trick or rhetorical sleight of hand. Run as many examples as you wish, you will always find that whenever initial price ratios differ, trade produces welfare gains (more stuff) for both parties. Economists today realize that the real world is a little more complex than this, but Ricardo’s basic insight has been shown to hold in case after case, so they almost always argue for freer trade.

Were he alive today, Ricardo would applaud the United States for trading wheat, pharmaceuticals, higher education, motion pictures, and consulting services for televisions, DVD players, steel, and other manufactured goods. By doing what they do comparatively best, allowing others to do likewise, and encouraging unrestricted trade, the United States, Britain, and other stalwarts of the World Trade Organization, Ricardo would argue, are helping to make the world a better place.

Robert E. Wright, financial and business historian, is the author, co-author, editor, or co-editor of six major works: Origins of Commercial Banking in America (2001); Wealth of Nations Rediscovered (2002); Hamilton Unbound (2002); History of Corporate Finance (2003); History of Corporate Governance (2004); and Mutually Beneficial (2004). A native of Western New York, he holds a Ph.D. in history from the State University of New York at Buffalo, and he has taught courses in history, economics, and business at New York University, Temple University, and the University of Virginia.