Wednesday, August 11, 2010

"I am not David Ricardo!"

In the fall of 2009, my graduate program at UNCG had the honor of hosting the famous Nobel Prize winning economist--Dr. Paul Krugman. He gave us a brief but enlightening lecture on exploring the origins and the direction of our recent financial crisis and resulting recession. After the lecture, I was fortunate enough to have time to speak with him. Though I hadn't read any of his books at the time (no longer true), I still wanted something for him to sign. At the time, I was reading David Ricardo's "Principles of Political Economy and Taxation". Since Ricardo was the father of comparative advantage in International Trade, and Krugman's Nobel winning work was in that area, I thought I had enough of a connection to justify using this book to get Krugman's autograph. Of course, he noticed what the book really was, made a quick joke, and proceeded to write in it "I am not David Ricardo!". This leads me to the point of this post: who is, or rather who was, David Ricardo.

While I would consider Adam Smith every man's
Economist, David Ricardo is more of every Economist's Economist. He lived during the early 19th century, and was the man who did the most to turn Adam Smith's work into an extended theoretical model. This model, known today as the classical model, still has a lot to tell us about how economies work and trade. Finally, he also introduced the concept of making use of how changes in increments or margins can inform us about optimal decisions and responses.

Here are the important points in his work, according to me:

1. The relative scarcity of a good with other goods is one of the fundamental determinants of its value, and should be taken in conjunction with its utility to consumers and its marginal production cost.

2. Labor spent on the production of capital (investment), must also factor into the cost of production of goods for immediate consumption.

3. When labor is not the sole input in a production process, but also capital of varying durability, a rise in wages has an ambiguous affect on the price of the good.

4. A rise in wages is most often associated with a fall in profits, and vice versa.

5. The implementation of land, labor, and capital are subject to diminishing returns.

6. A productive activity should be undertaken until its marginal return to the producer just equals the cost. And, if an agent can monopolize this product, it can extract all of the surplus from consumers up to that equimarginal condition.

7. If transactions costs are not too great, labor and capital will gravitate to where they are most productive, reducing the return in these industries to the average return, which is set by societal preferences and institutions.

8. All else held constant, the wages of the worker tend to fall toward the subsistence level, which is also set by societal preferences and institutions.

9. Wages tend to rise as the economy grows, because of the diminishing returns to the cultivation of land (perhaps no longer true).

10. If children are normal goods, rising wages mean a rising population, which will erode wage gains. Thus, making children inferior goods might be beneficial to workers in the short run.

11. Profits fall as the economy grows, assuming there is no improvement in technology or the division of labor.

12. As the economy expands and profits fall, wages rise but can be eventually eroded by increases in population. Thus, all else held constant, an expanding economy eventually results in a redistribution of wealth to monopolists.

13. Limited factor mobility within nations allows them to benefit from their own unique division of labor so that they can trade with another nations in a way that can leave at least one party better off without leaving any others worse off. This is true absolutely as well as comparatively.

14. Attempting to control the balance of trade by laws or taxes will either be totally ineffective, or leave both parties worse off in the long run.

15. In a static economy, the consumption of the government must eventually come out of wages, rent, or profit. They ultimately require workers, entrepreneurs, or landlords to reduce consumption or to liquidate capital stock. Either of these can be harmful to overall national output.

16. The ability of a tax to meet Adam Smith's requirements depends on elasticities of demand and the availability of substitute goods.

17. In the long run, the money supply should not affect the equilibrium output of an economy. (Take this with a huge grain of salt, and think about the limitations of this true statement).

18. Placing a tax on goods that a country exports and has a significant comparative advantage might be the least disruptive to overall output.

19. Profit inequalities are what determine the flow of capital at home and abroad.

20. Increasing output per capita should be the overall goal of all national economic policy.

21. An increase in value, and an increase in riches are NOT the same thing. A product can increase in value by becoming scarcer or harder to produce. This will reduce the wealth of society. Thus, declining value of products is usually a sign of the increasing wealth of a nation.

22. Increasing output per capita through the division of labor and technology is better that relying on pure savings and capital formation.

23. Real interest rates are ultimately governed by expected profits, but these are so volatile in the short term that any point estimate is usually unreliable.

24. Monopolists have more to gain from from protectionist policies than those facing competition.

25. Paper money is a good that derives its value most from its scarcity.

26. Banks are, by their design, vulnerable to consumer panics. Thus, no private bank should be allowed too much control over the money supply.

27. The economy as a whole benefits from substituting machines for workers, but the workers themselves may be harmed by frictional unemployment. Wealth redistribution of the surplus generated by the machines can compensate for this inconvenience.

28. Classical Doctrine for Output Growth: Division of Labor ==> Increased Savings ==> Capital Accumulation ==> Output Growth ==> Increase in Labor Demand ==> More Workers ==> Division of Labor.

Too Long to Read Summary: Paul Krugman signed my copy of David Ricardo's book. Ricardo formalized a lot of Adam Smith's work with his classical model of an economy. He argued that long run production costs at the margin make up natural prices, wages and profits move inversely, wages gravitate to subsistence levels and profits to zero as the economy expands, international trade is not a zero sum game, paper money should be regulated, monopolists play the subversive role of Adam Smith's Merchants, and the end goal of economic policy should be growth in output per worker.

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