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Thursday, August 1, 2013

Ricardo and the Ricardian system, II: the theory of value

This brings us to Ricardo's theory of value, or price. While Ricardo formally admitted that supply and demand determine day-to-day market pricing, he tossed that aside as of no consequence, and concentrated solely on long-run equilibrium, i.e. ‘natural’ price and the alleged macro-distribution of income in that equilibrium. Utility Ricardo brusquely disposed of as ultimately necessary to production but of no influence whatever on value or price; in the ‘value paradox’ he embraced exchange value and abandoned utility completely . Not only that: he frankly and boldly discarded any attempt to explain the prices of goods that are not reproducible, that could not be increased in supply by the employment of labour. Hence Ricardo simply gave up any attempt to explain the prices of such goods as paintings, which are fixed in supply and cannot be increased. In short, Ricardo abandoned any attempt at a general explanation of consumer prices. We have arrived at the full-fledged Ricardian – and Marxian – labour theory of value.
The Ricardian system is now complete. Prices of goods are determined by their costs, i.e. by the quantity of labour hours embodied in them, trivially plus the uniform rate of profit. Specifically, since the price of each good is uniform, it will equal the cost of production on the highest-cost (i.e. zero-rent) or marginal land in cultivation. In short, price will be determined by cost, i.e. the quantity of labour hours on the zero-rent land used to work on the product. As time goes on, then, and population increases, poorer and poorer soils must be brought into use, so that the cost of producing corn continues to increase. It does so because the quantity of labour hours needed to produce corn keeps increasing, since labour must be employed on ever poorer soil. As a result, the price of corn keeps increasing. Since wage rates are always kept precisely at the subsistence level (the cost of growing corn) by population pressure, this means that money wage rates must continue to increase over time in order to keep real wage rates in pace with the ever-rising price of corn. Wage rates must increase over time, and hence profits must keep falling until they are so low that the stationary state is reached.
To return to the idea of rent as not entering into cost: if we focus, as we should on the ‘micro’ – on the individual farmer or capitalist – it should be clear that the individual must pay rent in order to gain use of any particular plot of land in the productive process. To do so, he must outbid other firms in his own as well as other industries. Ricardo's refusal to even consider the individual firm, and his focus on holistic aggregates, enables him to overlook the fact that rents, even if differentials, enter into costs the way every expense on factors of production enters into them. This is the only way that is real and that counts in the real world: the point of view of the individual firm or entrepreneur. There is, in fact, no ‘social’ point of view, since ‘society’ as an entity does not exist.

can only increase at the expense of another. But the point of the free market in the real world is that generally production increases, so that the total pie tends to keep rising. And, second, if we focus on individual factors and on how much they earn, as does the later marginal productivity theory (and as did J.B. Say), then each factor tends to earn its marginal product, and we need not even concern ourselves with the alleged but non-existent laws and conflicts of macro-class income distribution. Ricardo kept his eye unerringly on the radically wrong problem – or rather, problems.
Ricardo's system is both gloomy and rife with allegedly inherent class conflict on the free market. First, there is tautological conflict because, given the fixed total, the income shares of one macro-group 
But there is even more class conflict here than implied by Ricardo's tautological macro-approach. For if value is the product solely of labour hours, then it becomes easy for Marx, who was after all a neo-Ricardian, to call all returns to capital exploitative deductions from the whole of ‘labour's’ product. The Ricardian socialist call for turning over all of the product to labour follows directly from the Ricardian system – although Ricardo and the other orthodox Ricardians did not of course make that leap. Ricardo would have countered that capital represents embodied or frozen labour; but Marx accepted that point and simply riposted that all labour producers of capital, or frozen labour, should obtain their full return. In fact, neither was right; if we wish to consider capital goods as frozen anything, we would have to say, with the great Austrian Böhm-Bawerk, that capital is frozen labour and land and time. Labour, then, would be earning wages, land would earn rent, and interest (or long-run profits) would be the price of time.
Recent analysts, in an attempt to mitigate the crude fallacy of Ricardo's labour theory of value, have maintained, as in the case of Smith but even more so, that he was attempting not so much to explain the cause of value and price but to measure values over time, and labour was considered an invariable measure of value. But this hardly mitigates Ricardo's flaws; instead, it adds to the general fallacies and vagaries of the Ricardian system another important one: the vain search for a non-existent chimera of invariability. For values always fluctuate, and there is no invariable, fixed base of value from which other value changes can be measured.
Thus, in rejecting Say's definition of the value of a good as its purchasing power of other goods in exchange, Ricardo sought the invariable entity, the unmoved power:

A franc is not a measure of value for any thing, but for a quantity of the same metal of which francs are made, unless francs, and the thing to be measured, can be referred to some other measure which is common to both. This, I think, they can be, for they are both the result of labour; and, therefore, labour is a common measure, by which their real as well as their relative value may be estimated.

It might be noted that both products are the result of capital, land, savings, and entrepreneurship, as well as labour, and that, in any case, their values are incommensurable except in terms of relative purchasing power, as Say had in fact maintained.
Part of Ricardo's impassioned quest for an invariable measure of values undoubtedly stemmed from his deep-dyed scientism. Ricardo was almost as interested in the natural sciences as in economics. From his early youth, Ricardo was keenly interested in the natural sciences, in mathematics, chemistry, mineralogy and geology. He joined the Geological Society in his 30s shortly after it was founded. It is probable that Ricardo's quest for an invariable measure of values was based on the physical science model; if ‘scientific’ in the physical sciences meant measurement, then surely this would be required in the human sciences as well. As Emil Kauder wrote, ‘I venture to say that Ricardo and his contemporaries believed that economics could only reach the dignity of a science if it could be based on objective measures like the Newtonian Physics’.8
An even stronger and more direct class struggle than that implied by the labour theory of value stemmed from Ricardo's approach toward landlords and land rent. Landlords are simply obtaining payment for the powers of the soil, which, at least in the hands of many of Ricardo's followers, meant an unjust return. Furthermore, Ricardo's gloomy vision of the future held that labour must be kept at subsistence level, capitalists must see their profits inevitably falling – these two classes doing as badly as ever (labour) or always worse (capital) while the idle and useless landlords keep inexorably adding to their share of worldly goods. The productive classes suffer, while the idle landlords, charging for the powers of nature, benefit at the expense of the producers.9 If Ricardo implies Marx, he implies Henry George far more directly. The spectre of land nationalization or the single tax absorbing all land rent follows straight from Ricardo.
One of the greatest fallacies of the Ricardian theory of rent is that it ignores the fact that landlords do perform a vital economic function: they allocate land to its best and most productive use. Land does not allocate itself; it must be allocated, and only those who earn a return from such service have the incentive, or the ability, to allocate various parcels of land to their most profitable, and hence most productive and economic uses.
Ricardo himself did not go all the way to government expropriation of land rent. His short-run solution was to call for lowering of the tariff on corn, or even repeal of the Corn Laws entirely. The tariff on corn kept the price of corn high and ensured that inferior, high-cost domestic corn land would be cultivated. Repeal of the Corn Laws would enable England to import cheap corn, and thereby postpone for a time the use of inferior and high-cost land. Corn prices would for a while be lower, money wage rates would therefore immediately be lower, and profits would rise, adding to the accumulation of capital. The dread stationary state would be put further off on to the horizon.
Ricardo's other anti-landlord action was political: by entering Parliament by joining Mill and the other Benthamite radicals in calling for democratic reform, Ricardo hoped to swing political power from the grip of the aristocracy, which meant in practice the landlord oligarchy, to the mass of the people.
But if Ricardo was too individualistic or too timorous to embrace the full logical consequence of the Ricardian system, James Mill characteristically was not. James Mill was the first prominent ‘Georgist’, calling frankly and enthusiastically for a single tax on land rent. In his high office in the East India Company, Mill felt able to influence Indian government policies.
Before obtaining this post, Mill had characteristically presumed to write and publish a massive History of British India (1817) without ever having been in that country or knowing any of the Indian languages. Steeped in the contemptuous view that India was thoroughly uncivilized, Mill advocated a ‘scientific’ single tax on land rent. Mill was convinced as a Ricardian that a tax on land rent was not a tax on cost and therefore would not reduce the incentive to supply any productive good or service. Hence a tax on land rent would have no bad effect on production – it would only have the effect of eliminating the ill-gotten gains of the landlords. In effect, a tax on land rent would be no tax at all! The land tax could be up to and including 100 per cent of the social product caused by the differential fertility of the soil. The state, according to Mill, could then use this costless tax for public improvement, and largely for the function of maintaining law and order in India.
We see now the pernicious implications of the fallacious view that any part of the expense of production is in some way, from a holistic or social point of view, ‘really’ not a part of cost. For if an expense is not part of cost, it is in some sense not necessary to the factor's contribution to production. And therefore this income can be confiscated by the government with no ill effect. Despite the deep pessimism of Ricardo about the nature and consequences of the free market, he oddly enough cleaved strongly, and more firmly than Adam Smith, to laissez-faire. Probably the reason was his strong conviction that virtually any kind of government intervention could only make matters worse. Taxation should be at a minimum, for all of it cripples the accumulation of capital and diverts it from its best uses, as do tariffs on imports. Poor laws – welfare systems – only worsen the Malthusian population pressures on wage rates. And as an adherent of Say's law, he opposed government measures to stimulate consumption, as well as the national debt. In general, Ricardo declared that the best thing that government can do to stimulate the greatest development of industry was to remove the obstacles to growth which government itself created.
While Adam Smith's free market views concentrated on the sinister nature of predatory government action, Ricardo was particularly struck by government's pervasive ineptness and counterproductivity. A typical and charming note was struck in a letter from Germany by Ricardo to James Mill in 1817: ‘We were very much delayed by the dilatoriness of the German Post, which being a monopoly, is of course very much mismanaged...’.
The paradox of Ricardo's gloom about the alleged class conflict on the free market and his determined opposition to virtually all government intervention was best and most wittily described by Alexander Gray:

Such is the Ricardian scheme of distribution; in place of the old harmony of interest, he has placed dissension and antagonism at the heart of things. ‘The interest of the landlord is always opposed to that of the consumer and manufacturer;’ So also the interests of the worker and the employer are eternally and irreconcilably opposed; when one gains, the other loses. Further, the outlook for all, except the landlord, is a process of continual pejoration.... Yet Ricardo remains immovably non-interventionist. ‘These, then’, he says, ‘are the laws by which wages are regulated’; and he adds inconsequently, ‘like all other contracts, wages should be left to the fair and free competition of the market, and should never be controlled by the interference of the legislature’. In a world of Ricardian gloom one might ask, and did in effect ask, why there should not be interference. An optimist carolling that God's in his Heaven, and that all's right with enlightened self-interest has a right to nail the laissez-faire flag to the mast, but a pessimist who merely looks forward to bad days and worse times ought not in principle to be opposed to intervention, unless his pessimism is so thorough-going as to lead to the conviction that, bad as all diseases are, all remedies for all diseases are even worse.10

Finally, a fundamental and fatal flaw in Ricardo's whole approach in his system was that he started at the wrong end. He began with his overriding focus on the laws of macro-income distribution; his theory of value and price was only a subsidiary appendage, enabling him to maintain that wages are not a part of cost, and therefore that the only influence of rising wages was to cause profits to fall. Ricardo, in short, never grasped the crucial point understood by his continental counterpart, J.B. Say: that there are no laws of macro-income distribution. Economics only establishes ‘micro’-laws determining price, including the prices of the various factors of production. In a sense, of course, the distribution of income in practice is a spin-off of market-determined factor prices; but this ‘distribution’ also depends on entrepreneurial profits and losses, in short on entrepreneurial responses to risk and uncertainty, and on the supplies at any time of the respective factors. None of the latter can be determined by economic theory. Once again, David Ricardo was pursuing a chimera, and in doing so took British economic theory off on a detour, or rather into a dead end.
Put another way, the French (Cantillon-Turgot-Say) analysis of the free market demonstrated that on the market there is no separate ‘distribution’ of income process, as there indeed would be under a state-controlled, or socialist economy. ‘Distribution’ is the indirect consequence of free production, exchange, and price determination.11
All of this escaped David Ricardo, who had little or no conception of the economy as a web of ‘micro’-relations linking together individual utilities, exchanges and prices. As Frank Knight has pointed out, Ricardo, in a letter to his disciple McCulloch, denied that ‘the great questions’ of macro-income distribution were ‘essentially connected’ with the theory of value. And further, Ricardo and his followers gave ‘practically no hint of a system of economic organization worked out and directed by price forces’.12
There is another point that needs to be made about Ricardo's basic economic goal. Chiding Adam Smith for being primarily interested in the total wealth of the nation rather than in the macro-distribution of income, Ricardo pursues his Malthusian hostility to population growth by asking what is the point of looking at gross rather than net income. As Ricardo puts it, in a famous and astonishing passage:

similar? Provided its net real income, its rent and profits be the same, it is of no importance whether the nation consists of ten or of twelve millions of inhabitants.
what would be the advantage resulting to a country from the employment of a great quantity of productive labour, if, whether it employed that quantity or a smaller, its net rent and profits together would be the same... To an individual with a capital of £20,000, whose profits were £2000 per annum, it would be a matter quite indifferent whether his capital would employ a hundred or a thousand men... provided, in all cases, his profits were not diminished below £2000. Is not the real interest of the nation. 

The difference between ten and twelve million may not make any difference to David Ricardo, but it makes a considerable difference, I should think, to the two million who would not have been around, and to their parents, friends and relations. There is no better example of the aggregative utilitarian economist looking upon the economy from the holistic viewpoint of a social slavemaster, rather than from the point of view of individuals on the market. As Alexander Gray, in his witty and perceptive way, puts it:

[Ricardo's] logic would lead to the desirability of the population being reduced to one, and that last remnant producing a vast net surplus with the aid of sorcery and mechanical contrivances. The repellent doctrine that man exists for the production of wealth, rather than that wealth exists for the use of man, here finds its classical utterance.

Austrian Perspective on the History of Economic Thought (2 volume set)

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