Wednesday, 5 September 2012

Economist of the Week - David Ricardo

Every prophet needs his evangelists – people who embrace his ideas, interpret and clarify them, in the end contributing to their field very much in their own name. Regarding the field of economics, the prophet was Adam Smith, but who is his evangelist? In this week's edition of Economist of The Week, we bring you Smith's most important follower, a stock broker turned economist – David Ricardo.

Image from Wikipedia

Early life

Ricardo was born in 1772, as the member of a strictly religious Sephardi (Iberian) Jewish family, the third of 17(!) children, who moved in recently to London from the Dutch Republic and before, Portugal. His father worked as a successful stockbroker, and Ricardo certainly had an aptitude for the business – all was set for him to carry on the family business, and live and die as a successful businessman. Actually, he was the opposite of Adam Smith in every imaginable way:
  • He had overseas roots, while Smith was of ancient Scottish blood
  • he was a sibling of many, while Smith was a single child
  • he lived in Southern England all his life, while Smith was devoted to Scotland
  • and most importantly, he choose economics more out of necessity than interest.
But how is that so? The answer lies with yet another crucial difference – love life.

Ricardo's gamble

In 1793, young Ricardo committed the biggest mistake a man of his age could commit (at least in the eyes of his father): he fell in love. His lady of choosing was however, a British Quaker – a mistress his parents could not tolerate. When he choose to marry Priscilla Anne Wilkinson, his father disowned him, and his mother stopped talking to him ever again – at the age of only 23, David was all alone.

A fresh start

All was not lost, however – his aptitude for business remained, and he started out on his own as a stock broker. He soon became successful – thanks to the connections he built while still working with his father, and had the money and influence to maintain an early 19th century upper-middle class lifestyle – that is, to visit the famous resort town of Bath on vacations along his wife. It was here where he had his first contact with economics – the businessman of his time (and of today) were never deeply engaged in academic discourse. His contact couldn't have been more perfect – he read Wealth of Nations.

Starting out as an economist

The book had a deep, if somewhat delayed influence on him – he was still only 27, and being faced with bureaucratic restrictions on trade throughout his career, he was very much inspired by Smith's message of free trade. He continued his successful career as a stock broker (later, he made a fortune buying British securities before the battle of Waterloo), but the increased financial instability of the Napoleonic wars lead him to publish his own views in his first economic paper in 1809 – at the age of 37.

Views and success

His views were very controversial – and hence very popular. In his first article, he argued that the current inflation experienced by the Bank of England was the direct result of excess money creation to fund war efforts, and that the country should return to the gold standard to curb inflation. Although today this would seem obvious to many, it was revolutionary at his time, and it laid the seeds of monetarism. His view was a part of the greater debate called 'bullion controversy', where anti-bullionists argued against the re-introduction of the standard.
His main work, On the Principles of Political Economy and Taxation, was published in 1817, and was also a great success. In it, he introduced the term of comparative advantage, which meant the advantage of a particular nation to produce certain goods – to use the familiar example of the cow farm, you're better off catering cows with a plain, while you should sell goats with a house in the hills. Hence, with unrestricted trade, you'll export the cows, while your hill neighbour can export the goats at the cheapest possible price, creating prosperity for all.

Other ideas

Besides the idea of comparative advantage, Ricardo contributed to the field of economics with several other important ideas. These included The law of diminishing returns, meaning that if you add more units to one of the factors of production and keep the rest constant, the quantity or output created by the extra units will eventually get smaller to a point where overall output will begin to fall. Sounds confusing, right?

But imagine: You have a single cow, which you can sufficiently supply with all the food it needs, hence she produces 100 litres of milk. You buy a second one – but now you have to divide your time between the two, which means that the cows will be less-well cared for, meaning that they will only produce say, 90 litres of milk each. The return is diminishingand if you buy too many cows, in the end their actual milk production will be less before their purchase.

We must also mention his value theory, where he stated that the relative prices of identical goods are only determined by the ratio of labour quantity used in their production – that is, if you have a cow and I have a cow, and I attend to her more, but use the same pasture and tools, in the end my milk will be more expensive. Hence workers will be forced to produce the same quality with the least work involved as possible.

Later life and death

Ricardo had 8 children, and he was a Member of the British Parliament starting from 1817. He died early, in 1823, at the age of 51, but despite his short academic career, his contributions to economics are nonetheless enormous – by expanding the scope of Adam Smith's theory of free trade and prices, the two essentially built the fundamentals of modern economics. His theories are influential to this day.

Congratulations – you have learnt everything about David Ricardo. Unfortunately, due to a school trip I'm going on with my class, I won't be able to post until Sunday – but do not despair, since Schoolonomic will be back with brand new posts starting from the end of the week.

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