Ricardo’s Macroeconomics: Money, Trade Cycles, and Growth

Published by EH.NET (September 2005)

Timothy Davis, Ricardo’s Macroeconomics: Money, Trade Cycles, and Growth. New York: Cambridge University Press, 2005. xii + 316 pp. $75 (hardcover), ISBN: 0-521-84474-6.

Reviewed for EH.NET by James C.W. Ahiakpor, Department of Economics, California State University, East Bay.

I very much looked forward to reading this book. I expected to find another fresh contribution to the reinterpretation of David Ricardo’s macro-monetary analysis in contrast with much of what one reads of him in the modern literature, based mainly on misrepresentations of his work by John Maynard Keynes and Joseph Schumpeter. I came away more disappointed than pleased with Timothy Davis’s work. On one hand, Davis reaffirms some earlier reinterpretations of Ricardo’s work, following mostly Sam Hollander, reinterpretations Davis calls “the new view” (p. 29). On the other hand, Davis does not appear to go much beyond these earlier reinterpretations. Indeed, some of his arguments and analysis might properly be described as retrogressions or a diminution in the quality of Ricardo’s macro-monetary analysis — a diminution because Davis takes some steps backward from some recent advances in the literature on Ricardo’s macroeconomics, particularly on the law of markets. Davis also misses several opportunities to assist advancement in modern macroeconomic analysis from Ricardo’s work.

The book contains eight chapters. The first lays out the background to David Ricardo’s emergence into economic writings, mainly on the issues of money, credit, taxation, trade, and the causes of economic growth and recessions. Significant among the motivating factors for Ricardo were the Napoleonic wars, the inflations and recessions associated with the cessation of these conflicts, the suspension of convertibility of the pound into specie and subsequent resumption, Ricardo’s study of Adam Smith’s Wealth of Nations and his disagreements with parts of Smith’s arguments, particularly Smith’s theory of value and views on bounties. The six subsequent chapters provide numerous textual evidence to support the theoretical summaries contained in chapter 1.

Thus, chapters 2 and 3 describe events during the business cycles of 1815 to 1818 and 1818 to 1825, respectively. These show that, contrary to some perceptions, the British economy was not mired in a decade-long depression following the Napoleonic wars. Chapter four documents Ricardo’s familiarity with economic events from his pamphlets, letters and speeches in Parliament, based on his experience as a professional stock jobber and a loan contractor, and having known the relevant sources of financial data. The main point here is to counter the prevalent notion of Ricardo as someone who was uninformed about economic events and built models purely from deductive reasoning. Chapter five, devoted to Ricardo’s analysis of postwar events, mainly contrasts Ricardo’s views with those of Robert Malthus. Ricardo comes out as clearly having views more consistent with the facts about the British economy’s adjustments through recessions and recoveries. Chapter six attempts an analysis of Ricardo’s views on the law of markets, while chapter seven is devoted to Ricardo’s monetary analysis. The concluding eighth chapter summarizes some of these arguments again and draws some parallels between Ricardo’s views on the resumption of convertibility of the pound and the gold standard in the early 1820s and Keynes’s views on Britain’s return to the gold standard in 1925. There is also an impressive set of appendices covering 64 pages, including financial, price, and trade data. Analysts, besides Keynes, whose interpretations of Ricardo Davis rebuts in the book are Joseph Schumpeter, Mark Blaug, Frank Fetter, T.W. Hutchison, Piero Sraffa, D.P O’Brien, Lionel Robbins, B.A. Corry, William Coleman, Terry Peach, and to some minor extent, George Stigler and Jacob Viner. Indeed, Davis also takes some dissenting positions from those of Sam Hollander, e.g., pp. 142, 147-48. So why wouldn’t I rate the book as a major contribution to the advancement of scholarship on Ricardo’s macroeconomics?

First, most of the interpretations rebutted are rather old, before the 1970s, and are mainly reaffirmations of Sam Hollander’s earlier work. It is curious, for example, that Davis does not refer to Blaug’s editions of Economic Theory in Retrospect, but only to his 1958 views on Ricardo. Second, in several cases the textual evidence cited is not the most suitable to the case at hand, particularly on the law of markets and on machinery and unemployment. Third, numerous pieces of textual evidence are cited without carefully laying out the theories they are supposed to validate. One easily can get lost wondering what the relevant macroeconomics is supposed to be, if one does not already know. For example, several of the quotations cry out for identification with Ricardo’s and Malthus’s employment of the classical forced-saving principle (in the reverse), e.g., pp. 136, 140, 160n, a concept Davis hardly mentions. That identification would have been a helpful counter to the view gaining currency with some writers that the forced-saving doctrine is mainly an Austrian analytical concept. Fourth, Davis repeats the sterile debate over whether Say’s Law might be interpreted as an identity or an equality proposition. This in spite of the fact the identity version would be meaningful only for a barter economy, a point Davis recognizes (p. 162). And since the classics dealt with a monetary economy, that discussion seems unworthy of the ink and paper spent on it; the point is made in a chapter in Kates (2003), a book to which Davis also contributed.

Fifth, and what is most disappointing, Davis accuses Ricardo of having failed to employ the law of markets consistently, and having adopted the equality version which “allows for a temporary glut of all commodities” (p. 162). He later quotes Ricardo’s (4: 344) own statement, insisting that “there may … be a glut of 2 or of 10 commodities but … there cannot be a glut of all” (p. 173), but offers no reconciliation of the apparent inconsistency with his interpretation. In fact, as J.S. Mill explains, money is included among the commodities, and this is why there cannot be a glut of all commodities at the same time (also mentioned in Kates (2003, p. 113)). It is also from such understanding that we easily can make sense of Ricardo’s declaration to Malthus: “Men err in productions, there is no deficiency of demand” (which Davis quotes on p. 147). Earlier, Davis (pp. 41-42) argues that Ricardo’s macroeconomics “suffers because it does not integrate his insight that aggregate demand might, in theory, be deficient and that, in practice, the hoarding of cash sometimes occurs.” But Ricardo (1: 358-59; 5: 199-200, cited on pages 156-57), for example, does employ hoarding by the public and the Bank to explain the occurrence of economic distress. Davis (p. 182) also quotes Ricardo as making the same point about hoarding.

Sixth, in the chapter on the law of markets, Davis repeats the claim that the so-called “Treasury view” of fiscal policy, attributed to Ricardo, assumes Say’s identity and full employment: “he assumed full employment with no underlying analysis … [he] assumed away the underlying problem [of wage and price adjustments] and then concluded that no remedy [to unemployment in a recession] was required” (p. 162; also p. 182). But Ricardo’s argument is simply that whatever a government spends out of tax revenues or borrowed funds must be at the expense of private sector spending (see Ricardo’s statements quoted on pp 166 and 168). Ricardo’s use of the term “capital” to refer to the funds transferred from the private sector to government may have confused many readers who follow Keynes and B?hm-Bawerk in interpreting “capital” to mean only capital goods, and thus conclude that Ricardo did not recognize the existence of excess productive capacity in recessions. But the problem with that confusion of “capital” with capital goods in the modern literature has been publicized since 1990. Thus, Davis could have made a greater effort to find consistency in Ricardo’s (1: 265) recognition that, in economic distress, “much fixed capital is unemployed, perhaps wholly lost, and labourers are without full employment” (quoted on p. 182), with Ricardo’s views on fiscal policy rather than to accept that he assumed full employment. That “Hollander (1979, 515) also concedes that Ricardo adhered to a full employment model” (p. 166) is no good reason for repeating the claim now. Besides, of what use is any macroeconomic theory for understanding economic recessions if it is founded on the assumption of full employment, a point Keynes (1936) successfully used to discredit classical economics? Of course, Keynes had no valid basis for that attribution to the classics, as has been pointed out since 1995 and mentioned in Kates (2003).

Seventh, Davis interprets Ricardo as having argued the position of discretionary monetary policy (chapter 7). This in spite of Ricardo’s prescription of convertibility as a means of restraining excessive paper money creation, or under a purely paper money system, the Bank of England having the prime duty of keeping the price level from varying — that is, observing a price-level stability rule. Indeed, it would appear that Ricardo’s aversion to a central bank’s ability to vary the price level and thus distort the distribution of incomes, through the mechanism of forced-saving, led to his not prescribing the responsibility of lender of last resort function to the Bank. The pursuit of price-level stability assures that a central bank would expand its notes in periods of excessive demand for money during panics, the very condition under which the lender of last resort function is typically urged in modern macroeconomic analysis. Besides, Ricardo (esp. 1: 363-64; 3: 91-92) well understood that capitals — investment funds — are supplied by savings, not the quantity of money a central bank creates. Variations in market rates of interest reflect the relative demands and supplies of such capitals or savings. Thus, it properly is not the business of a central bank to attempt to manipulate market rates of interest.

Instead, Davis claims that Ricardo did not advocate the lender of last resort function for the Bank of England because that function already had been undertaken by the Exchequer (pp. 20, 209, 221). One would think that a person of Ricardo’s brilliance, which the book also seeks to illustrate, would have argued that function for the Bank if he thought it was proper. It also seems strange that Davis sees nothing wrong with a suggestion attributed to Thornton, namely, that “the Bank might amass a hoard [of gold] sufficient to fund an external drain for up to two years” (p. 212), as a viable, let alone sensible, monetary policy. From where does the Bank, a private corporation, find the means to engage in such a loss making proposition? It would, it seems to me, also be unwise even for a state corporation to do the same. But Davis holds the suggestion to be “vastly superior” to Ricardo’s position.

Davis attempts to play up his perceived analytical superiority of Ricardo’s over Smith’s in the book, which I think leads to some incorrect claims. One is that Smith assumed that “profits are exogenously fixed” (p. 25), only to be contradicted with a quote from Smith (p. 26n) as well as Smith’s argument that profit rates are reduced by the competition of capitals (p. 35). He also quotes Smith as arguing that “The increase of stock, which raises wages, tends to lower profit” (p. 170), the same inverse wage-profit relation famously attributed to Ricardo. Ricardo indeed took a great deal of his macro-monetary analysis from Smith, besides David Hume. J.-B. Say also drew on Smith’s Wealth of Nations in formulating the law of markets. Yet Davis accuses Smith of having failed to understand that increases in investment would lead to increased incomes and the demand for goods and services over time (pp. 35, 183), whereas Ricardo understood that process as part of Say’s Law. Ricardo did criticize Smith’s views on bounties, but conceded Smith’s main point that bounties misallocate capitals and raise the price level (Ricardo, 1: 316); see also Davis’s quotations of Ricardo, pp. 128-30. Ricardo employed a slightly different process to arrive at that conclusion, particularly that the importation of money in return for the exported corn raises the price level. But in Davis’s account, Smith was simply prone to committing the “fallacy of composition,” and thus was wrong in his conclusion (p. 35; see also pp. 171, 183). In the process of denigrating Smith’s analysis, Davis misses a good chance to draw a useful lesson for modern policy analysis from the corn bounties debate, namely, that subsidizing exports in order to encourage their domestic production does not promote overall efficient economic growth and well-being. Davis’s apparently low regard for Smith’s macroeconomic analysis also shows in his questioning whether Smith accepted Hume’s price-specie flow mechanism (p. 8). But a careful or perhaps a sympathetic reading of Smith, which Davis quotes (p. 8n), and the rest of Smith’s chapter on money, would indicate that he did follow Hume’s monetary analysis.

Some other minor points: (1) By not keeping clearly in mind the classical distinction between “capital” as funds from capital goods, Davis (p. 128) gives a distorted interpretation of Ricardo’s (1: 395) explanation that “every rise of wages will have a tendency to determine the saved capital [funds] in a greater proportion than before to the employment of machinery. Machinery and labour are in constant competition, and the former can frequently not be employed until labour rises.” This was not a question of Ricardo having “recognized the theoretical possibility that capital might displace labor; but as a practical matter he associated a high stock of physical capital with a high demand for labor” (p. 128; italics added). Ricardo (1: 388, 395) also appears to be more illustrative of Ricardo’s view on machinery and unemployment than 1: 390, which Davis quotes (p. 21) to make the point. (2) Davis does not explicitly recognize that Ricardo employed the forced-saving mechanism — the lagged adjustment of wage rates behind changes in the price level, which leads to increased employment when prices are rising and increased unemployment when prices are falling — as in Ricardo (9:20), “We know from experience that the money price of labour never falls till many workmen have been for some time out of work” (cited on p. 140n). But by asserting that Ricardo recognized that wages and prices are flexible (pp. 40, 127), Davis appears to land Ricardo in the midst of Keynes’s mythical group of classical economists who did not recognize that wages typically are rigid in the short run. (3) Since Keynes’s time, modern macroeconomists have tended to associate investment with only the purchase of capital or producers’ goods. Thus, by characterizing Malthus’s concerns with “oversaving” as his having been concerned over “excessive investment” or “the production of capital goods” (pp. 176-81), Davis likely gives the wrong impression of Malthus’s argument. Increased saving in the quotations cited refers to the diversion of funds from the employment of “unproductive” laborers, such as service workers, to more employment of “productive” laborers, including those in manufacturing or agriculture.

I think it would help to encourage modern economists to appreciate the value of reading the classics if historians of economic thought drew useful lessons in terms of theoretical analysis and appropriate policy formulation from the classical literature. Otherwise, dwelling upon their disagreements may rather give the impression that the history of economic thought is mostly about “the wrong ideas of dead men,” and the time spent reading that literature is little more than a “depraved form of entertainment.” Much, indeed, still can be learned from the work of David Ricardo by macroeconomists and monetary analysts. Davis’s book shows, for example, the importance to Ricardo of employing relevant data to evaluate economic arguments. In the absence of national income accounts data, Ricardo relied upon tax revenues as well as Bank of England financial records to gauge the economy’s performance in the early nineteenth century. That lesson alone perhaps makes the book worth reading. My criticisms mostly have been occasioned by Davis’s failure to make much more of the material at hand to inform modern macro-monetary analysis and his failure to have utilized more recent materials relevant to his study. Perhaps I might have been less disappointed with the book, had it been titled, “The Historical Foundations of Ricardo’s Macroeconomics.”

James C. W. Ahiakpor is Professor of Economics, California State University, East Bay, Hayward, CA. He is the author of “Ricardo on Money: The Operational Significance of the Non-Neutrality of Money in the Short Run,” History of Political Economy 17 (Spring), 1985: 17-30; “Say’s Law: Keynes’s Success with its Misrepresentation,” in Steven Kates, editor, Two Hundred Years of Say’s Law, Cheltenham, UK: Edward Elgar, 2003:107-32; Classical Macroeconomics: Some Modern Variations and Distortions, London and New York: Routledge, 2003; and editor of Keynes and the Classics Reconsidered, Boston: Kluwer Academic Publishers, 1998.