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David Ricardo’s Economic Theories Essay


Introduction

Born in 1772, David Ricardo was an English conformist economist. He gave a systematized conventional explanation of the 19th-century science of economics. David Ricardo extensively wrote about the Iron Law of Wages, which argued that all efforts aimed at increasing the real income of different workers yielded futile outcomes. Ricardo joined his father (who had already made heavy fortunes on the London Stock Exchange) in business at the age of 14. Even after pursuing his interest in Chemistry, Mathematics, and Geology, he developed a passion for economics after reading the book Wealth of Nations, a scholarly work by Adam Smith. David Ricardo is well known for his works such as On The Principles of Political Economy and Taxation. As revealed in this study, he developed the theory of rent, wages, and profit wrote about the Iron Law of Wages and the Theory of Comparative Advantage.

The Theory of Comparative Advantage

Nations produce goods and services at different efficiency levels. While two nations may have the capacity to produce two different types of goods, each of them may be best placed to manufacture or supply one of the types of goods at a higher pace relative to the other.1 According to Faccarello, the theory of comparative advantage advocates for efficiency-oriented investment whereby nations or even firms should consider producing goods and services, which they are effective and efficient at producing.2 Hence, as Rothbard asserts, they should be willing to incur an opportunity cost for the goods and services they are not effective at producing.3 From the above assertion, since such goods are required in the economy, nations should consider buying them from countries, which are more efficient in their production. This strategy is the underlining principle in the theory of comparative advantage.

To illustrate the theory of comparative advantage, supposing hypothetically that England can produce leather shoes at the rate of 200 pairs per hour and that it can make shirts at 125 pieces per hour. Supposing also China can produce similar shoes at the rate of 150 per hour and similar shirts at the rate of 300 pieces per hour. Table 1 below shows the opportunity costs in these two nations when they decide to produce products that they are well-positioned in manufacturing. From the illustration (see table 1), it is evident that if the cost of importation is lower relative to that of low production efficiency, then the two nations can gain from trading with one another.

Table 1. Opportunity Cost and the Concept of Comparative Advantage.

Products/Units Produced Per Hour
Nation Shoes Shirts
England 200 125 (opportunity cost)
China 150 (opportunity cost) 300

Although initially developed by Adam Smith, David Ricardo formally postulated the theory of comparative advantage in his book titled On the Principles of Political Economy and Taxation in which he compared the relative cost of producing wine and clothes in Portugal and England. In his analysis, David Ricardo deduced that Portugal could produce clothes and wine at very low labor costs compared to the production expenses for similar quantities in England. Nevertheless, relativity was apparent in the cost of producing both products in the two nations.4

Although Portugal could produce the two items with ease, Watson asserts that the cost of producing excess wine was far low relative to producing cloth.5 David Ricardo concluded that Portugal should produce wine and buy clothes from England and vice versa for England. This conclusion suggests that comparative advantage exists even if one nation may be having absolute benefit with reference to the relative efficiency of production ability when compared to another country.6 The theory is in line with the United Nations on Permanent Sovereignty over Natural Resources (PSNR) concept, which emphasizes national progress, both economically and politically. PSNR gives states the liberty to regulate the flow of their natural resources. In such a situation, the lecture notes by Seay also concur that comparative advantage is successful in reducing the cost of running an economy.7

The Theory of Rent, Profits, and Wages

David Ricardo left the legacy of having developed the theory of profits, rent, and wages. According to Depoortère, Ricardo presented rent as “the difference between the produce obtained by the employment of two equal quantities of capital and labor.”8 As Czyżewski and Matuszczak confirm, the theory argues that economic development leads to higher cultivation of poor virgin land, which only left landowners as the principal beneficiaries.9 He used the term rent to describe the personal benefits arising from the utilization of scarce resources. The term also captures the concept of positive externalities whereby such benefits may be enjoyed by third parties without financially hurting the targeted organization, person, or property owner. In his theory of profits, he argued that augmented wages resulted in decreased real profits since revenue derived from manufactured goods and services has wages and profits as the main two components.10 To illustrate this concept, consider a shirt costing 50 USD. Here, the manufacturer has included a certain amount of wages plus a profit margin in arriving at the price. Therefore, if the cost of the shirt cannot exceed 50 USD due to economic factors such as demand and supply, high wages decrease the profit levels. He also noted that profits varied depending on the cost of necessities.

The Iron Law of Wages

The Iron Law of Wages is an economic theory suggesting that real earnings tend to fall within minimum wages appropriate for a worker to sustain his or her life in the long-term. As Baumol asserts, the theory has its roots anchored on classical economics, including David Ricardo’s theory of rent.11 According to Depoortère, this school of thought emphasizes, “market price of labor would always, or almost always, tend toward the minimum required for the subsistence of the laborers, reducing as the working population increased and vice versa”.12 David Ricardo observed that this situation could only happen under some conditions. In explaining such circumstances, he drew a distinction between the market and the natural price of labor.

The natural price implies the cost of maintaining different workers or laborers not only physically but also in compliance with diverse customs within a nation. Market price entails the real wages paid to laborers. Ricardo observed that market price could forever exceed the level of the natural wage akin to diverse countervailing tendencies in different economies. To illustrate this theory, in a manufacturing firm, owners of the factors of production and capital must not only pay wages agreed upon in the employment contract (market price wages) but also incur other costs such as supporting employees or laborers’ training and development (natural wage).

Accuracy of David Ricardo’s Theories

Although other suppositions may be precise, Depoortère observes that the theory of rent and profits might be useful but not accurate since it relies only on land economic issues.13 One major demerit is that it presumes that land can only be applied in farming and that outputs increase disproportionately with capital and labor. As Depoortère reveals, Ricardo claimed that an increase in population implies the need to cultivate more land to guarantee adequate food supplies.14 However, having a substantial land under cultivation attracts extra expenses, a situation that introduces questions concerning the accuracy of the postulated theory.

The relevance of David Ricardo’s Theories to the Present Economy

David Ricardo’s theories are relevant to the present economy. For example, according to Watson, the theory of comparative advantage is accurate in predicting circumstances under which international trade flourishes.15 By deploying the theory, nations that have absolute advantages in terms of the low cost of various products can specialize in the production and exportation of items, which have the highest cost advantage as populated by David Ricardo. In this context, as Faccarello points out, comparative advantage leads to specialization in terms of absolute advantages possessed by nations.16 However, the theory is unsuccessful since it compels countries to import no matter whether they are more efficient in the overall production of all goods and services compared to others.

Conclusion

David Ricardo, a conservative economist of the 19th century, developed significant theories that marked an important pillar, which anchored various economic arguments on labor, capital, and land. Indeed, differences in the ability of nations to produce easily at different levels prescribe an important theoretical basis established under Ricardo’s theory of comparative advantage, which forms the basis of international trade. However, the theories face limitations, which hinder their accuracy when applied to the present economies. They are limited in terms of focus. For example, the theory of rent was developed focusing only on agriculture.

The validity of the Global Community’s Criticisms About the WTO’s Treatment of Developing Countries

Introduction

In global trading interactions, some countries may create policies that impair others from trading competitively in the market. Without creating rules and checks in the form of trading pacts, this situation introduces an imbalance in the development of different nations. A similar situation also emerged following the creation of the North American Free Trade Agreement (NAFTA). In fact, according to Matsushita et al., NAFTA’s trade discrimination benefited Britain more compared to other nations.17 In the move to eliminate the possibility of a nation benefiting from discriminatory practices in the global trade, the World Trade Organization (WTO) plays a pivotal role in this case. Nevertheless, the organization also faces various criticisms from global communities concerning its seeming unjust treatment of developing countries, a situation that makes it wise to reflect on the validity of these claims.

Global Community’s Criticisms about the WTO’s Treatment of Developing Countries

The WTO’s key agenda is to ensure that all member countries, including emerging economies, especially those in sub-Saharan Africa, participate equally in the global trade without any form of discrimination. In his book, “International Political Economy”, Oatley reveals the struggles that political stakeholders have to go through in their fight to win from the international economic deals.18 However, according to Matsushita et al., members of the global community criticize this focus by claiming that its implementation favors developed nations.19 For example, as Timmermann and Henk reveal, amid the WTO’s increased focus on market liberalization, the EU20 and the U.S. has resorted to policy frameworks that seek to protect their local industries from the influx of foreign-produced products and services.21 In response, some member states have resorted to creating free trading areas that increase their capacity to penetrate new markets, especially within the Asia-Pacific region. According to the lecture notes by Seay22, Britain is a major beneficiary of free trade.23

The WTO has made significant efforts to establish a multilateral system of trade. However, this move has attracted anti-WTO protests among players in the global community. Timmermann and Henk assert that such players interpret a national regulation that seeks to implement policy frameworks for protecting local industries as a barrier to the WTO’s facilitation of free trade.24 This state of affairs introduces difficulties in the WTO’s efforts of protecting the intellectual property. For example, according to Timmermann and Henk, while developed nations can manufacture HIV/AIDS medicines at a patented cost, the WTO member nations in sub-Saharan Africa and South America are poor to the extent that they cannot purchase them at the set prices (49). Hence, if they must buy the medicines or manufacture them, they can only do so under the more affordable generic label. However, Timmermann and Henk assert that such a move would violate the WTO’s intellectual property rights pacts (TRIPS).25 This situation subjects developing nations to potential trading sanctions. Consequently, the WTO is criticized following its inability to ensure that emerging economies integrate some technologies, especially in medicine and agriculture, into their local systems. Arguably, this option can only work without the TRIPS pacts.

The WTO comes under heavy criticism in terms of its methods and actions for enhancing free trade. For example, Matsushita et al. assert that the organization widens the gaps between developing poor nations and rich developed countries.26 This way, according to the lecture notes by Seay, it opposes its primary role of fixing disparities in the trading capacity of different nations.27 In fact, Matsushita et al. posit that discrimination in global trade causes market distortions that result in a loss of about 700 billion USD of export revenues in developing nations.28 This situation compromises its export-oriented strategy of economic growth.

Matsushita et al. exemplify this bias by claiming that some rich nations “maintain high import duties and quotas in certain products, blocking imports from developing countries like clothing.”29 The WTO also faces the criticism of supporting protectionist policies.30 For example, according to Timmermann and Henk, developed nations adopted policies that aimed to protect their agricultural sectors, yet the WTO did not adopt appropriate strategies for ensuring they do not lock their markets from developing economies.31 Indeed, poor countries remain under pressure to open their markets as a strategy for ensuring the free flow of global trade. One would expect such deprived countries to launch complaints during ministerial conferences in search of fairness. However, many of them do not participate actively in negotiations such as the Doha and Uruguay Rounds.

Parties to an international system feel treated justly if they have equal say and engagement in the decision-making process with others. However, Matsushita et al. assert that the WTO’s discussions are unrepresentative and/or non-inclusive of all parties to the world trade system.32 According to the lecture notes by Seay, this situation prejudices the consensus-building approach to the international system decision-making process.33 Such non-inclusion makes sense upon considering delegating the decision-making power to not only a small but also an informal steering committee, namely, the consultative board. The fact that the consultative board develops harmony on behalf of the member countries makes the WTO a non-transparent global organization due to the minimal say of a majority of developing nations in the WTO system, yet decisions made bind them. This case presents the WTO as a body that regards developing nations as inferior in making decisions that should equally bind their developed counterparts, hence reinforcing the criticism that the organization favors the industrialized nations. Indeed, more emphasis on the need to remain faithful to the general principles set out in law can pave the way for a friendlier and efficient dispute settlement mechanism where all parties feel equally involved.

The validity of the Complaints

Timmermann and Henk argue that the WTO serves the purpose of providing a platform for intergovernmental negotiations in matters concerning international trade.34 It also helps in the elimination of hindrances to global commerce and ensuring the existence and protection of rules for conducting international trade. This way, different nations can take advantage of their comparative advantage to produce goods and services to gain optimally from international markets as a mechanism for fostering domestic, social, and economic development. Indeed, according to Ismail, the 2001 ministerial conference held in Doha advocated for the need for incorporating agriculture as a key component for the Doha development agenda.35 It could enhance the capacity to lower the cost of living of the public in the WTO member states. However, Britain emerged as a major beneficiary of the agreements. Hence, the claim that the WTO has not successfully eliminated all forms of bias in favor of developed nations in comparison to the developing nations is valid.

The WTO operates under the premise of developing fair trading agreements among nations. This rationale emerged after the Second World War through the General Agreement on Tariffs and Trade (GATT). According to Matsushita et al., the entity (created in 1947) had an objective of negotiating and bargaining for reducing various tariffs that prevented some nations from engaging proactively in the global trade.36 In fact, according to Oatley, such tariffs had been increased following threats by the EU and Japan, a situation that they pursued via engaging with the WTO to endorse the movement that sought to disadvantage America’s exports.37

The purpose and function of the GATT emerged from the challenges experienced in the clause of the Most Favored Nations (MFN). The clause gave some nations specific trading rights while denying others an opportunity to participate equally in international trade. The GATT was to eliminate this selective discrimination. Nevertheless, the global community criticizes the WTO for its failure to eliminate all forms of trading discrimination, especially those that disadvantage developing countries. The reported inaccessibility and restrictions witnessed when it comes to integrating technologies from the developed world, especially in medicine and agriculture, into emerging economies’ local systems validate this criticism.

Conclusion

The WTO has a consultative committee with derogatory powers to enhance consensus building, a situation that raises an important question concerning the need for equal representation and participation of developing nations in its decision-making processes. Additionally, while the WTO focuses on enhancing free trade and reducing or eliminating protectionism, developed countries such as the UK and the U.S. adopted policies that aimed at protecting their industries from competition, especially in agriculture. Nevertheless, such nations continue to trade in the international system overseen by the WTO. While fully cognizant of this reality, the WTO continues to call upon developing nations to open up their markets to global traders, including those with protectionist policies. These concerns validate criticisms raised concerning the WTO by various global communities, including non-governmental organizations such as the World Federalist Movement.

Works Cited

Ismail, Faizel. “Is the Doha Round Dead? What is the Way Forward? World Economics, vol. 13, no. 3, 2012, pp. 143-169.

Matsushita, Mitsuo, et al. The World Trade Organization: Law, Practice, and Policy. 3rd ed., Oxford University Press, 2015.

Oatley, Thomas. International Political Economy. 5th ed., Pearson/Longman, 2012.

Timmermann, Cristian, and Henk van den Belt. “Intellectual Property and Global Health: From Corporate Social Responsibility to the Access to Knowledge Movement.” Liverpool Law Review, vol. 34, no. 1, 2013, pp. 47-73.

W. Seay. “The Origins of Political Economy.” Econ 101, 28 Nov. 2017, Virginia Commonwealth University, Richmond. Lecture.

Baumol, William. “Marx and the Iron Law of Wages.” The American Economic Review, vol. 73, no. 2, 1983, pp. 303-308.

Czyżewski, Bazyli, and Anna Matuszczak. “A New Land Rent Theory for Sustainable Agriculture.” Land Use Policy, vol. 55, 2016, pp. 222-229.

Depoortère, Christophe. “Say’s Involvement in the 1819 French Edition of Ricardo’s Principles and Issue of Rent.” European Journal of the History of Economic Thought, vol. 24, no. 1, 2016, pp. 80-118.

Faccarello, Gilbert. “A Calm Investigation into Mr. Ricardo’s Principles of International Trade.” European Journal of the History of Economic Thought, vol. 22, no. 5, 2015, pp. 754-790.

Rothbard, Murray. Mises Daily Articles, Web.

Watson, Matthew. “Historicizing Ricardo’s Comparative Advantage Theory, Challenging the Normative Foundations of Liberal International Political Economy.” New Political Economy, vol. 22, no. 3, 2017, pp. 257-272.

Footnotes

  1. W. Seay. “The Origins of Political Economy.” Econ 101, 28 Nov. 2017, Virginia Commonwealth University, Richmond. Lecture.
  2. Gilbert Faccarello, “A Calm Investigation into Mr. Ricardo’s Principles of International Trade,” European Journal of the History of Economic Thought, vol. 22, no. 5, 2015, p. 754.
  3. Murray Rothbard, “The Ricardian Law of Comparative Advantage,” Mises Daily Articles, Web.
  4. See more in Faccarello, page 755.
  5. Matthew Watson, “Historicizing Ricardo’s Comparative Advantage Theory, Challenging the Normative Foundations of Liberal International Political Economy,” New Political Economy, vol. 22, no. 3, 2017, p. 259.
  6. Faccarello, 755.
  7. W. Seay, “The Origins of Political Economy.”
  8. Christophe Depoortère, “Say’s Involvement in the 1819 French Edition of Ricardo’s Principles and Issue of Rent,” European Journal of the History of Economic Thought, vol. 24, no. 1, 2016, p. 86.
  9. Bazyli Czyżewski, and Anna Matuszczak, “A New Land Rent Theory for Sustainable Agriculture,” Land Use Policy, vol. 55, 2016, p. 223.
  10. Depoortère, 92.
  11. William Baumol, “Marx and the Iron Law of Wages,” The American Economic Review, vol. 73, no. 2, 1983, p. 303.
  12. Depoortère, 99.
  13. Depoortère, 14.
  14. Depoortère, 97.
  15. Watson, 257.
  16. Faccarello, 783.
  17. Mitsuo Matsushita, et al., The World Trade Organization: Law, Practice, and Policy (Oxford University Press, 2015) 63.
  18. Thomas Oatley, International Political Economy, 5th ed. (Pearson/Longman, 2012) 121.
  19. Matsushita et al. 56.
  20. adopted the name the EU in 1988. Initially, it was called the European Economic Community EC)
  21. Cristian Timmermann, and Henk van den Belt, “Intellectual Property and Global Health: From Corporate Social Responsibility to the Access to Knowledge Movement,” Liverpool Law Review, vol. 34, no. 1, 2013, p. 48.
  22. W. Seay, “The Origins of Political Economy.” Britain’s economy grew following its successful business of aircraft building Timmermann and van den Belt, 49.
  23. Ibid.
  24. Matsushita et al. 57.
  25. W. Seay, “The Origins of Political Economy.”
  26. Matsushita et al. 73.
  27. Ibid, 75.
  28. To get a detailed view of protectionist policies, visit the lecture notes by Seay Timmermann and van den Belt, 51.
  29. Matsushita et al. 97.
  30. W. Seay, “The Origins of Political Economy.”
  31. Timmermann and van den Belt, 51.
  32. Faizel Ismail, “Is the Doha Round Dead? What is the Way Forward? World Economics, vol. 13, no. 3, 2012, p. 144.
  33. Matsushita et al. 63.
  34. Oatley, 122.
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