Income distribution
“The principal problem in Political Economy”, Ricardo famously stated in the Preface to his Principles, is “to determine the laws which regulate... the proportions of the whole produce...
which will be allotted to... rent, profit, and wages” (1951-73, I: 5). The main task he set himself thus consisted in finding the laws governing the income shares and their development over time. The theory of differential rent, which he first adopted in the Essay on Profits of February 1815, allowed him to separate this problem into two parts: “By getting rid of rent... the distribution between capitalist and labourer becomes a much more simple consideration” (1951-73, VIII: 194).In the Essay on Profits, and then more extensively in chapter 2 of the Principles, Ricardo expounded the principles of extensive and intensive diminishing returns in agriculture due to the scarcity of land. The clarity of his exposition has led to the identification of this theory with his name, although he acknowledged earlier expositions by authors such as James Anderson, Edward West, and Thomas Robert Malthus. Unlike those authors, Ricardo integrated the theory of differential rent into a system of political economy whose main aim was the determination of the general rate of profits. He first focused attention on extensively diminishing returns and assumed that the available plots of land can be brought into a ranking of natural “fertility”, reflecting the unit costs incurred in the production of the agricultural product, which for simplicity he supposed to consist of corn only. In the first settling of a country, where the total demand for corn is low, only land of the highest fertility will be cultivated and there will be no rent, because land, even that of the best quality, is not scarce (Ricardo 1951-73, I: 69). As capital accumulates and the population grows, recourse must be had to less and less fertile land in order to satisfy the growing social demand for corn.
As a consequence, the costs of production and hence the price of corn will have to rise. For a given level of demand and hence gross output, the price of corn will equal unit costs (including profits at the normal rate) on the marginal land, for which the proprietors under competitive conditions obtain no rent, because this quality of land is not scarce. Accordingly, on the marginal land the product is shared out only between wages and profits. On the intra-marginal lands the landowners obtain rents that correspond to the cost differential between the unit costs on the quality of land owned by them and the marginal land. This implies that, contrary to the views of Smith and the Physiocrats, rent arises not because of the generosity of nature, but rather because of its “niggardliness”; that it is not the cause of a high price of corn, but rather its effect; and that rent “cannot enter in the least degree as a component part of its price” (1951-73, I: 77).For Ricardo it was clear that “profits come out of the surplus produce” (1951-73, II: 130-31; also I: 95); the problem was to determine the size of the share of profits (relative to those of wages and rents) and the level of the rate of profits. In his early monetary writings, Ricardo followed Smith in maintaining that the rate of profits depends on the “competition of capitals”, but in spring 1813 he began to doubt the correctness of this doctrine. In correspondence with Malthus he stressed the importance of the production conditions in agriculture for the level of the general rate of profits, and he already referred to “my theory” without however explicating it in any detail (Ricardo 1951-73, VI: 95). In March 1814 he composed “some papers on the profits of capital”, which however have been lost, and to Trower he wrote in the same month:
The profits of the farmer... regulate the profits of all other trades,- and as the profits of the farmer must necessarily decrease with every augmentation of capital employed on the land, provided no improvements be at the same time made in husbandry, all other profits must diminish and therefore the rate of interest must fall.
(1951-73, VI: 104)According to Sraffa’s interpretation, the “rational foundation” of the determining role of the profits of agriculture was that:
in agriculture the same commodity, namely corn, forms both the capital (conceived as composed of the subsistence necessary for workers) and the product; so that the determination of profit by the difference between total product and capital advanced, and also the determination of the ratio of this profit to the capital, is done directly between quantities of corn without any question of valuation. (1951: xxxi)
Sraffa stressed that the corn model was “never stated by Ricardo in any of his extant letters and papers” (1951: xxxi), but concluded from the available indirect evidence that Ricardo “must have formulated it either in his lost “papers on the profits of capital” of March 1814 or in conversation” (1951: xxxi). The proposition that the profits of the farmer regulate the profits of all other trades recurs in the Essay on Profits (Ricardo 1951-73, IV: 23), together with the statement that “the rate of profits.. . must depend on the proportion of production to the consumption necessary to such production” (1951-73, IV: 108). In the Essay, however, the advanced capital in agriculture is assumed to consist not only of corn but of several commodities, including also manufactures, so that Ricardo’s reasoning in the Essay only “reflects” the corn-ratio argument, since “both capital and the ‘neat produce’ are expressed in corn, and thus the profit per cent is calculated without need to mention price” (Sraffa 1951: xxxii, emphasis added).
It has not been much noticed that in the Essay on Profits the “rate of rent” was calculated by Ricardo also as a percentage of the advanced capital, that is, as the ratio of the amount of rent (in corn) to the amount of capital advanced (also expressed in corn). This misled several commentators, including Marx (1861-63 [1989]: 73-4, 308), into wrongly supposing that it had been a proposition of Ricardo that the accumulation process was bound up with a fall in the rate of profits and a rise in the rate of rent (so defined).
In the Principles, and more explicitly in one of his Notes on Malthus (1951-73, II: 196-7), Ricardo later clarified that no such inverse relationship between the rates of rent and profits exists (see Gehrke 2012: 60-61). What Ricardo had maintained in the Essay, and had indeed demonstrated on the basis of his corn-ratio theory, was that in a given technical environment real wages (that is, corn wages) and the rate of profits are inversely related to one another.However, Ricardo soon realized that the corn-ratio theory was not general enough, although he was convinced that the basic idea underlying it was correct. Therefore the same principle recurs in a different and more general form in the Principles. But whereas the rate of profits was conceived in his early theory as a material ratio between two quantities of corn, it was now determined as a ratio between two quantities of labour: the amount of labour embodied in the surplus product (at the agricultural margin, and thus exclusive of rent) and the amount of labour embodied in the social capital (where Ricardo frequently identified capital with wages, setting aside all other items of circulating and fixed capital). This novel conceptualization was made possible by adopting the labour theory of value, that is, by introducing the hypothesis (in section 1 of chapter 1, “On Value”) that the exchange values of commodities are governed by the relative amounts of direct and indirect labour embodied in them, which allowed Ricardo to make bundles of heterogeneous commodities commensurable, and thus to determine the general rate of profits for the system as a whole. It also allowed him to state that “in proportion... as wages rose, would profits fall” (Ricardo 1951-73, I: 111), that is, to confirm in the more general framework his earlier finding that the two distributive variables are inversely related to one another. The labour theory of value thus enabled him to dispel the wrong idea, deriving from Smith’s “adding-up theory” of prices, that real wages and the rate of profits could move independently of one another.
However, Ricardo knew that the labour theory of value was “not rigidly true” (195173, VII: 279). In sections 4 and 5 of the chapter “On Value” he noted that “the principle that value does not vary with the rise of fall of wages” is “considerably modified by the employment of machinery and other fixed and durable capital” and “modified also by the unequal durability of capital, and the unequal rapidity with which it returns to its employer” (1951-73, I: 30, 38, original emphases). Different proportions between capital laid out in advanced wages (direct labour) and in means of production (indirect labour), as well as different durabilities of the means of production, made the relative prices of commodities depend on income distribution: the higher the rate of profits (and, correspondingly, the lower the real wage rate), the relatively more costly are commodities produced with a high proportion of indirect to direct labour. Except for the unrealistic case of equal proportions, the relative prices of two commodities will therefore “deviate” from the relative amounts of direct and indirect labour embodied in them. Ricardo first tried to play down this problem, by adopting a standard of value which minimized the magnitude of these deviations, and to argue that the “modifications” were small in magnitude and thus could be neglected. He then tried to cope with the problem in terms of his concept of an “invariable measure of value”. Originally, and following Adam Smith, this concept was only meant to allow for interspatial and intertemporal value comparisons, that is, comparisons relating to different technical environments. For the standard to be invariable it had to be a commodity produced with an unvarying quantity of labour. However, Ricardo was then facing also the different problem that even in the same technical environment two commodities could vary in relative value from a change in income distribution. In a manuscript on “Absolute value and exchangeable value”, written shortly before his death, Ricardo tried to investigate how the prices of commodities produced under different production conditions vary with changes in income distribution, and concluded that for the standard to be invariable it would have to be a “medium between the extremes” (1951-73, IV: 372). Subsequent research has shown that the two requirements cannot be met simultaneously (see Kurz and Salvadori 1993).