Smith & Ricardo: Political Economy and Rent

Smith, Adam. 1987. The Wealth of Nations. New York: Penguin Classics. [Book I]
Ricardo, David. 1971. “On Rent.” in Principles of Political Economy and Taxation. Harmondsworth: Penguin.
Foley, Duncan K. 2006. Adam’s Fallacy: A Guide to Economic Theology. Cambridge: Harvard University Press. [Intro, Ch. 1-2]

Taking up these texts of classical political economy, I found it very helpful to read them alongside Foley’s Adam’s Fallacy. Foley’s central contention is that Smith inaugurated a separation of economics and politics: This separation of an economic sphere, with its presumed specific principles of organization, from the much messier, less determinate, and morally more problematic issues of politics, social conflict, and values, is the foundation of political economy and economics as an intellectual discipline” (xiii). I know Emma Rothschild has an interesting take on the wedge between politics and economy in Smith’s thought that slightly complicates the way this separation was accomplished in political economic thought, but Folely nonetheless presents a compelling intellectual history of this problematic division.

For Foley, Smith’s fallacy is both moral and logical: “The moral fallacy of Smith’s position is that it urges us to accept direct and concrete evil in order that indirect and abstract good may come of it. The logical fallacy is that neither Smith nor any of his successors has been able to demonstrate rigorously and robustly how private selfishness turns into public altruism” (3). The basis of Smith’s project is the division of labor, which increases productivity, and the concomitant “propensity to truck, barter, and exchange” (117). (Foley says Smith leaves aside whether exchanged induced the division of labor or the other way around.) The limits of exchange are set and determined by the extent of the market, which in turn also impacts the scale of production.

According to Foley, in Smith’s view: “The links between the division of labor and the extent of the market create a system of positive feedbacks, in which increases in the division of labor lower costs, raise real incomes, and extend the market, thus leading back to more increases in the division of labor. This process creates a self-reinforcing positive spiral of economic development” (10). But this dynamism in productivity might outpace demand and the ability of industries to absorb new workers, leading to unemployment of labor and capital. Smith wishes this away assuming that investors and workers will find new industries (Say’s Law), which Foley chalks up to “a belief in the efficiency of the financial institutions of a capitalist economy” (11).

According to Smith, the division of labor and increased specialization via exchange necessitated the creation of an across-the-board equivalent commodity (i.e. money), leading him to discuss value. Smith introduces use- and exchange-value. Without dwelling too much on value itself, Smith delves into an extended discussion of price (real and natural prices). In this discussion he forwards a labor theory of value: “Labour, therefore, is the real measure of the exchangeable value of all commodities” (133). This labor is the real or natural price of commodities, while the market (or nominal) price fluctuates because of supply and demand. But Smith argues that a host of factors lead the market price to hover (“gravitate”) around the natural price of the commodity.

However, “Smith seems to abandon the labor theory of value in midstream and shifts over to this second way of looking at the prices of commodities, developing what has come to be called an adding-up theory of value” in which prices are rendered through an accounting of wages, profit, and rent—or an “adding-up theory of value” (18). “In the price of corn, for example, one part pays the rent of the landlord, another pays the wages or maintenance of the laborers and the labouring cattle employed in producing it, and the third pays the profit of the farmer” (153). Two pages later Smith says these are the three original sources of all revenue and all exchangeable value.

Growing accumulation and increased competition, along with rising wages and rents, will lead to a falling rate of profit, according to Smith. Specifically on the added-value of rent Smith contends that rent is determined by the price of the commodity produced on the land, land then has no natural rent, but is somehow a component of price. Price determines rent, but rent also determines price? The circularity of Smith’s argument becomes a central point critiqued by David Ricardo, who re-centers the labor theory of value that Smith sidelined. As Foley notes, “The problem with the adding-up theory of value becomes particularly acute in the case of rent, which Smith analyzes, quite convincingly, as a residual determined by the level of prices. But if this account of rent is correct, the adding-up theory, which tries to explain the level of prices by the natural level of rents, is unacceptable because it depends on circular reasoning” (28).

Foley closes his opening chapter by revisiting Adam’s Fallacy through the famous contention that we don’t get our meals because of the good graces of the butcher or the baker, but rather by the pursuit of their own self-interest: “But to support the claim that this pursuit of self-interest is a positive good, Smith would have to show that antagonistic market exchange relations are the only possible way to support the division of labor, and that we have no alternative to accepting the distributional inequities and moral violence that accompany private property relations as the means to securing our dinners” (43).

Smith held that the value of a commodity was equivalent to the amount of labor it could command in the market; Ricardo, however, argued that the value of the commodity was only based on the amount of labor it embodied. In Smith’s formulation, as Ricardo pointed out, the value of a commodity would depend on the wage. The important thing for Ricardo was to decipher the value of a commodity without any reliance on wages. But if the value of the commodity is determined solely by labor, Ricardo still recognized that its proceeds are distributed between wages, profit, and rent. He claimed workers were forced to consume away their wages, landowners forced to maintain their privileged aristocratic position via opulent status symbols, while frugal capitalists were the only class saving their profits and accumulating capital. The cycle could go on endlessly unless stymied by falling rates of profit caused by growing population (building off Malthus) and rising costs of food and land. Profits could eventually reach zero—what Ricardo called a stationary state.

As I understand it, Ricardo believed that the dynamics of agriculture determined the rest of the economy, so that agriculture could be used to model the economy as a whole. Foley gives a concise rendition of this thinking. Plots of land could be conceptually ranked in order of their fertility/productivity, meaning that with the growth of population increasingly less fertile plots would be farmed, leading to diminishing returns from cultivating sequentially less fertile plots. More crops would be produced on the whole as farming expands, but always with marginally diminishing output (again, building from Malthus). As Foley points out, this contradicts Smith’s faith in the division of labor and growing population producing ever-greater productivity.

Because the capitalist is foot-loose with investment always seeking higher profit rates, rents must be set such that the capitalist is enticed with an average profit rate (that is, more or less the same rate if the capital were employed elsewhere, namely industry). But the rent can’t be so low as to give the landowner the freedom to seek a higher-paying capitalist. Foley explains, “Therefore, the rent must be set just high enough to make the profit rate on the plot of land equal to the profit rate on all the other cultivated plots and on industrial capitalist production. This is Ricardo’s theory of rent. The rent is ‘differential’ because it depends on the relative fertility of the landowner’s plot to the marginal plot of land” (74). (The marginal plot of land being the abstract plot that garners zero rent—i.e. one in which no profit rate is possible.)

This process causes the rent of more fertile lands, being the most desirable in terms of profit rates, to rise. Meanwhile, an increasing amount of the actual produce of the land ends up being used simply to pay the increasing rents. But Ricardo also posits that profit rates will tend to equalize across these plots and across economic sectors because of competition. Distribution, as Ricardo understands it, means that capitalist will garner equivalent profit rates on their capital, while workers remain at subsistence levels and landowners spend rents on luxury items. “The effect of capital accumulation is to increase the population, food output, and agricultural labor force; to increase total rents; but to lower the rate of profit as the surplus on the marginal land declines because of diminishing returns. The total amount of profit may increase in the early stages of capital accumulation, because the amount of capital is rising faster than the profit rate is declining, but eventually the amount of profit has to decline as well” (78). But profits eventually bottom out, though Foley points out that technological change and foreign trade can help perpetuate accumulation. But it would seem that within Ricardo’s vision that these are only stop-gap measures whose effectiveness will be eroded by trends toward equalization.