2nd The basic problem
3rd The short-term market law
4th The role of the rent in value assessment
5th The role of the capital in value assessment
6th Can different labour qualities be converted into normal working hours?
7th Criticism of the Ricardian Theory of Value
8th Long-term development of a national economy
In the previous chapter, I already pointed out that at the end of the 18th century, economic theories were developed mainly in England, but also on the European continent, which on the one hand tried to prove that a free market economy leads to essentially better results than a state-controlled mercantilist economy, but which on the other hand also tried to describe the functioning of a market economy.
The first approach has already been described in the previous chapter and was referred to as liberalism. This approach is normative, it aims to show which economic system will increase the welfare of a population most effectively. The second approach shall be described here as Classicism, its concern is of an explicative nature, it is not primarily intended to advertise a free market economy, but to show which laws a market economy is subject to. Only with this second approach we want to deal in this chapter.
However, I had already mentioned that the individual economic authors can by no means be strictly distinguished between these two groups. For example, Adam Smith, who was at the centre of the previous chapter and is considered to be the founder of the newer national economy, has contributed significantly to both the development of liberal ideas as well as to the formulation of an explicative market theory. He is therefore mentioned in literature both as a representative of old liberalism and as an early classicist.
In the previous chapter we have dealt solely with Adam Smith's liberal ideas and in this chapter we will abstain to include Adam Smith's contribution to the classical market theory.
The focus of this chapter shall be set solely on the remarks of David Ricardo, who has brought the considerations, which were treated already by Adam Smith, to a certain culmination and conclusion. It is precisely for these reasons that the literature distinguishes between the optimistic, early classical view of Adam Smith and the late classical, markedly pessimistic view of David Ricardo and Robert Malthus.
David Ricardo lived from 1772-1823 and became known primarily for his two major works 'The High Price of Bullion, a Proof of the Depreciation of Bank Notes' (1809) and 'On the Principles of Political Economy and Taxation' (1817). Among his most important contributions to economic theory are the foundation of the classical labour value theory, the finding that the monetary value can only be guaranteed by a central bank monopoly, and his theory of comparative costs, in which he proves that in general all countries can benefit from international trade.
The necessary temporal limitation of a chapter in this seminar even makes it necessary, even within the total contribution of David Ricardo, to limit oneself to a single but quite central topic of classical theory and to deal only with David Ricardo's theory of value. In this, we will mainly limit ourselves to the works of Ricardo. The theses of Robert Malthus are included in this presentation only insofar as they are necessary for understanding the Ricardian value system. Ricardo himself has taken up some of Malthus' ideas. Ricardo's contribution to the theory of foreign trade will then be discussed only in the second part of this lecture.
2nd The basic problem
In this chapter we will therefore deal exclusively with the value problem and its solution by David Ricardo. We must clarify to which determinants the value of a good must be traced back, which value the individual goods obtain, on what it depends if the value of the good X turns out to be greater than the value of the good Y.
In this context, the first thing we have to realise is that the value of individual goods plays a central role in the question of which goods are produced. Economic activity is always necessary when there is a shortage, that is, when the available resources are not sufficient to produce all the goods for which there is a demand. Here, it must be determined which products should be produced in this case and to what extent. In economic theory, this problem is called the problem of allocation, the distribution of scarce resources to the individual possible types of use.
In this context, it must be assumed implicitly that the respective predominant technology does indeed allow us to use one and the same resource for different purposes. It is only because several purposes of the scarce resources are known that the problem arises at all, to which purposes scarce resources should be distributed.
The answer can only be that in each case the kind of allocation to the individual possible types of use is desired, which gives the highest possible benefit for a given resource stock and a given technology.
Now, it is decisive that the values that goods acquire on a free market play a central role in solving this allocation problem in a market economy. It is the price ratios which direct the resources to the individual types of use. Let us illustrate this relationship with an example.
For the sake of simplicity, let us assume that we only know two types of use, that by using the available resources only the goods X and/or goods Y can be produced. We assume here, that a certain distribution of resources to both goods has taken place previously, e.g. half of the resources are used for goods X and half for goods Y.
We now want to assume that the needs of consumers have changed in such a way that they achieve a greater benefit if they consume much more of good X and accordingly less of good Y. Consumers will therefore demand more of good X and less of good Y.
In free markets, this shift in demand now automatically causes that the price of X rises, but that the price of Y falls. This shift in value relations causes entrepreneurs to produce more of good X and less of good Y, and this is because they earn more from the production of good X due to the changed prices of goods. Thus, the price ratio has ultimately controlled the allocation of resources.
The classical theory of value now strives to clarify the question of what the value depends on in the sense of a price that is valid in the long term. Firstly, it is important here that the term 'value' in the context of the old-classical doctrine always refers to the long-term price only. The problem of short-term price fluctuations is only marginally approached in the classical literature and follows completely different rules.
Secondly, when the classics talk about values, they are always only interested in the relations of long-term prices, but not in the absolute level of a price. This is because it depends on the values of the goods, which goods are produced in which quantities and that here only the structure of the prices, i.e. the price ratio, is decisive. If e.g. the absolute price of both goods X and Y doubles and therefore the ratio of the prices to each other has not changed, there is no reason to change the allocation of resources to the two goods.
In the answer to the question of which determinants ultimately determine the value of a good, David Ricardo follows the view common at his time, which is also found with Adam Smith and which traces the value of a good back to the cost sum necessary to produce it. It is important to note that it depends on how many costs are necessary with a given technology, not necessarily what costs are actually incurred. An entrepreneur who is not up to date with the technology and therefore has higher costs than his competitor will still not be able to obtain a higher price on the free market than his competitor. The price that prevails is always determined by the competitor who succeeds in offering a certain good at the lowest cost.
However, David Ricardo is not satisfied with this answer. He clearly recognises - and this is his actual contribution to classical value theory - that this answer could only satisfy if there was only one cost factor present. But in reality, it must be assumed that several cost factors must be applied in the production of most goods. Production usually requires a certain piece of land, i.e. the production factor land, furthermore the use of capital for the purchase of machines, and furthermore quite different qualities of labour.
If we now must assume several factor types, we will only come to a satisfactory result if we are able to indicate the role of the individual cost types for the total cost level. Let us illustrate this correlation again with an example:
For a certain good X, 100 working hours and interest in the amount of 100 GE (monetary units) would be required. For another good, on the other hand, only 30 working hours would be needed, but due to a mechanisation of production, 400 GE would be needed. So which good has a higher value? In fact, this question depends on the value of an hour of work compared to a GE of capital. The value problem of a good is traced back to a value problem of the individual cost factors. Only if I know the reasons on which the price ratio of wages and interest depends, I can make a binding statement about the value of a good. A value problem (that of the goods) is traced back to another value problem (that of the production factors), the problem is not solved, an unknown is explained with another unknown.
David Ricardo has clearly recognised this problem; his effort is to trace back the individual cost types to a single cost element. In this respect, he endeavours to exclude both the rent as well as the price of land, and further to exclude capital investment as possible determinants of the value of a good. Furthermore, according to a given technical relation, the individual labour input is converted into units of normal working hours (standardised working hours). Finally, it is possible to indicate how many normal working hours are required to produce a good; and the ratio of these working hours in the use of two goods to each other then finally determines the value relation of both goods.
3rd The short-term market law
Although David Ricardo's theory of value focuses on the long-term prices of goods, we want to begin the report with briefly outlining the ideas of the classicists, above all John Stuart Mill, about the determinants of short-term price changes.
Basically, the old classics anticipated the neoclassical market theory in this point in its essential features. Accordingly, short-term prices are corrected whenever supply and demand diverge. If supply rises above demand, the price falls; the suppliers fear to be stuck with their goods at the previous price and are therefore willing to offer discounts. Now this price reduction has two effects: on the one hand, the demand increases, on the other hand, the supply decreases with the consequence that supply and demand come closer together and finally, if the price is sufficiently reduced, they correspond to each other.
The same applies mutatis mutandis if demand exceeds supply initially. In this case, prices rise in the short term, as this time the demand side fears that they will not be able to benefit at previous prices. But if the price rises, demand falls and supply rises, both thus approaching each other again, until a new equilibrium price has been reached finally at which supply and demand correspond precisely.
These considerations, however, only refer to the short-term market reactions, which are of less interest to David Ricardo.
4th The role of the rent in value assessment
We now turn to Ricardo's reasoning that eventually it is the number of required standard working hours that determines the long-term value of a good. Let us begin with the thesis that the rent cannot determine the value of a good.
David Ricardo assumes a situation where the demand for agricultural products (and it is on these products that the present problem is illustrated) is initially so low that the respective most fertile soils are sufficient to satisfy the demand.
For whatever reason, e.g. due to an increase in population, the demand for soil products was now increasing to such an extent that the most fertile soils were no longer sufficient to meet the demand for products. The price of goods is rising. Farmers are therefore induced to cultivate less fertile soil, which of course means that the cost per unit of product is higher in the case of poorer-quality soil. But these additional products will only be offered on the market if the costs are also covered on the worst-quality soil, in other words if prices have risen in proportion to the increase in costs. However, since identical products achieve a uniform price on the market, the owners of the better-quality soil receive a price that is higher than their costs, in other words they receive a rent.
This rent was thus - according to David Ricardo conclusions - a consequence of the price increase of soil products. But what was the consequence of a price increase could not simultaneously be the cause of this price. Thus Ricardo - or at least it seems so - has eliminated the rent as a possible determinant of a long-term price of goods.
5th The role of the capital in value assessment
Let us now turn to the question why even interest on capital cannot be included - according to Ricardo's opinion - in the circle of determinants of the value of goods. David Ricardo assumes in his reasoning that a production lasts one period at a time. Since the employed workers must be paid immediately, but since the sale proceeds are only available after the completion of the product, the entrepreneur is forced to take out a loan in order to pay and employ the workers in the first period.
If we now assume that all workers are employed for the same wage, the required credit amount, which corresponds to the wage costs, corresponds exactly to the number of hours worked. Thus, two enterprises employing the same number of workers (with the same number of working hours per day) must obtain the same amount of credit and pay the same amount of interest at the same interest rates. Conversely, if twice as many working hours must be performed in the production of good X than in the production of good Y, then the interest paid in the production of good X is also twice as high as in the production of good Y.
In other words, the incurred capital costs always represent a certain percentage of the labour costs that is the same for all productions and thus change the absolute value, but not the value relations between the individual goods. But since David Ricardo is only interested in the value relations, since they alone determine the management of production, David Ricardo seems to have succeeded in eliminating the capital costs as determining factor of the value of goods.
We want to keep in mind that David Ricardo assumed in his reasoning that the time period required for production is identical for all products and covers one period. In the criticism of the Ricardian theory of value more below, we will see that this assumption is very problematic, but that the result was obtained only under this assumption.
6th Can different labour qualities be converted into normal working hours?
If we follow David Ricardo's reasoning, then remains only the problem that in almost all productions employees of the most different quality (unskilled workers, semi-skilled workers, skilled workers) are employed, so that initially, even if we only accept employees as determining factors for the value of a good, still remains a multitude of different production factors of different quality, so that it continues to be unclear how the values of the individual work qualities are to be classified, so that then a uniform standard for the working hour is found.
David Ricardo has indeed accepted this fact of a multitude of different work qualities. He was of the opinion, however, that there are purely technical relations, which remain quite constant in the short term, which permit the conversion of one working hour of a qualified employee into normal working hours. For example, one working hour of a foreman could correspond to 3 standardised working hours.
The crucial point in this procedure is that David Ricardo was convinced that the addressed ratio of the individual working hours to each other presented by no means an economic problem. In this respect, a value ratio is always an economic problem and not a purely technical problem when this ratio depends on the scarcity of the individual labour force.
If we follow David Ricardo's reasoning, then at the end of this chain of evidence there is a single production factor: the standardised working hour. Then we are actually able to indicate the number of standardised and necessary working hours for the production of each good and thus to determine exactly how the values of the individual goods relate to each other. Assuming the validity of these steps of evidence, David Ricardo has obviously succeeded to solve the problem of the classical objective value theory. Even when in reality a large number of different production factors is almost always required for the production of a good, it is possible to determine the value of each good by specifying the number of standardised working hours.
7th Criticism of the Ricardian Theory of Value
Let us now ask about the possible criticism of this value theory. Let us begin with the first step of the reasoning: with the proof that, as being a result of a price increase, rents could not at simultaneously be the determining factor of that same price.
Reminder: According to David Ricardo, there is an increase in the demand for agricultural products and this leads to price increases due to scarcity of the goods. This reasoning can be accepted in any case.
In a second step, the attempt by the suppliers to meet this increased demand by expanding production results in the necessity to cultivate soil of inferior quality. This assertion can also be accepted.
On free markets, products of the same quality also achieve a uniform price, regardless of whether different unit costs are incurred in production in the individual enterprises. This statement also complies with the currently valid theory.
Furthermore, the products which cause higher unit costs due to inferior quality of the soil are only produced and offered on the market if the price at least corresponds to the unit costs. This statement can certainly not be criticised either.
The same price at unequal unit costs ultimately leads automatically to the fact that the owners of the better soils receive a rent.
Therefore, it seems that the attempt to remove the rent from the circle of determinants of a price was successfully conducted by David Ricardo. The question arises, however, as to why this line of argument has validity only for soil and thus for soil rents. Does this reasoning not apply actually to all conceivable production factors? The fact that a proportion of cultivated soils receive rents is obviously solely because soils have different qualities. But does this not apply to the other production factors, too?
Let us review this question for the capital. As we know, we must reckon quite often with the fact that committing capital is sometimes quite risky. In these cases, the market grants risk compensation to the providers of capital in the form of higher interest rates. In this context, it can be affirmed that if the risk taken is higher, the interest rate will be higher. On the other side, however, there are also capital investments that involve almost no risk. Thus, we can see that the quality of the capital also varies and that therefore different interest rates must be paid for different capital.
Although it seems that the quality of the soils was of a different character than the quality of the capital. The fact that soil rents are granted is due to the condition of the soil, that is, the characteristics of the offered production factor. But that capital shows a different quality is based on the fact that enterprises, i.e. the demanders of this production factor, are willing to take a different risk.
Nevertheless, there is one thing in common. Enterprises that demand capital need capital of different quality depending on the risk taken. An entrepreneur who wants to set up an investment with a very high risk will also need investors who are willing to take a higher risk. It is this different willingness of the suppliers of capital that determines the quality of the granted capital.
With regard to the production factor labour, David Ricardo of course assumes different qualities also. And he certainly also assumes that employees who show above-average quality also receive above-average wages. Why should we not be able to say here that the qualitatively better employees receive a quality rent?
If, however, the rent concept proven for soils by David Ricardo can de facto be applied to every conceivable production factor, all factors are catapulted out of the circle of possible determinants, with the result that the value of goods remains undetermined as long as one wants to derive the value of goods objectively from the factor input.
This is precisely the answer of the Viennese School, the first variant of neoclassical theory. The value of a good can never be ascribed to the use of a factor of production alone; rather, it is determined solely by the benefit that the end consumer derives from the consumption of a good.
A slightly different answer finds the Cambridge School, the third variant of the neoclassical theory. These representatives of the Neoclassicism assume that the value of a good is determined by supply and demand, that a change in the supply of a production factor as well as a change in demand can cause a change in the value of goods.
In a second step, let us now ask to what extent David Ricardo's attempt to remove the cost of capital from the list of possible determinants is convincing. We have already pointed out at the reasoning above, that David Ricardo succeeded in removing the cost of capital from the list of possible determinants of the value of goods only because he implicitly assumed that all enterprises needed a single period for their production. This assumption is certainly not in accordance with reality.
In reality, we have to assume that production usually requires several periods due to roundabout methods of production and that the duration of these roundabout production methods differs from product to product.
But if this is the case, we can no longer consider the capital costs to be the same percentage of labour costs everywhere. Let us consider an example:
We assume that an enterprise A produces quite labour-intensively, that 10 employees are employed for a total of 100 working hours - already converted into standardised working hours - and that the production from the beginning to the end is just one period. Before starting production, the entrepreneur is forced to take out a loan that is just enough to pay off the workers. For the sake of simplicity, we will assume that there are no other costs apart from labour costs, e.g. raw materials are processed which are already in the possession of the entrepreneur.
We now assume a second enterprise B, which, in contrast to enterprise A, produces very capital-intensively, whereby we again want to assume here that the raw materials required for production are already in the possession of this enterprise. Furthermore, it is assumed for the sake of simplicity, that the machines required for the production of the end product are produced in this enterprise itself. Again, 10 workers would be employed with a total of 100 standardised working hours.
The production of the end product now requires two periods for the entire production process, whereby initially only the required machine is produced in the first period, with the help of which the end product is then produced in the second period. The roundabout production method therefore comprised two periods for enterprise B, but only one period for enterprise A.
These assumptions now result in enterprise A requiring a loan that is enough to allow the employees to work a total of 100 hours and to pay them immediately. Since the interest rate was 3%, would be added to the labour costs another 3% of labour costs as interest costs on the total cost sum.
Enterprise B, by contrast, requires a loan that is enough to employ the workers for two periods. If the interest rate is the same, this means that interest costs must be added to the labour costs, which do not amount to 3% but 6% of the total labour costs.
This shows that the value sums of both products are not only increased in their absolute level by including the capital costs, but that the value relations change as well. This proves that when considering production periods of different lengths, the value relations between two goods are determined not only by the number of necessary and standardised working hours, but also by the level of the capital costs. The attempt to reduce the number of types of production factors to one has thus failed.
Let us finally turn to David Ricardo's third step, proving that the multitude of different qualities of work can be ascribed to a standardised quality of work. As shown, David Ricardo tries to solve this task by ascribing the wage differences of different work qualities to purely technical determinants, which can be regarded furthermore as constant at least in the short term and thus be regarded as given.
Just this assumption must be doubted, however. In reality, these value relations in wages are of an economic nature and thus are problem variables and not data variables as assumed by Ricardo. We speak of economic problems here whenever the value relations depend on the scarcity of these factors. And indeed, we have to assume that scarcity relations are involved in determining the value relations of the different qualities of work. Let us illustrate this thesis with a simple example:
We assume a small enterprise which employs 10 unskilled workers for the production of a handcraft product. The workers comply with the standardised quality of work and additionally need a foreman who supervises the hand movements of the workers. We would also like to assume that in the past, the foreman was traditionally paid twice the wages of the unskilled workers. Although it is incomprehensible to me how one should be able to assume that for technical reasons the supervision of the workers is worth just twice as much as the execution of the work, we still want to assume that on the basis of such notions the foreman's salary was fixed previously.
We now want to assume that the employment relationship of the foreman is discontinued, e.g. because he retires, so that the enterprise must hire a new foreman. We also want to assume that foremen have become very scarce as a result of a booming economy and that the enterprise can therefore only employ a new foreman on the condition that he is paid not twice but three times the basic salary of the other workers employed.
In this example, the value relations of the individual work qualities are clearly determined by scarcity relations and it will have to be conceded that even in reality it must be reckoned with this possibility (the scarcity of certain skilled workers) very often. But then David Ricardo has also missed his aim in this third step of evidence: he has again tried to explain an unknown (namely the value of a good) by another unknown (namely the value of a work quality among several) and thus missed his aim. The problem would only be solved if he had succeeded in clearly ascribing the respective wage relations to data quantities which do not require any further explanation.
Let us try to summarise these three points of criticism in David Ricardo's reasoning: David Ricardo did not succeed in reducing the multitude of actually existing types of production factors to a single variable. Thus, it remains that the attempt of the representatives of the classicism, to ascribe the value of a good to objective quantities, namely to the necessary unit costs of a good, has failed.
Now this certainly does not mean that David Ricardo's theory of value should be thrown on the rubbish heap of teaching history. It remains the merit that David Ricardo is almost the only one of the classical scientists to have succeeded in recognising the problem of every objective theory of value. It was a great achievement to have correctly recognised that ascribing the values of individual goods to the necessary unit costs can only be satisfactory if it can be proven that a single homogeneous production factor alone determines the value of a good.
It is said that the correct recognition of a problem is already half the solution, but it is just only the one half. At the solution of the correctly identified problem one of the famous errors of reasoning in the history of national economics is present. But even here, the way in which David Ricardo proceeded in order to finally attribute the multitude of production factors that determine the value of goods to one determining factor must be described as markedly brilliant.
Ricardo's error was firstly due to the fact that he failed to recognise that the reasoning for the elimination of the factor soil could basically be applied to any factor of production; secondly, that he apparently proceeded from the assumption that the differences in the length of production periods were irrelevant to his reasoning; and finally that he thirdly overlooked the fact that the wage relations between the individual qualities of work very often depend on scarcity and thus on a problem variable that has to be clarified within the framework of an economic science.
8th Long-term development of a national economy
Our model of the Ricardian value theory discussed so far was static and stationary. It was static because we limited ourselves to the value that a good will achieve in the long run. We did not ask in which way and in which period of time such a value is achieved in practice.
The concept was moreover stationary, because we were only asking what value a good would achieve in the present world. We have not yet examined what changes in these values can be expected in the long term, whether we can assume a growth rate in these values and whether these values are heading towards a certain limit in the very long term.
David Ricardo has also reflected on these dynamic aspects of a value theory in his work, and at the end of this chapter we will briefly introduce this dynamic model of Ricardo and then examine it critically. In doing so, Ricardo also draws on the theory of population developed by Robert Malthus.
As is well known, Robert Malthus had made a very pessimistic prognosis about population development and the possibility of adequate economic growth. In his popular version, this theory states that the population has the tendency to grow in the sense of a geometric series, while the food supply can only grow in the sense of an arithmetic series.
We always speak of a geometric series when the respective numbers correspond to a scheme as follows:
The values of a certain variable - in the example of the population theory of Malthus: the population - thus double from period to period, or in general, the values of the respective next period result from the value of the previous period, in which this is multiplied by a constant variable (in our example with size 2).
By contrast, we speak of an arithmetic series whenever the respective numbers correspond to the following scheme:
The values of the variables mentioned here (the food margin in our example) increase from period to period by one unit or generally by a constant absolute amount.
Behind the statement that the population is developing in the sense of a geometric series, there is of course no real, empirically verifiable assumption, unless the exact length of the period is given. If the population is growing, at some point it will have doubled, which may be the case in ten years, then we would assume rapid, frightening growth of the population; but that may also only happen after 10 000 years, then we would assume very moderate growth of the population.
A certain informative content is given to Malthus' thesis about population growth, though, already when the length of the periods remains identical always.
The further statement that the food scope grows only in the sense of an arithmetic series is derived from the law of diminishing marginal revenue of the soil, which had been developed by both David Ricardo and Robert Malthus.
According to this, the soil revenue can be increased by cultivating more soil that has been uncultivated or by switching to a more intensive type of cultivation. However, the increase in revenue decreases with each increase in the area of cultivated soil or with each increase in intensification. This increase in revenue is known as marginal revenue.
The reason for this decline in marginal revenue in the case of an expansion of the cultivated soil area is that more and more soil must be used that is less suitable for cultivation. Initially, the best quality soils are selected, but the more is produced, the more soils must be used which are of inferior quality.
If one chooses the way of an intensification in order to increase the total revenue, the intensification leads to decreasing marginal revenues, because a multitude of factors (of the soil conditions) is involved in every development and because in the course of the intensification the optimal composition of the individual factors is more and more abandoned.
If we now assume that the population is growing and that the marginal revenue of the land is decreasing more and more due to the expansion of soil production, a regularity is developing, which is shown in the following diagram:
On the abscissa we want to draw the size of the population and, derived from this, also the number of workers employed in agriculture, whereas on the ordinate we draw the marginal revenue of the soil.
We assume a point in time when the size of the population was still relatively small and, for example, was equivalent to size B1. Due to the smaller population, it was still possible to cultivate only the best quality soils, with the consequence that only a low rent was achieved, the quality of the cultivated soils did not yet show any considerable differences.
The surface below the dividing line for the rent represents the total revenue of the production after deduction of the rent. This remaining sum is now divided between entrepreneurs and capital providers on the one hand and workers on the other hand. The wage total here is equal to the product of the number of workers employed in agriculture multiplied by the prevailing wage rate, which roughly corresponds to the subsistence minimum. It can also quite well be acknowledged that the current wage rate is above the subsistence level, too. On the one hand, the entrepreneurs have a relatively large profit margin which allows them to raise wages; on the other hand, the possibility is quite conceivable that, due to a shortage of labour, the entrepreneurs will be forced to grant more than the subsistence minimum as wages in order to be able to employ sufficient workers at all. Let us note that at this starting point of the development the profit, i.e. the profit rate is relatively high yet.
We now like to assume that the population will continue to grow (according to the geometric growth predicted by Robert Malthus) and that therefore increasingly those soils of poorer quality will have to be used additionally for cultivation. Since the price of the soil products must at least cover the unit costs that arise on the qualitatively poorest soil, the result is an ever-increasing amount of rent that accrues to the owners of the qualitatively better soil. Of the total production, the total area below the marginal revenue curve, less and less is left for profit and wages; and this means that especially the profit rate decreases, since the wage is anyway largely equivalent to the subsistence minimum and for these very reasons it cannot be reduced further:
Now we want to ask ourselves whether there is an end point in this economic development where growth stops and subsequently remains in a stationary state. The graph shows that once the population has reached the size B3, the economic development comes to an end. The profit rate has fallen to zero, the rentiers and the workers share the total product, whereby the wage rate still corresponds to the subsistence minimum only. Entrepreneurs and capital providers have no incentive to expand production, which means that, according to Robert Malthus' pessimistic population theory, the population expansion can only be stopped by famine or war.
Let us now turn to David Ricardo's assessment of this dynamic model and examine the individual assumptions of this model. The first thing that stands out is that Ricardo, and with him Robert Malthus of course, only considered the production of agricultural products. Now, in the initial phase in which the classical theory was developed, it may have corresponded to reality that agriculture had accounted for over 90% of total production, so that it seems understandable and also justified to exclude industrial and manual production from the consideration in a simple model. We must add, however, that the share of industrial production increased very fast, so that even during Ricardo's lifetime this part of the economy could no longer be ignored in an overall model.
But if we assume that in the meantime a large part of the production consisted of non-agricultural products, the question arises whether the law of diminishing revenues, initially developed only for agriculture and for the production factor soil, can still be regarded as decisive for the development of the entire national economy. Of course, the economic development of the entire national economy depends primarily on the course of revenues in industry, if we must assume that the major part of the domestic product is produced in industry and craftsmanship.
Despite this circumstance, we can certainly adopt the revenue development shown by Ricardo. It has in fact turned out relatively quickly that the regularity observed in the law of diminishing revenues actually has very little to do with agricultural production, but rather with the fact that several production factors are involved in the production of almost all goods, and that for a given technology there is always an optimum input ratio of these factors. Thus, if only one of these factors of production, e.g. the labour force, is used more intensively while the other factors remain constant, the marginal revenue must inevitably decrease. This means that we can assume that in the area of industrial production, too, marginal revenues can be expected to decrease.
In this case, however, we have to modify Ricardo's growth model in the sense that with industrial production, the scarcity rent no longer accrues to the landowners but to the enterprises, and that therefore, after deducting the entrepreneurial profit, the remaining total income must be divided between landowners, capital providers and employees. However, this makes it unlikely that the profit rate will tend towards zero.
Ricardo's growth model is further subject to the criticism that Ricardo has considered insufficiently that the law of diminishing marginal revenue applies only if the technology of production remains unchanged. To the extent that technical progress occurs, the productivity, including the marginal revenue, will increase, with the consequence that the marginal revenue curve in our diagram will be shifted outwards, and thus the point of stagnation will be repeatedly shifted into the future.
De facto, in the course of industrialisation, production was increased to such an extent that the growth rate of production soon exceeded the growth rate of the population, thus enabling not only the domestic product but also - due to an ever-increasing influence of the trade unions on wage levels - the wage income to be increased.
This trend was intensified by the fact that the growth rate of the population decreased after a certain point in time and sometimes even became negative. This development completely contradicts the pessimistic view of Robert Malthus. It depends on many factors. In the early stages of industrialisation, a worker needed children so that when he could no longer work at a certain age, he could be supported by his children who had grown up in the meantime. As infant mortality was extremely high in the early stages of industrialisation, a worker could only hope to be supported in old age if he bore a larger number of children.
This necessity disappeared as soon as the governments introduced social legislation and therefore the workers were able to survive materially without material support of their children with the help of their retirement pension. Infant mortality also declined with increasing medical progress, so that the desire to have children could be achieved even with fewer births.
As time went by, the education of the children became more and more expensive, so that the own children turned from an initial source of income into a cost factor very soon. This turnaround has certainly also contributed to the fact that the birth rate declined as prosperity increased.
Finally, it must be mentioned in this context that due to the emancipation movement, more and more women pushed into gainful employment, with the consequence that the desire to have children was postponed because there was too little time left for bringing up children.
However, in the most economically advanced economies, a renewed reversal towards higher birth rates can be observed. Here, too, several factors are likely to be responsible. Firstly, the per capita income has often risen so sharply that families can afford to have children again. In addition, having children often raises social prestige, especially if one can afford to give the children an excellent education. Furthermore, more and more states are bearing a considerable part of the costs associated with bringing up children. This also includes the measures for the establishment of state-subsidised day care centres for children. Finally, enterprises are also increasingly willing to open up career opportunities for women with children by, for example, providing part-time work also for managers, allowing parents to take their children to an in-house nursery or eventually allowing parents longer periods of parental leave.
In summary, we come to similar conclusions in the assessment of the dynamic model as in the assessment of the static value model. With his population theory, Robert Malthus correctly recognised the fundamental problem of every theory of population. He has shown that poverty can only be overcome if the growth rates of the population and the domestic product are brought into harmony. Even when his model was based on partly erroneous assumptions, he provided the impetus for a very fruitful discussion on population issues.