Classical Economics Flashcards
Globalisation
free movement of labour - work where you like
free movement of capital - invest where you like
free trade, buy and sell where you like
Smith’s case for free trade
2 countries can gain from trade when they have absolute advantage in different countries
UK: steel is cheap to produce, corn is expensive - US is the other way around
so specialise and trade, both countries will benefit
Ricardo on Free trade
suppose both goods expensive in the UK, cheap in the US
not in the US interest to trade which Ricardo says is because of comparative advantage
Comparative advantage
assume UK and US have same amount of inputs (use graph of production frontier of steel and corn - different slopes)
specialisation and trade makes both countries better off so UK could specialise in steel and exchange some of it for US’ corn and vice versa
both countries end up better off in both goods
this is an argument for free trade
Arguments against free trade
- National security - selling weapons to a country you could fight
- Infant industry - suppose UK will eventually have a comparative advantage in steel but has to build it up first (economies of scale) - would need to protect it from foreign competition
Government intervention on free trade
governments aren’t good at forecasting comparative advantage so might protect the wrong industries
once you put tariffs on, lobbyists and politicians who want the industries votes will see they never come off
by the time the protected industries become competitive, technology or consumer demand may have moved on
Further arguments for free trade
- Increases size of firms’ markers with economies of scale and more incentive to create new technologies
- Facilitates knowledge spillovers to other countries so they can learn deem imports of advanced consumer goods, import of advanced capital and learn by contact with foreign traders
- Turns monopoly into competition, ‘dynamising’ firms who now have to hold onto their markets with technological innovations, efficiency gains and increased investment and therefore capital stock
- Tariffs lead to retaliation (both countries worse off)
Ricardo’s view on retaliating to tariffs
Ricardo says you shouldn’t retaliate as tariff’s damage consumers more than they benefit producers whatever the other country’s policy
Bastiat: retaliation is like throwing rocks into your harbour because someone has done the same to theirs
Current bid for Unilateral free trade
Brexit pessimists estimate that leaving EU will cost UK up to 10% of GDP due to lost volume of trade
Economist for Brexit say to keep free trade with EU and abolish all tariffs against rest of the world and forecast a 4% gain in GDP
Adam Smith institutes post-Brexit trade deal
will be no tariff or non-tariff barriers on imports to the UK
imports will be regulated in same manner as domestic production
Why Ricardo isn’t good enough for libertarians with regards to trade
talks about countries trading but countries don’t trade individuals and firms do
if you talk about countries trading you lose sight of the fact that there’s no difference between trade across and within national boundaries
Ricardo’s theory of rent - corn model
Landlords rent out land to farmers and capitalist farmers combine their capital equipment with hired labour to produce corn
workers work for a subsistence wage, if wages rise, population rises, less food per head so wages come back down again
assume 3 landowners A,B & C rent out land to three farmers
the limits of production depend of demand for corn
Corn model continued
if Farmer A makes £160 from two workers at £20 subsistence wage his surplus is £120
But landlord can force farmer to pay rent
As land A yields £80 more surplus than B, farmer B will pay up to £80 to rent land A
Therefore landlord A can force farmer A to pay the same
Hence both farmers end up with B’s original profit
conclusion: profit depends on profitability of marginal land (worse land in use)
Rent depends on difference between marginal and better land
Corn model - what happens next?
profits are positive so investment takes place and so capital accumulates
this raises demand for labour to work the capital
so wages rise, population rises, more births (follows Malthus) and demand for corn then rises
Effects of increased demand for corn
more land comes into cultivation - all 3 farms fully worked
price of corn rises due to increased demand
workers’ real wages eventually return to subsistence
ie money wages match rise in prices and double too
what has happened to incomes of the 3 classes?
workers - no real change, money wage has doubled but so has price of corn
Farmers(capitalists) - profits fall to zero
landowners - total rents rise and total share of product rises
Lesson’s drawn from Ricardo
- As population increases, landlords get an even larger share of national product
- The price of corn determines rents
- Profits will eventually fall to zero or to the point where farmer is no better off than his workers therefore investment and growth Peter out
- You can tax rents without damaging the economy
Suppose you put 50% tax on rents: if landlord takes land out of cultivation, he gets no rent, so better to keep renting and pay the tax
so tax on on land, unlike taxes on capital and labour, doesn’t give a disincentive to supply it
Why should all profits fall to zero if Ricardo only looks at agriculture?
- Because like Smith he believed that profits tend to equality between all industries - thus falling agricultural profits drag others down
- because industry, like agriculture, will have to pay higher wages (to keep workers at subsistence) even though their prices haven’t risen and so profits fall independently
Long-term consequences of Ricardo’s Theory
- Landlords depicted as unproductive and parasitical (as they steal the profits and extinguish growth)
This added momentum to campaign against protection of agriculture e.g British Corn Laws
Corn laws were a tariff on imported corn which kept the price of bread high, pushing up money wages and reducing profits (repealed in 1846 after Ricardo’s death)
2.Used by single tax movement:
Henry George, Progress & Poverty (1879) said to only tx rents but tax them as high as you like to raise revenue
so there’d be no interference with supply of factors of production
critics however say there would be interference as landlords improve their land so taxing land would be a disincentive
a solution to this would be to tax the unimproved component of the land i.e tax according to its value without improvement
Land value tax
Currently in Denmark, Russia and Singapore
problem lies in working out what unimproved value would have been
usual method is to tax all land on basis of average price of land in the area
so improving land will push up the general rate of tax
but improved land won’t pay any more than unimproved
