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Smith, Ricardo and the FM

Smith, Ricardo and the FM
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First Published: Tue, Mar 04 2008. 11 13 PM IST
Updated: Tue, Mar 04 2008. 11 13 PM IST
Is it time to revive a dusty debate that goes all the way back to the birth of modern economics? That old dispute could help us understand a contemporary issue: How will high food prices and volatile farm output affect economic growth in the long run?
That there are concerns on this score is evident. Global food prices have been on fire over the past year. Farm productivity is stagnant. Arable land is being lost to urban expansion and climate change. Food security of the poorest could be under threat.
In his Budget speech of 29 February, finance minister P. Chidambaram made several mentions of the risks from high food prices and the near-stagnation in agriculture. He noted that capital formation in agriculture has increased from a low of 10.2% of India’s gross domestic product (GDP) in 2003-04 to 12.5% in 2006-07. He also added that farm investment has to rise further to 16% of GDP if India is to sustain 4% growth in agricultural output. While Chidambaram seemed more concerned about the immediate impact of sluggish farm output on inflation, there should be longer-term concerns about the impact on economic growth as well.
The 18th century English economist, David Ricardo, believed that societies would be forced to cultivate increasingly less fertile land as demand for food expanded. Food prices would rise, pushing up wages and rents. This would leave a smaller part of the national income for profits. Low profits would make new investments unattractive to the capitalist class. Ricardo believed that the capitalist economy would eventually settle into a stationary state of zero growth.
Ricardo was proved wrong. The discovery of the Americas led to a sudden increase in the supply of high-quality land. Technical improvements increased farm productivity. Relative prices of food have fallen dramatically over the past century. But the Ricardian belief that an agricultural pinch would act as a constraint on economic growth got a fresh lease of life in the development debates of the 1950s.
The early development debates in the 1950s in India and elsewhere took a lot from Ricardo’s glum talk about constraints on growth. Our textbooks told us how India has to ration scarce savings, foreign exchange and food if it is to grow.
Prime Minister Manmohan Singh mentioned these issues in a speech he gave on 7 February 2007. “In the past it used to be said that India’s economic growth was being held back by a trinity of internal and external constraints—a foreign exchange constraint, a food and wage goods constraint and a savings constraint. Today, we can say with confidence that we have broken each of these constraints,” he said. He also added that India now faces a new set of constraints such as poor infrastructure and the shortage of skilled manpower.
Have we really broken the food and wage goods constraint? Perhaps. But what if we haven’t? Would India be condemned to low economic growth because food inflation will push up wages and compress profits? Not necessarily, if we go by the perspective of another old economist Adam Smith.
Smith came before Ricardo. His was the more optimistic view. This 17th century Scottish economist believed that the division of labour and specialization would spur innovation and growth. No stationary state for him.
In a recent blog post on economic history, Mark Koyama of Oxford University compared the two views of economic growth. “There are, broadly speaking, two different perspectives in economic history: a Ricardian/Malthusian perspective…emphasizes the significance of the constraints that bound pre-industrial economies… This view was certainly the dominant view amongst economic historians in the post-war period and it seems also to have dominated discussions in development—particularly the emphasis on importance natural resources, savings and population control and the comparative neglect of institutional considerations that typified the approach taken in the 1950s and the 1960s follows from a Ricardian paradigm,” writes Koyama. He earlier described “Smithian growth based upon falling transactions costs and increases in specialization and the division of labour.”
Coming back to our own day and age, the question then is: Will higher food prices be an inevitable Ricardian constraint that will damage long-term economic growth or will more reforms in agriculture and related industries such as retailing help spur growth through more specialization and falling transaction costs?
It perhaps seems a bit odd that what Smith and Ricardo wrote around 200 years ago should continue to be so relevant in the 21st century. But then great economics is like a great book. Every new generation finds fresh meanings and insights from the old classics.
So: Smith or Ricardo? Who’s your choice?
(Your comments are welcome at cafeeconomics@livemint.com)
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First Published: Tue, Mar 04 2008. 11 13 PM IST