Maithus, Ricardo, and Marx-
Stnfs and Diminishing Returns

Two Englishmen, writing soon after Adam Smith, saw instead a gloomy world of conflict and strife—of workers, capitalists, and landlords climbing on each others’ backs, each trying to increase his own share of the sustenance produced by society. T. R. Maithus and David Ricardo, two other great founders of modern economics, challenged the orderly world of Adam Smith with disturbing predictions which also have a modern look today, nearly two centuries later.

Maithus and the Specter of Famine. More people mean more power to produce and more output. But more people also mean more mouths to feed, more backs to clothe. In 1798, Maithus, then a young British minister, wrote his nowfamous Essay on the Principle of Population. He gloomily predicted that population would rise far faster than the productive power associated with more people. Looking at rising birth rates, Malthus pointed out that the population could double every generation if each woman had only four surviving children, half of them girls who would produce more children in the next generation. Malthus felt that this might well give a geometrical population increase—2, 4, 8, 16, 32, 64, and so on—with a doubling each generation.

But the world’s land could not possibly increase its food output at this rate over the long run, Malthus argued. Thus, unless population growth was checked by moral restraint, or by such disasters as war or disease, it must ultimately be checked by recurrent famines as the population out-ran the food supply. The British standard of living was hardly above the subsistence level for much of the population; unless steps were taken to control the growth of population, the outlook for growth in output per capita and for a better life was bleak.

Ricardo and the “Law of Diminishing Returns.” David Ricardo, another famous British economist, provided a further intellectual justification for Malthus’ fears. Ricardo first stated the “law of diminishing returns.” Loosely, the law says that if the number of workers applied to any fixed supply of land is increased, the crops obtained from the land will increase, but sooner or later output will increase at a slower rate than the rate at which workers are added.

The implications of this “law” for the standard of living of a growing population seemed clear. Given the world’s supply of tillable land, sooner or later food output per worker would fall when the point of diminishing returns was passed in the application of more and more workers to the limited supply of land. And as population grew thereafter, food output per capita (more accurately, per worker) would decline steadily.

But at the same time as diminishing returns pressed down on the food available for individual workers, it would enrich the landlords. For as more and more workers sought sustenance from the land, the price of each piece of land (in sale or in rent) would rise. Ricardo, the economic theorist par excellence, explained through the law of diminishing returns precisely how fast rents would rise and wage rates fall as more workers were applied to the increasingly scarce land.

Assume momentarily that all land and all workers are identical in productive power. Then basically the wage rate would be set by the (declining) contribution each additional worker added to total output. Rent per acre would be set in the same way by the (rising) contribution attributable to each increasingly scarce acre. In a market system, the price of land and labor would be bid up or down to just what each was”worth” through its contribution to a businessman or farmer hiring it in search of profits. Why? Because it would pay profit-seeking businessmen and farmers to pay up to the amount added by each additional worker or acre; and competition for workers and land would drive wages and rents up to those levels. Here we need not be concerned about the details. You merely need to see that, under diminishing returns, with a growing labor force the nation’s total output might grow, but marginal, or additional, output per worker (and therefore the worker’s real wage) would fall. At the same time output per acre (which determines the rent paid to the landowner) would rise steadily.

But what of capital accumulation, the path to progress in Smith’s system? Ricardo saw the importance of thrift and accumulation in man’s attempt to improve his lot. But here again, Ricardo wrote, the fact of diminishing returns rears its ugly head. As more and more capital is accumulated relative to scarce land, the return on capital (interest or profits) will be squeezed down more and more. In the end it is the landlords who wax ever richer, while both workers and capitalists find their individual returns (in the form of wages and of profits) squeezed to the barest minimum.

Were Malthus and Ricardo right? If history has proved them wrong in the nations of the 1 If you don’t want to accept this loose statement as intuitively right, look ahead to the Appendix to Chapter 22 where the principle is stated precisely and explained more fully. Western world, where did they go astray? Have they been proved right in China and India, where starvation is an ever-present threat for a billion people? Have the rising standards of living of the Western world been temporary, and will Malthus’ specter reappear with the modern population explosion? As with Smith, Malthus and Ricardo have lessons for today. Their arguments will reappear in the modern analysis of growth.

Marx and the Collapse of Capitalism. Fifty years later came Karl Marx, the gloomy prophet of the downfall of the entire capitalist system which Adam Smith had praised so highly. Like his classical predecessors, Marx was interested in the grand dynamics—the progress of society or its road to collapse. But he saw no progress. Instead, he foresaw collapse, as capitalists seized ever-larger profits while forcing the workers into the degradation and eventually to revolt which would overthrow the capitalist system.

Marx built an elaborate theoretical structure on the fallacy that labor is the source of all value. He said that any return to another productive resource, such as capital or land, is merely a misappropriation of the “surplus value” produced by labor. But we need not be concerned with the details of this argument. To Marx, capital accumulation was again at the center of things. The desire for profit leads men to accumulate capital and to wring every ounce of effort out of the workingmen who must labor for their bread. Because capitalists are powerful and rich while laborers are poor and divided, capitalists can in fact push down the real wages of their workers to the point where workers can barely subsist. The higher profits lead to more and more capital accumulation, as Smith and Ricardo had predicted before him.

But to Marx the end result of all this was quite different, though it had been hinted in the worryings of Parson Maithus. Capitalism will develop increasing crises, Marx wrote. Too much of society’s income will go to the rich capitalists. Too little will be paid to the masses to permit them to buy the output of the new factories and machines. Thus capitalism will face increasingly severe crises and depressions, with resulting unemployment and chaos. Finally, the hungry workers, long  ground under the heel of the wealthy capitalists, will rise in revolt and overthrow the capitalist system. So, wrote Marx, would come the downfall of capitalism, brought on by the very process of capital accumulation which the classical economists had praised as the foundation of economic growth.

Clearly, Marx has been wrong in the Western world. Real wages have not been ground down over the long run. Both they and profits have risen rapidly in total, and real wages per worker are vastly higher now than a hundred years ago. Interestingly, the rate of return per dollar of capital invested (loosely, the profit rate or the interest rate) has apparently not increased, though of course the total return to capital has grown enormously with the vast accumulation of capital. And apparently modern monetary-fiscal policy has brought great depressions under control.

Let us stop now and examine more rigorously some of the issues that were exposed by Smith, Maithus, Ricardo, and Marx.

The Deepening of Capital and Diminishing Returns. It is relatively easy to explain the growth in total output of an economy as capital and labor grow. The production-possibilities curve moves out. Unless unbalanced (“excessive”) capital accumulation brings on the crises suggested by Malthus and Marx, an increase in any or all of the factors of production will raise total output. Thus, more workers, more capital goods, or more natural resources will increase total production. (Note that increased natural resources are a real possibility in new nations; for example, until nearly 1900 the United States had continuous access to more land through the open frontier westward.) But how to increase output per ca pita is a much more difficult problem. For more workers, given the law of diminishing returns, will produce more total output, but output per worker will fall, assuming that the stock of capital and land remain constant.

Neglect for a moment the supply of land (natural resources) as of decreasing importance in the advanced economies. Then, if the number of workers increases, at least a parallel increase in the stock of capital would appear to be the only hope for avoiding declining real wages as a result of the law of diminishing returns. If the ratio of workers to capital rises, output per additional worker will fall. The stock of capital must rise faster than population grows, if output per worker is to rise.

This is what economists call the “deepening” of capital—more capital per unit of labor. It is this deepening of capital, the analysis of the preceding paragraphs suggests, that is the fundamental hope for progress, for economic growth.

Let us reconsider now, more analytically, the effects of capital deepening in a simple system. To take the simplest case, assume there is no land, but merely labor and capital as productive factors. Suppose capital grows faster than the labor supply. What then happens to per capita output? The answer is given by Ricardo’s law of diminishing returns. Total output will grow, but not in proportion to the growth in the capital stock. Thus, the return per unit of capital (the interest rate or profit rate) will fall as capital deepens. Here labor is the relatively fixed factor (just as was land in Ricardo’s case). Thus, the wage rate (the return to labor) will be bid up as labor becomes ever more scarce relative to capital; labor replaces the “greedy landlord” of Ricardo’s system. But last, note that higher wage rates and lower interest rates in the system do not necessarily imply a higher percentage share of the total national output for labor. This is because there are more units of capital being used. The increased number of units may more than offset the lower return per unit and thus keep the aggregate share of capital in the national output from falling absolutely, or even relatively to the share of labor.

It is important to be clear about the reasoning of the preceding paragraph. It is the foundation for much of the modern theory of growth, and for moving on now to a new factor—technological progress.