Ricordo’s Dream

 

Ricordo’s Dream: How Economists Forgot the Real World and Led Us Astray

Nat Dyer (2025, Bristol University Press)

      In my second year of college, I spent considerable time in the company of economics students. One day I asked one of them to give me the ten-minute version of the introductory course. ‘Well,’ he said, ‘Day one, Markets. Assume perfect information, and perfectly rational actors.’ ‘Okay,’ said I, ‘does it make any difference that neither of those things exists in real life?’ ‘Not really,’ he said, ‘we're just modeling.’ As it turns out, I was right to be suspicious. An awful lot of academic and professional economics rests on premises as illusory as those, and it makes a difference.

       In 1817, David Ricardo published a seminal work of economic theory, On the Principles of Political Economy and Taxation. Only Adam Smith’s Wealth of Nations, from forty years earlier, held anything like its influence on the next several decades of economic thinking. For thirty years, Ricardo had been a brilliant stock broker on London's exchange, before retiring to theorize in rural comfort. His friends included thinkers like Thomas Malthus and James Mill, whose son, John Stuart Mill, would build on Ricardo's work.

       The first four chapters of Ricardo's Dream delve into a famous theory of his, still cited today. In essays about international trade, he put forward the idea of 'comparative advantage', on a simplified model of two countries (England and Portugal) and two commodities (wine and cloth.) Using hypothetical man-hour numbers and some algebraic sleight of hand, Ricardo proved (so to speak) that England should produce cloth and ship it to Portugal. The Portuguese, in turn, should concentrate on wine-making, notwithstanding that they could likely produce their own cloth more cheaply. The example was salient because of the Methuen Treaty of 1703, which had formalized just such a relationship, so that England began consuming port instead of French wine, and the mills of northern England found a reliable market in Portugal.

      There’s quite an interesting story behind that story. First, the numbers in the equation were completely invented by Ricardo, as he freely admitted. Second, using man-hours only, without reference to wages or other costs of production, very likely introduced other errors; imagine a model that used miles per gallon as the sole factor in the cost of car ownership. Third, it’s a bad example of free trade in the global economy, because Portugal was not actually on an equal footing with England, for military and political reasons having to do with England’s long-running contest with France.

       Fourth, to consider only those two nations is to miss a major piece of the story: what were the Portuguese doing with all that cloth? They were trading it on the west coast of Africa for slaves, who were sent to Brazil to work in gold mines. The gold they produced made its way to England, to make up the trade balance between wine and cloth, amounting to many millions of pounds over the eighteenth century. All this is omitted from Ricardo’s deft little straw-man equation.

      Economics did become a more practical affair between the mid-nineteenth century and the Second World War. The middle chapters of the book name a few economists who were not averse to building theories on actual evidence; sometimes they even included the role of the government in business and economic life.

       Regrettably, I think, the past fifty years have seen a pronounced swing in the other direction, toward mathematical models that have taken on a life of their own. In particular, modern financial markets operate on the assumption that “market prices reflect instantly all available present and future information about the assets traded, allowing calculating traders to allocate money to the best and most efficient purposes. The only genuinely new information is that which cannot be predicted and is, therefore, by definition random, leading to limited price fluctuations.” Wouldn’t that be a nice safe world? It’s just not the one we live in, as nineteen-year-old me suspected.

        There’s an awful lot of dumb economic news these days. I found this book an entertaining way to get some perspective on it, even when it’s alarming to think about. If all we do–if all we can do–is extrapolate from what has come before, our predictive powers will never be that great.

 

 

Any Good Books, April/May 2025