David Ricardo on Wages and the Deflation of Currency

David Ricardo

Found in The Works of David Ricardo (McCulloch ed. 1846, 1888)

Two years after their victory at Waterloo, when David Ricardo wrote “The Iron Laws of Wages,” in 1817, the British had already won the Napoleonic Wars, but the suspension decreed in 1794 of redemption in gold of the banknotes issued in profusion by the Bank of England (BoE) to finance that war was still four years in the future.

There were much more paper money in circulation than what would be possible to redeem with the paltry reserves of gold in the coffers of all the banks in the empire if the pre-war parity were to be respected.

Because the honor of the Crown demanded the public debt to be repaid at the parity in which it was contracted, a long and painful deflationary process was initiated as the troops were demobilized, military costs slashed, and gold gradually accumulated again in the vaults of the BoE.

Therefore, nominal wages needed to be reduced substantially if the deflation of the currency was to be successful and redemption at the pre-war parity resumed.

These, then, are the laws by which wages are regulated, and by which the happiness of far the greatest part of every community is governed. Like all other contracts, wages should be left to the fair and free competition of the market, and should never be controlled by the interference of the legislature. (FROM CHAPTER V.: ON WAGES)

Indeed, the demobilized troops were swelling the ranks of the unemployed putting downward pressure on wages at the time that the deflationary process was reducing domestic consumption and investments.

The sooner the excess of paper money were to be reduced and the relative prices adjusted to the pre-war parity, the shortest the painful situation would pass.

However, Parliament, decided then as part of the “poor laws”, to enact The Poor Employment Act of 1817 (officially the Public Works Loans Act of 1817), by which they would fund, with the issuance of further banknotes, local public works in order to keep the wages from failing.

Ricardo, in arguing for market determination of wages, was stating the obvious, and at the same time, showing the contradiction between the deflationary and wage supporting policies pursued by the British government.

At the end of the process, real wages would be higher than during the war, once production was diverted from military procurement back to consumer goods, and in Ricardo’s eyes, the palliative measures taken by Parliament were only delaying that from happening.