Was Ricardo right?

David Ricardo was right - rising raw materials prices will kill off economic growth. That seems to be the opinion of companies, consumers and financial markets.
To see what I mean, remember Ricardo's theory of rent, set out in his Essay on Profits. Economic growth, he said, would raise the prices of "raw produce" which would squeeze profits and eventually remove the motive for inventment and hence growth:

By bringing successively land of a worse quality, or less favourably situated into cultivation, rent would rise on the land previously cultivated, and precisely in the same degree would profits fall; and if the smallness of profits do not check accumulation, there are hardly any limits to the rise of rent, and the fall of profit....
The sole effect of the process of wealth on prices, independently of all improvements, either in agriculture or manufactures, appears to be to raise the price of raw produce and of labour, leaving all other commodities at their original prices, and to lower general profits...
in every society advancing in wealth and population, independently of the effect produced by liberal or scanty wages, general profits must fall.

Of course, he spoke about how rising food prices - and hence higher wages - would lower profits. This is not happening now. But something very similar is. Rising commodity prices - other "raw produce" - could squeeze general profits and hence economic growth.
No less than five groups of people are behaving as if this vaguer version of Ricardo' theory is about to be vindicated - at least in the UK - and are betting on slower future growth.
1. Commodities markets. Despite recent dips, both the CRB and Goldman Sachs' commodity price indices show that prices of raw produce are near record highs.
2. The gilt market. Real interest rates - those on longer-dated index-linked gilts - are under 1%. A long-standing rule of thumb is that, in equilibrium, real interest rates should equal trend growth.
3. The equity market. The yield on the All-share is now 1.9 percentage points above that on 10-year index-linked gilts - a near-record high. Maybe investors need a relatively high yield on shares to compensate for the fact that future dividends will grow so slowly.
4. Companies. They're not  investing. In the last 4 quarters, their retained profits exceeded their capex by £24.1bn - 2% of GDP, a near record (table I of this pdf). And they have also cut R&D spending (pdf) in the last two years, despite low interest rates and high profits. Both facts betoken a pessimism about long-term future growth.
5. Consumers. Retail sales fell 1.3 per cent in January (pdf). The permanent income hypothesis tells us that this could be because consumers have cut their expectations for future incomes - perhaps, taking their cur from companies, gilt and equity markets.
Four different groups are , then, telling us that future growth will be low. With commodity prices at near-record highs, this is consistent with a belief in some version of Ricardo's theory of rent.
Of course, there are other explanations for all five facts.  But none are as consistent with Occam's razor and the presumption of individual rationality.   

Comments

[Tim Worstall]

I know so little about the theoretical background here that perhaps I shouldn’t comment.
But the rising prices of commodities, most especially metals, I think most unlikely to continue. They’re a bubble. Just a view from inside those markets if you wish. Might be a few years before it bursts but it will, either from substitution or from new extraction methods or perhaps simply new mines.

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