Resurrecting Malthus and Ricardo
Why two old school economists obsessed with land, agriculture and food matter in the new economy
Since I’ve been talking about old books for the new economy, here are two really old dudes — Adam Smith’s less well known co-founders of liberal economics — whose work matters to the new economy more than we realize. The two were besties in real life but intense intellectual rivals in their work, which focused on “soil” — the mostly forgotten third production factor (next to capital and labor).
David Ricardo is remembered as a big optimist — the evangelist of unbound opportunities — while the notoriously pessimistic Thomas Robert Malthus was the negative nelly of the profession: he gave name to both the dismal science and the Malthusian catastrophe, so let’s go from gloom to glam and start with Malthus.
Thomas Malthus and population dynamics
Malthus' lasting legacy is a grim prediction which didn’t come to pass. In his Essay on the Principle of Population he argued that the population of England would grow geometrically while food production only linearly.
So eventually and inevitably population growth would outrun food supply. If you’re not into algebra stuff, “linear” means a straight line, while “geometric” (or “exponential”) here means a curve that is always curving upwards.
No matter how steep you draw the line and flat the initial curve, eventually the curve will cross the line. Curve = food consumption, line = food production — when food consumption outruns food production we get something called hunger.
As we know, England didn’t die from starvation, even though she had multiple brushes with hunger pangs over the years. These brushes we now call Malthusian checks or catastrophes, depending on severity.
To understand his true contribution, let us generalize his model into two exponential curves and keep in mind that all organic and evolutionary growth process are exponential. They usually represent supply and demand over time, or any inflow and outflow of things, in particular perishables like food.
If at any point in time demand outruns supply and there is no stock of products, we’re in trouble — a Malthusian check. When production outruns consumption we might be in heaven. Let’s see.
We see Malthusian dynamics more often than we realize. Especially when the flatter curve starts higher and the steeper curve eventually crosses it we get well-known inflection points:
- In startup finance, the famous “hockeystick” is Malthusian process. Cash outflow usually starts above cash inflow — the valley of tears you have to fill with outside financing. Eventually cash inflow should get steeper than outflow, and at some point they cross — the break-even point. At this point the hockeystick kicks in.
- Another Malthusian process is the hype-disappointment cycle. Here the “production” curve is actual results and the “consumption” curve is expected results. If expectations go into overdrive and slowly come to the realization that actual results don’t follow suit, we reach the inflection point Paul Krugman calls “Wile E. Coyote moment” — the moment gravity kicks in and we’re making the hard fall into the trough of disappointment. Sounds familiar? Think dot-com bust!
- Yet another Malthusian process is the adoption cycle. The “consumption” curve is cost of adoption — likely to start high but falling. The “production” curve is the benefit of adoption. In network economies this depends on the number of other adopters, so it should curve upwards. If and where these two curves cross something called the “critical mass” is reached.
So in other words Malthus' invention has quite a few applications, not all of them dismal. Let’s look at what Ricardo has to offer.
David Ricardo and the power of position
Unlike Malthus, his dear friend David Ricardo was a happy-go-lucky guy and also some kind of opportunist who made a fortune in speculating on the outcome of the Battle of Waterloo. Today he would probably get into trouble for that.
Among his many contributions, I’d like to focus on the concept of “rent”. Today the term pops up in a bunch of related contexts, like if you pay rent for your apartment or receive retirement payments as a rentier.
Technically it is a recurring payment that comes from some sort of privileged position of ownership, for which you don’t need to put in a lot of effort and which nobody can take away from you — in economic terms, you’re living the dream.
In the dark ages, robber barons used to extract rents from traveling merchants by building castles on top of outcroppings from which they could control major trade routes. The merchants paid for the simple privilege of not getting robbed of their wares.
More recently the Sicilian water mafia got hold of all water supplies and extracted steep rents from farmers. As you see, rents are kinda sketchy things and economically, rent-seeking is a problematic term.
In business it is a really really good term and it comes in three qualities. To start from the bottom, there’s revenue, then there’s profits, then there’s recurring, non-diminishing profits — rents.
Three basic types:
- Schumpeterian rents, derived from a technology advantage — as soon as this advantage has dissipated the Schumpeterian rents will cease. This was a big point in the Microsoft antitrust case I wrote about earlier.
- Marxian rents, derived from the market structure and the market power of the producer, often reduced to market concentration and the power of big players to keep small players out. Barriers to entry are much more powerful than Schumpeterian rents, and less likely to dissipate. But they’re still only the second best.
- Ricardian rents are not derived from keeping competitors out but from keeping customers in — in technology adoption this is the so-called lock-in effect. Once your customer invests in your offering they have to continue buying from you to keep it afloat — or as a very smart person said: “maintenance is the new innovation”…
Ricardo wrote about rents in the realm of agriculture — originally rent was the annuity collected by land owners just as profit was collected by owners of capital, and wages by laborers.
Land is used for farming as long as the yield is bigger than the costs of producing (there’s some tricky disclaimers to that point which I might discuss elsewhere). But the quality of soil differs, and if you hold a truly good piece of land you are wont to collect Ricardian rents from being able to produce more and better food on the same acreage than a farmer toiling on low quality soil.
Translated into the new economy “truly good piece of land” means two things. For one, it means mindspace. If you are the entity people think of first when they want to solve a problem you’re golden — think Google. For two, it means geography: if you wonder what is the best place in the world to found a tech company, there’s only one answer: Silicon Valley.
And no matter how expensive doing business in the Valley is, the benefits outstrip the costs. Truly the former peach capital of the world is now the best piece of land for growing young companies.