Money, Bank Credit, and Economic Cycles - The Ludwig von Mises ...

Bank Credit Expansion and Its Effects on the Economic System 331Hence the “Ricardo Effect” is a third microeconomicexplanation for the behavior of entrepreneurs, who react to anupsurge in voluntary saving by boosting their demand forin voluntary saving exerts on the productive structure, though he didnot expressly quote Ricardo. This is the only instance we know of inwhich the “Ricardo Effect” is directly applied to an analysis of the consequencesof a rise in voluntary saving, and not to the role the effectplays in the different phases of the business cycle, theorists’ predominantconcern up until now. The excerpt in question is found on p. 293 ofThe Pure Theory of Capital (London: Macmillan, 1941), and successivelyreprinted thereafter (we quote from the 1976 Routledge reprint). It readsas follows: “The fall in the rate of interest may . . . drive up the price oflabour to such an extent as to enforce an extensive substitution ofmachinery for labour.” Hayek later returned to the topic in his article,“The Ricardo Effect,” published in Economica 34, no. 9 (May 1942):127–52, and republished as chapter 11 of Individualism and EconomicOrder (Chicago: University of Chicago Press, 1948), pp. 220–54. Thirtyyears later he dealt with it again in his article, “Three Elucidations of theRicardo Effect,” published in the Journal of Political Economy 77, no. 2(1979), and reprinted as chapter 11 of the book New Studies in Philosophy,Politics, Economics and the History of Ideas (London: Routledge and KeganPaul, 1978), pp. 165–78. Mark Blaug recently admitted that his criticismof the “Ricardo Effect” in his book, Economic Theory in Retrospect (Cambridge:Cambridge University Press, 1978), pp. 571–77, was based on anerror in interpretation regarding the supposedly static nature of Hayek’sanalysis. See Mark Blaug’s article entitled “Hayek Revisited,” publishedin Critical Review 7, no. 1 (Winter, 1993): 51–60, and esp. note 5 on pp.59–60. Blaug acknowledges that he discovered his error thanks to anarticle by Laurence S. Moss and Karen I. Vaughn, “Hayek’s RicardoEffect: A Second Look,” History of Political Economy 18, no. 4 (Winter,1986): 545–65. For his part, Mises (Human Action, pp. 773–77) has criticizedthe emphasis placed on the Ricardo Effect in order to justify aforced increase in wages through union or government channels withthe purpose of raising investment in capital goods. He concludes thatsuch a policy only gives rise to unemployment and a poor allocation ofresources in the productive structure, since the policy does not stemfrom an increase in society’s voluntary saving, but rather from the simplecoercive imposition of artificially high wages. Rothbard expresses asimilar view in Man, Economy, and State (pp. 631–32). Hayek does so aswell in The Pure Theory of Capital (p. 347), where he concludes that dictatorially-imposedgrowth in wages produces not only a rise in unemploymentand a fall in saving, but also generalized consumption of capitalcombined with an artificial lengthening and narrowing of the stagesin the productive structure.