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

370 Money, Bank Credit, and Economic Cyclesa short-term decrease in the demand for consumer goods andin their price, and thus a boost in real wages which encouragedthe substitution of machinery for workers, growth in thedemand for capital goods and a lengthening of productivestages. Now we see that the relative rise in the price of consumergoods causes a drop in real wages, motivating entrepreneursto substitute labor for machinery, which lessens thedemand for capital goods and further reduces the profits ofcompanies operating in the stages furthest from consumption. 80reverse was in his essay, “Profits, Interest and Investment,” included inpp. 3–71 of the book of the same title. Hayek offers a very concise descriptionof the “Ricardo Effect” on pp. 13–14 of this essay, where he states:It is here that the “Ricardo Effect” comes into action andbecomes of decisive importance. The rise in the prices of consumers’goods and the consequent fall in real wages means arise in the rate of profit in the consumers’ goods industries,but, as we have seen, a very different rise in the time rates ofprofit that can now be earned on more direct labour and on theinvestment of additional capital in machinery. A much higherrate of profit will now be obtainable on money spent on labourthan on money invested in machinery. The effect of this rise inthe rate of profit in the consumers’ goods industries will betwofold. On the one hand it will cause a tendency to use morelabour with the existing machinery, by working over-time anddouble shifts, by using outworn and obsolete machinery, etc.,etc. On the other hand, in so far as new machinery is beinginstalled, either by way of replacement or in order to increasecapacity, this, so long as real wages remain low compared withthe marginal productivity of labour, will be of a less expensive,less labour-saving or less durable type.Hayek also deals with the action of the “Ricardo Effect” in the most expansivephases of the boom in the following papers: “The Ricardo Effect”(1942, pp. 127–52), and the previously-cited “Three Elucidations of theRicardo Effect” (1969). Other interesting writings on this topic include thearticle by Laurence S. Moss and Karen I. Vaughn, “Hayek’s Ricardo Effect:A Second Look” (1986, pp. 545–65) and the one by G.P. O’Driscoll, “TheSpecialization Gap and the Ricardo Effect: Comment on Ferguson,” publishedin History of Political Economy 7 (Summer, 1975): 261–69. See alsoJesús Huerta de Soto, “Ricardo Effect,” Eponymous Dictionary of Economics:A Guide to Laws and Theorems Named after Economists, Julio Segura and CarlosRodriquez Braun, eds. (Cheltenham, U.K.: Edward Elgar, 2004).80 Or as Mises explains: