This was something I just finished writing, inspired by your question. I hope it helps to answer it.
I was first introduced to the concept of the Ricardo Effect through Jesús Huerta de Soto’s Money, Bank Credit, and Economic Cycles, which was the first major treatise on economics that I had read. At the time, de Soto’s argument in favor of the Ricardo effect sounded convincing (I tried to apply it prematurely in my article on the Recession of 1937), but since then I’ve come some ways in my understanding of price formation and capital theory, and to some extent I have reviewed different literature on the Ricardo effect, and so I think it’s worthwhile to give some thoughts on the concept — especially since its validity is widely contested, including by other Austrians.
Unfortunately, I have not done the amount of research I should have done. What’s funny is that some time ago the Ricardo effect was set to be a major area of research of mine, since I was really interested in the relationship between the laborer and the machine. Also, I was never sure of Huerta de Soto’s claim that unemployment during an expansion of the capital structure should necessarily rise (since according to Huerta de Soto, a rising price of labor leads to the use of labor-saving devices [p. 329, 2009]).
According to Huerta de Soto, the Ricardo effect first appears in David Ricardo’s On the Principles of Political Economy and Taxation, and then in the appendix “On Machinery” added in the third edition of Ricardo’s treatise. This well known, and heavily debated, argument is then applied to ‘Austrian’ capital theory by Hayek (see: F.A. v. Hayek, “The Ricardo Effect.” Economica, New Series, 9(34), May 1942; F.A. v. Hayek, “Three Elucidations of the Ricardo Effect.” The Journal of Political Economy, 77(2), 1969). For what it’s worth, Huerta de Soto’s interpretation of Hayek’s Ricardo effect may be a little generous, given that Hayek’s definition is as follows, “The theorem called the Ricardo Effect asserts that in conditions of full employment an increase in the demand for consumer goods will produce a decrease of investment, and vice versa.” (Hayek, 1969) What I discuss here are Huerta de Soto’s conclusions in regards to labor.
Labor is a factor of production (a capital good or producers’s good — you can follow/join a debate on whether or not this is true here [it continues after that specific page, as well]). Labor is not homogeneous, but it’s safe to assume that most labor is relatively non-specific (obviously, the skills of a doctor are more specific than the skills of a cashier, although I would argue that this doesn’t necessarily make the doctor less mobile than the cashier, unless the doctor voluntarily surrenders that mobility). Within a Hayekian framework, this means that all entrepreneurs throughout all stages of production are likely to demand labor from a similar pool of supply.
Let’s assume that the economy is at full employment prior to a period of structural lengthening. The price of labor is set at X, which is a figure derived from aggregate monetary demand for labor throughout all stages of production (I’m assuming a certain degree of homogeneity to avoid the complexities of the reality of widely varying wages for different skills). X here represents an equilibrium price, where all those looking for employment are employed and all unemployment is voluntary.
Time preference lowers, savings rise, and the market rate of interest (and natural rate of interest — let’s assume the two are equal) falls. There is an increase aggregate demand for capital goods and a fall in aggregate demand for consumer goods. Deaggregated, this suggests a fall in demand for goods of the final stage of production (consumer goods) and the lengthening of the structure of production through the addition of new phases, as well as a widening of existing stages (depending on profit signals). Why? The availability of saved resources makes it possible for entrepreneurs to profit by producing goods which those which would have otherwise formed the first stage of production can buy.
What about wages? At this point, wages are at price level X. It’s true that the addition of new investments will cause an increase in demand for labor (given its relative non-specificity) in whatever stages receive the newly saved money, but it should be remembered that there will necessarily be a fall in demand for labor in the first stage of production, and necessarily in earlier stages of production (which are now less profitable, because consumer spending falls). So, given credence to some wage inflexibility, it’s fair to assume some unemployment, but I don’t think it’s valid to claim that a lengthening structure of production will cause a permanent tendency towards unemployment. Instead, I would argue that the long-term tendency is back towards equilibrium, or full employment, as wage prices re-arrange themselves to changing patterns of demand.
What about an increase in demand for labor saving devices? George Reisman’s critique applies here. Reisman argues that a rise in wages would discourage the use of labor in both industries that require certain specific capital goods (machinery, for example) and in the industries that produce those capital goods, and thus if it were true that labor was absolutely replaced by machinery as the structure of production expanded then the production of capital goods in later stages would be limited by the amount of labor demanded (Reisman’s actual argument is slightly different. He argues that the rise in cost of production of machinery, as a result of a rise in wages, would discourage the use of machinery, but we know that price isn’t decided by cost of production [Reisman’s confused interpretation of Böhm-Bawerk’s theory of cost of production, otherwise]).
So, while I think there’s reason to believe that changes in the capital structure will require changes in the wage levels of different workers, which may take some time to adjust, overall there’s no reason to believe that rising wages will cause the unemployment of laborers in favor of machinery (especially since such unemployment would itself cause downward pressure on wages).
Now, regarding a possible interpretation of Hayek’s Ricardo effect as explaining the tendency for a “falling rate of profit”, I think it’s important to detail that Hayek didn’t believe this caused by rising wages (as Ricardo did), rather by a tendency towards an equalization of the rate of profit among all stages of production. Furthermore, this is profit purely in the monetary sense, not when considered against the actual purchasing power of an entrepreneur’s earnings.
Again, though, I’m not making these comments with any attempt at authority. This is my analysis based on what I know so far. I might revisit this topic at a later date. Reisman compares Rothbard’s and Hayek’s belief in a falling rate of profit as time preference lowers with Keynes’s marginal efficiency of capital (which has been criticized by a great deal of Austrians, including Reisman and Huerta de Soto). As I read Keynes’s General Theory I’d like to compare the two concepts myself. I have a feeling that the causation behind the “falling rate of profit” (where for Hayek it’s actually an equalization tendency) in the two theories are completely different.
Anyways, your comments and/or corrections are welcomed.