But this is exactly what you’re implying. The argument is that as total consumption falls, that savings must necessarily rise (correct), and that this would yield consumer price deflation and therefore higher real wages rates. The higher wage rates, in turn, would make capital more lucrative relative to labor, and therefore it would increase investment. Again, this argument assumes a high degree of substitutability amongst labor and capital, somewhat similar to Marxian analysis. What I’m saying, though, is that a higher rate of capital accumulation is the result of an out-ward shift in the supply of loanable funds, and therefore a lower rate of interest, and a relative elevation in the price of capital goods, which direct production towards the higher phases (this is the necessary and sufficient cause).
Again, if your position was valid (the ricardo effect), then it would be possible to increase investment, in relative terms, by arbitrarily elevating real wages and by arbitrarily causing forced deflations (contracting the total supply of money below the demand for money). Additionally, if this transition process, namely a transition to more capitalistic methods of production (lengthen the structure of production), is delayed, for whatever reason, then we should expect either (a) temporary short-term involuntary unemployment (until the structure of production begins to expand and until the higher phases of production bid away labor from the lower phases), or (b) a lower demand for labor and therefore a reduction in real wage rates back to previous conditions (towards the marginal product of labor).
If the transition is seamless, as we should expect in an undisturbed setting, then (a) and (b) won’t occur (or will occur by a very limited extent). The reason why there is no “paradox of saving” is precisely due to the fact that the structure of production expands, increasing the division of labor, and because of a lower interest rate (all of which reduce the marginal cost of production and prevent a collapse in profits, and in fact increase total profits in the aggregate). Essentially:
If the structure of production does not expand, and if real wages rise due to general price deflation (of consumer goods) then we should expect a lower demand for labor (reduction in real wages back to the marginal productivity of labor) and/or involuntary unemployment.
Real wages rise in the long-run because of a lengthened structure of production (investment), i.e., a higher degree of capital per worker, and not becuase of a lower demand for final goods and services.
I understand your reasoning but let me address your last 3 points in reverse:
3. There is a confusion of causality.
There is no confusion of causality. The debate is over whether the Ricardo effect can account for one (among others) microeconomic effects that occur during an increase in voluntary savings. Even if it’s wrong, there is no [intentional] suggestion that causality is reversed.
2. Real wages rise in the long-run because of a lengthened structure of production (investment), i.e., a higher degree of capital per worker, and not becuase of a lower demand for final goods and services.
Yes, I said that. I clearly said that the permanent rise in real wages is only due to the above. NO disagreement here.
If the structure of production does not expand, and if real wages rise due to general price deflation (of consumer goods) then we should expect a lower demand for labor (reduction in real wages back to the marginal productivity of labor) and/or involuntary unemployment.
This “lower demand for labor” is exactly what the Ricardo Effect predicts but it is only due to the increase in real savings that increases the demand for capital goods in its place. The Ricardo Effect absent an increase in real savings may indeed make no sense, in which case you are correct. But the point here is that when real savings are increased, then the Ricardo Effect does make sense. It takes Austrian capital theory to demonstrate the conditions that make it valid. That’s what Hayek has basically done and de Soto is simply elaborating on this point.
I understand, but I believe that the Ricardo effect conflates different phenomena (doesn’t hold the ceteris paribus condition). Again, if it were true, than one could say that labor unions are actually beneficial. They would, in the short-run, cause involuntary unemployment as they increased their wages above the marginal product of labor at the expense of other laborers. But the secondary effect would be an elevated demand for investment and additional capital accumulation. This would, in turn, reemploy those laborers that initially went unemployed due to the wage rigidity, but at a new and higher real wage rate (due to the increased supply of capital).
This doesn’t make sense, for the reasons I’ve already mentioned and which you already understand.
That’s kind of a weak refutation of the Ricardo effect. Government-dictated wage hikes would not bring about the necessary allocation of resources between investment and consumption. A mandated wage hike per se is not a solution, not because the Ricardo effect is invalid, but because the mandated increase would not correspond to market preferences in any case, even if there was a tendency for investment to go up in relation to consumption as the Ricardo effect would have it.
As to the argument against FRB being the cause of the biz cycle, I agree with the earlier poster. Private banks couldn’t possibly readjust their loans between investors and consumers so as to balance out investment and consumption and prevent a bubble. And the ability to expand as drastically via FRB still comes about from the central bank.
The ‘bubble’ happens because entrepreneurs over invest in response to artificially low interest rates, not because time preferences have changed. Why are interest rates artificially low? Because of FRB.
In short, it’s not the job of FRB to bridge the divide between old and new time preferences (time preferences haven’t changed)—it’s the job of FRB to stop pyramiding loans and therefore causing artificually low interest rates and malinvestment in the first place.
And, I agree that in a free market FRB is prevented from causing much harm, because of competition—but we don’t have a free market, because as you correctly point out, FRB banks are insured against failure by the central bank.
I agree with Esuric. Specifically, I agree with this (except the mention of real wages):
In my opinion, real wages can’t rise without an increased marginal product of labor, which in turn requires additional capital. This is because “higher real wages” just means “more stuff and more junk owed, per unit of labor”. But, output of more stuff per unit of labor can only happen with more capital. For those who are curious, here’s excerpts from two critiques of the Ricardo effect derived in the praxeological branch of Austrian economics:
edit: On second thought, I take that back. Starting from full employment in this scenario, and without the possibility of capital accumulation, the mechanism available for increased labor productivity would be discovery of additional natural resources. This would be an example of real wages increasing due to changes originating from within the economy—or endogenous changes. At this point says Hutt, in a completely free market economy, this increase of real incomes will effect changes in consumers’ evaluations of (a) leisure preferences; (b) time preferences; and (c) liquidity preferences.
Economic theory tells us we have no way to know what these changes will be—the only thing we can know with certainty is that there will be changes. (Austrian praxeological theory, at least—I venture to guess that mainstream economics has some quantities and magnitudes for us to plug in somewhere?). So, we don’t know what the net effect will be on the capital structure. Ricardo, however, says he knows the answer—and he knows it to be in the favor of an increase of savings and investment, and capital accumulation.
But, in order to stake out this position, Ricardo must presuppose to know not only the direction, but also the magnitudes of changes in consumers’ (a) leisure preferences; (b) time preferences; and (c) liquidity preferences. This is the root of his fallacy. But, we have to cut Ricardo some slack here—he was without Menger’s revolutionary insight of ordinal valuation according to subjective preferences, and without a host of other key economic discoveries.
On the other hand, the real wage increase Esuric refers to above is that caused by government-mandated nominal wage increases—an exogenous impetus of change. The qualitative effects are the same as in the first case, however: consumers will re-prioritize their preferences. As in the first case, we can’t predict the relative magnitudes of the changes. And, again, Ricardo believes he knows the answer, but doesn’t.