In discussing the effect an increase in savings has on the structure of capital, Huerta de Soto gives three reasons why it leads to a more productive capital structure. The third reason being the Ricardo effect, descirbed as follows:
Professor Jesus Huerta de Soto: This increase in real wages, which arises from the growth in voluntary saving, means that, relatively speaking, it is in the interest of entrepreneurs of all stages in the production process to replace labor with capital goods. To put it another way, via an increase in real wages, the rise in voluntary saving sets a trend throughout the economic system toward longer and more capital-intensive productive stages. In other words, entrepreneurs now find it more attractive to use, relatively speaking, more capital goods than labor. This constitutes a third powerful, additional effect tending toward the lengthening of the stages in the productive structure. It adds to and overlaps the other two effects mentioned previously.
This increase in real wages, which arises from the growth in voluntary saving, means that, relatively speaking, it is in the interest of entrepreneurs of all stages in the production process to replace labor with capital goods. To put it another way, via an increase in real wages, the rise in voluntary saving sets a trend throughout the economic system toward longer and more capital-intensive productive stages. In other words, entrepreneurs now find it more attractive to use, relatively speaking, more capital goods than labor. This constitutes a third powerful, additional effect tending toward the lengthening of the stages in the productive structure. It adds to and overlaps the other two effects mentioned previously.
and also:
Professor Jesus Huerta de Soto: Hence it is easy to understand why increases in saving are generally followed by decreases in the prices of final consumer goods.
Hence it is easy to understand why increases in saving are generally followed by decreases in the prices of final consumer goods.
How does it follow that higher real wages, as a result of low prices of consumer goods, will make labour more expensive relative to capital goods and hence, more attractive to the entrepreneur?
Or am I missing something.
"You don't need a weatherman to know which way the wind blows"
Bob Dylan
you meant what about any given unit of money?
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nirgrahamUK:first we have voluntary saving, these investments go into capital growth, the structure of production is lengthened. there is more capital per labourer than before, hence the productivity of labour increase. real wages increase therefore, and so this further incentivises entrepeneurs to swap out labourers for capital goods.
The point is he is trying to explain how this capital growth occurs, one of the explanations is the Ricardo effect, so this doesn't really help since this presumes the capital structure has already adjusted to the new rate of savings when that is exactly what we are attempting to describe.
nirgrahamUK:so, increased savings, relative to consumption in the economic system, does increase productivity, (thats why it seems a good idea to save/invest, rather than save/hoard, the intention is to be more productive than your competitors, and you need to invest in capital to be more productive) this increase of productivy per labourer, increase real wages. and
Once again this is what we're trying to explain.
nirgrahamUK: you meant what about any given unit of money?
That the purchasing power of any given unit of money will increase if prices decrease (say, a huge amount of gold suddenly disappears).
there are only two ways the value of money, or purchasing power per unit of money can increase.
one is an arbitrary increase in demand for money. e..g through a sudden destruction of gold. this is entirely nominal in its effects, as decribed by rothbard as above. the real wages of workers does not increase, it must stay the same, nominally it will fall as 1 dollar does the job that two used to before. This does not explain at all capital increases nor does it relate to the ricardo effect.
the second way, is if productivity of labour has increased, through the presence of an extended capital structure (more capital per labourer etc.) , then Soto's quote applies. labour is more productive, labour is more expensive, this is an incentive to find alternatives to labour.
nirgrahamUK:one is an arbitrary increase in demand for money. e..g through a sudden destruction of gold. this is entirely nominal in its effects, as decribed by rothbard as above. the real wages of workers does not increase, it must stay the same, nominally it will fall as 1 dollar does the job that two used to before. This does not explain at all capital increases nor does it relate to the ricardo effect.
The real wages of workers does increase, since their gold can buy more goods. Since as you said it's purchasing power increases.
nirgrahamUK:the second way, is if productivity of labour has increased, through the presence of an extended capital structure (more capital per labourer etc.) , then Soto's quote applies. labour is more productive, labour is more expensive, this is an incentive to find alternatives to labour.
But we're trying to explain why labour becomes more productive!
GilesStratton:The real wages of workers does increase, since their gold can buy more goods. Since as you said it's purchasing power increases.
any unit of gold that they have would buy more, hence it is necessary that this adjust their nominal wage rates; there is less gold to be paid nominally, its in the definition of this branch of the analysis, there has been no more productivity. their nominal wage must decrease so as to maintain the real wage rate, a money unit only has the power to bid for the purchase of that which can be purchased, and that which can be purchased has not changed. there are not a larger supply of consumer goods.
to paraphrase you; The real wages of workers does not increase, since their reduced gold income can not buy any more goods, than the goods that are available after every production cycle, even though the nominally lesser gold they do earn, by virtue of an offsetting increase in purchasing power leaves their real wage unchanged
GilesStratton: nirgrahamUK:the second way, is if productivity of labour has increased, through the presence of an extended capital structure (more capital per labourer etc.) , then Soto's quote applies. labour is more productive, labour is more expensive, this is an incentive to find alternatives to labour. But we're trying to explain why labour becomes more productive!
we are? i thought you were comfortable with the idea that labour that has access to better tools, greater capital, is more productive than labour without it.
i thought that rather than trying to understand why labour becomes more productive; you wanted to understand how labours increasing productivity through extension of capital structute, leads to incentives to labour being substituted for capital ....(this is because of change in costs)
nirgrahamUK: any unit of gold that they have would buy more, hence it is necessary that this adjust their nominal wage rates; there is less gold to be paid nominally, its in the definition of this branch of the analysis, there has been no more productivity. their nominal wage must decrease so as to maintain the real wage rate, a money unit only has the power to bid for the purchase of that which can be purchased, and that which can be purchased has not changed. there are not a larger supply of consumer goods. to paraphrase you; The real wages of workers does not increase, since their reduced gold income can not buy any more goods, than the goods that are available after every production cycle, even though the nominally lesser gold they do earn, by virtue of an offsetting increase in purchasing power leaves their real wage unchanged
Ah, yes, you're correct here, but that was a tangent anyway.
nirgrahamUK:i thought that rather than trying to understand why labour becomes more productive; you wanted to understand how labours increasing productivity through extension of capital structute, leads to incentives to labour being substituted for capital ....(this is because of change in costs)
I think you're missing the point of my question. I'm not trying to understand why labour becomes more productive, that much I know. What I'm trying to understand is, why, before labour becomes more productive (e.g. before the capital structure has had time to adjust) it becomes less preferable to hire them.
GilesStratton:I think you're missing the point of my question. I'm not trying to understand why labour becomes more productive, that much I know. What I'm trying to understand is, why, before labour becomes more productive (e.g. before the capital structure has had time to adjust) it becomes less preferable to hire them.
where does soto say that the moment 5 year projects to build factories are adopted, this voluntary savings instantly increases real wages etc.etc?
actually i dont know what book you are reading, it wouldnt hurt for me to read the PDF!
I finally got around to reading Hayek's paper and now understand how it occurs. I believe Professor Huerta de Soto used somewhat unclear language in his very brief exposition of the effect, in fact Hayek makes this very point. The term real wages does not so much refer to the prices of goods in comparison to the wages received by the workers as it refers to the relationship between the costs of wages and the prices of goods, from the perspective of the entrepreneur. In the case of an increase in savings, the prices of consumer goods decreases and hence the business on the stages closest to production will begin to suffer losses. As a result of this they will attempt to turn over their capital less frequently and to employ more machines and heavy capital in order to produce the same amount, thus employing less labour.
Actually it's a great paper by Hayek, it's well worth reading, as is Huerta de Soto's book.
What is the specific paper by Hayek that you are referring to? I am currently working on the book by De Soto: “Money, Bank Credit, and Economic Cycles”. I have wrestled with the concept of the Ricardo Effect myself, and followed a thread where you were discussing it in detail. Below is a clip of your post on March 12 2009, after your reading Hayek's paper.
The term real wages does not so much refer to the prices of goods in comparison to the wages received by the workers as it refers to the relationship between the costs of wages and the prices of goods, from the perspective of the entrepreneur. In the case of an increase in savings, the prices of consumer goods decreases and hence the business on the stages closest to production will begin to suffer losses. As a result of this they will attempt to turn over their capital less frequently and to employ more machines and heavy capital in order to produce the same amount, thus employing less labour.
I guess Hayek is comparing the COST of wages to the reduced consumer prices from the prospective of the entrepreneur. I'd like it if you could elaborate on that a little. I suppose if an employer is paying some employees $10.00 per hr., that doesn't exactly paint the whole picture as far as what it cost him to pay that????? Is Hayek focusing on cost in the form of lost opportunity? Also, I guess the consumer price, from the perspective of the entrepreneur would be thought of as the selling price, or his return on investment. Am I headed down the right road here?
Also, I'm not following too well about the lower stage businesses who after starting to suffer losses, “attempt to turn over their capital less frequently.” I'm not too clear just what “capital” you are referring to here, or why they would want to slow down their operation.
Even Stephen
hayekianxyz:That's not what I'm asking. I understand that. My question is that Huerta de Soto claimed (drawing on Hayek, I believe) that as people refrain from consumption (this is before the increase in productivity from the lengthened capital structure) the price of goods drop due to a decrease in demand. This then has the effect of raising real wages.
Savings (investment) and consumption (aggregate demand, or price of consumption goods--lower order goods) are tradeoffs. When aggregate demand falls, savings increases, lowering the natural and market rate of interest, allowing for more capital intensive roundabout methods of production (forced investment). This is demonstrated by the Hayekian triangle (lengthened--or one firm becoming two). More capital means higher labor productivity, and therefore higher labor demand, translating into higher real wages. Wages and income are functions of capital (the way the capital is ordered also effects real wage rates); it causes the PPF to shift outwards. Nominal wages may fall, but the price of goods falls faster (purchasing power of money increases PP=1/p increases). Remember, goods are not bought with money, or with labor, capital, or land, but only with other goods (Say's law--productions bought with productions).
So causally, it goes like this: Increases savings => original means of production released from lower stages => interest rate falls => investment is directed towards producer goods (relative increase in the price of producer goods--though they may still fall) => more capital, higher labor demand => original means of production and fixed capital goods moved towards higher stages => higher real incomes.
Real wages can rise as the purchasing power of money falls, but most of that will have to be liquidated.
"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."
More capital will be invested in high stages of production thereby bidding up wage rates. And because labor and capital goods are always in competition in those higher stages of production, once labor's wages increase they will face increased competition from capital goods. The capital goods prices will also be bid up, so in answer to your question, I guess they will both see more competition with one another, but I'm not sure why wages would be more attractive relative to capital goods. We should email de Soto on that one. I'm just reading his book now, quiet good.
Am I crazy or did no one address HayekianXYZ's question?
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Did they really need to Jargon? This thread was made back when economists were economists and Austrian Capital theory was discussed freely and hardcore theory was actually uttered in the forums... It was a more advanced and simpler time.
Thanks for ressurecting this thread.