Ricardo effect

Ricardo effect is a proposition of David Ricardo that an increase in wage rates will lead to a replacement of labor by machines and vice versa, an increase in machinery costs will lead to the use of more labor.

This proposition is often cited by interventionists who claim that raising wage rates will increase the use of machinery and thus total production. The argument confuses cause and effect; it is the increased use of capital goods that raises wage rates. Unless increased savings become available, any increase in the use of capital goods by one industry merely reduces the quantity of capital goods available for other industries. When interventionism takes the form of higher than market wages in one firm or industry, it merely produces a shift in the use of the available supplies of capital goods. It thus reduces the marginal productivity of both labor and capital and results in a drop in total production and consumer satisfaction, as existing capital is shifted to where it is less productive than in a free or unhampered market.