The ratchet effect is an economic term that refers to a situation in which processes move more easily in one direction than the other. This means that, while progress is easy to achieve, it is hard to backslide. The idea behind the ratchet effect is based on the notion of a positive feedback loop, in which each step forward reinforces the last, making it increasingly harder to go back.

The concept of a ratchet effect is rooted in the dynamics of how change happens in the economic world. In a dynamic environment, the future is often determined by the past and present: the economic structure is built on the history of decisions and trends, meaning that resetting the "clock" to an earlier point can be very difficult. This is why it is often said that “history is written by the winners”: the past dictates how the future plays out.

The ratchet effect is seen all across the economic spectrum. On a macro-level, it manifests itself in where government policies are determined, with a “ratcheting” of certain pro-business or pro-labour stances. On a micro-level, the ratchet effect affects individual markets including consumer and labour markets, where certain prices or wages keep going up as a result of mismatches of competition.

For example, when a pay gap is created between employees doing the same job, it can be hard to “un-ratchet” this position even if the employer decides to offer a wage reduction. This can then lead to a race to the bottom, as employers work to remain competitive within their industry.

On the other hand, the ratchet effect can benefit those who control the market’s power dynamics. Politicians, for example, may use the ratchet effect to create a wedge between their economic opponents in order to maintain their own power. In cases where the ratchet effect hinders competitive dynamics, it may unfairly benefit those who are able to keep the cycle going.

Ultimately, the ratchet effect can influence markets, sectors, and even entire economies. Policymakers can use the ratchet effect to create an environment where progress is adopted more easily than reversals. But, if not carefully monitored, this can lead to major inequalities that hinder overall progress. Therefore, in order to effectively manage the ratchet effect, policymakers should ensure that it is actively monitored through responsible public engagement.