Say’s Law and the Permanent Recession
Mainstream media discussion of the macro economic picture goes something like this: “When there is a recession, the Fed should stimulate. We know from history the recovery comes about 12–18 months after stimulus. We stimulated, we printed a lot of money, we waited 18 months. So the economy ipso facto has recovered. Or it’s just about to recover, any time now.”
But to quote the comedian Richard Pryor, “Who ya gonna believe? Me or your lying eyes?” A Martian economist arriving on earth would have to admit the following: the US economy has experienced zero real growth since 2000. This is what I call the permanent recession. Permanent, because, unlike past downturns—there will be no recovery. To make the case for this view, I will rely on the ideas of several classical and Austrian economists: J.B. Say, James Mill, Mises, Rothbard, W.H. Hutt and Robert Higgs.
I will begin with the J.B. Say, who is known for the eponymous Say’s Law. To explain I will quote from Say’s Treatise on Political Economy:
[A] product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value…. Thus the mere circumstance of creation of one product immediately opens a vent for other products.
Say’s Law can be explained in the following terms:
1. The way that a buyer demands a good is by supplying a different good.
2. The supply of one type of good constitutes the demand for other, different goods.
3. The source of demand is production, not money. Money is only a temporary parking place for past production.
In the modern economy with division of labor, most of us demand goods when we supply our labor. I work as a software engineer. I supply my labor writing computer software. And from that supply I am able to demand other goods, such as coffee.
Say’s ideas were used to settle a debate between the British economists David Ricardo and Thomas Malthus who believed recessions were caused by a general glut. The concept of a glut for a single good is easy enough to understand: there is more supply on the market than demand at the offered price. A glut can be alleviated by a fall in the price of that good. The producers of the good may take a loss if the market price is below their costs, but the market can always clear at some price.
The idea of a general glut is that all markets for all goods are in surplus. And for some reason, prices are unable to fix the problem. Ricardo opposed Malthus, arguing that the concept of general glut violates sound economics and clear thinking. He argued this point using Say’s Law: because demand is constituted by supply, aggregate demand, meaning the demand for all goods on the market, consists exactly of all things supplied. Aggregate demand is not only equal to, but identical to, aggregate supply. The two can never be out of balance. And if a general glut is a logical impossibility, then it cannot be the cause of a recession.
The idea of aggregate supply and demand in getting out of balance has appeared many times in the history of economic thought. The same idea is either called overproduction or underconsumption, depending on whether the problem is too many goods or not enough purchasing power. Keynesian economics is a form of underconsumption theory. The overproduction/underconsumption theory has been debunked by sound economists, but like a zombie, it refuses to die.
It is acknowledged by both sides that, if Say’s Law is true, then Keynes’s entire system is wrong. Keynes knew this, so he took upon himself the task of refuting Say’s Law as the very first thing in his General Theory. Keynes’s argument was that Say’s Law is only valid under the conditions of full employment, but that it does not hold when there are unemployed resources; in that case we are in the Keynesian Zone where the laws of economics are turned upside down.
But, as Stephen Kates explains in his book Say’s Law and the Keynesian Revolution (subtitled How Economics Lost its Way), Keynes failed in his attempt to overturn Say’s Law. Kates shows beyond any dispute that Say and his fellow classical economists were well aware that there could be unemployed resources, and that Say’s Law was still valid in that case.
To summarize, there is no such thing as a general glut or a demand deficiency, we can have idle resources, and Say’s Law is still valid. So how did classical economists explain recessions? Producer error. Producers had produced the wrong mix of goods. James Mill in his essay “Commerce Defended” explains the meaning of producer error:
What indeed is meant by a commodity’s exceeding the market? Is it not that there is a portion of it for which there is nothing that can be had in exchange. But of those other things then the proportion is too small. A part of the means of production which had been applied to the preparation of this superabundant commodity should have been applied to the preparation of those other commodities till the balance between them had been established.
Kates and Gerard Jackson have argued that the classical economist had a theory of producer error much like the one later developed by Mises. Mises developed existing ideas and integrated Austrian capital theory and time preference theory to provide an explanation of why many producer errors occur at the same time. We know this as the Austrian theory of the business cycle.
Mises called the production errors malinvestment. These errors happen systemically because of fractional reserve banks loan money into existence that is not backed by savings. That misleads producers into thinking that there are more real savings available than society wishes to save. Producers then make both the wrong mix of capital goods of different orders, and the wrong proportion of capital goods in relation to consumption goods.
When there is malinvestment there must be a recession, for the following reason: there were never enough real resources to complete all of the capital projects that were started during the boom. The firms that started these projects either over-estimated the demand for their output, or, under-estimated their costs. Somewhere along the way, firms will discover that they cannot obtain all of the factors they need at a price below their costs. They cannot make profits. Many of them fail.
I will give an example of how malinvestment leads to a recession. I worked in San Francisco during the tech bubble. There were many tech startups. Each one assumed that they would be able to grow by hiring more employees at the prevailing wage rates. But the prevailing wages did not reflect the true scarcity of skilled technical people because all of these businesses planned to hire more workers over the same time frame. But the number of skilled engineers could not possibly grow that fast. If you think of a software engineer as a form of human capital, a software engineer has a long period of production and requires many inputs (mostly coffee, but some other things as well).
And there just weren’
Article from Mises Wire
