Say’s Law and Macroeconomic Ignorance
Probably the greatest error in modern economics was the abandonment of Say’s law, otherwise known as the law of the markets. In a nutshell, it demonstrated that through the division of labour, production is firmly linked to consumption, and the former is tied to the latter through the medium of money and credit.
While there are variations in production outputs of individual goods, in free markets there can never be a general glut. It was this that Keynes had to disprove in order to create a role for the state, intervening to make up for the supposed deficiencies of free markets. While reasoned analysis shows that Keynes failed to disprove Say’s law, he managed to convince the mainstream establishment that he had actually succeeded.
This article traces the history of Say’s law, from Jean-Baptiste Say’s original work on the subject to the present day. It shows how Keynes bent the truth about free markets, that an understanding of Say’s law explains why state intervention fails, and why prices will continue to rise in the imminent economic recession.
Back in the 1930s, forward looking economists trying to justify an economic role for the state had a hurdle in classical economics to mount: the self-evident truth in what was described as Say’s law. Otherwise known as the law of the markets, Say’s law pointed out that we turn up at the factory or office to do a day’s work, so that we can afford all the things other people produce that make life tolerable, and even pleasurable.
It refers to the writings of Jean-Baptist Say, a French economist who in his A Treatise of Political Economy, originally published in 1803, described the relationship between production, consumption, and the role of the division of labour in how humans organise themselves economically-speaking. It was a remarkable achievement, defining the science of economics and the roles of money and credit in great detail, when the science was yet young.
That was over two centuries ago, before Marx proposed his rearrangement of everyone’s economy so that on behalf of workers the state acquired the means of production, and rapacious capitalists and their bourgeoise lackies would be forced to submit to the workers’ collective will.
Long before Marx and Engels, this law of the markets invited controversy. In his Principals of Political Economy published in 1820, Thomas Malthus argued it was wrong because he believed it was deficiency of demand that led to production gluts and unemployment. It was inconsistent with observed economic cycles. Malthus had gained public credence following his 1798 Essay on the Principals of Population.
Malthus’s riposte was publicly refuted by James Mill, Robert Torrens, and Say himself. David Ricardo entered into private correspondence with Malthus challenging his concept of demand deficiency. This debate continued through the first half of the nineteenth century, when economists finally accepted that a general glut of goods was implausible. Logically, therefore, a recession in the sense of inadequate demand was impossible.
Malthus was promoting a proto-Keynesian argument, and this point was taken up by Keynes in his General Theory as his justification for overturning classical economics:
“Thus, Say’s Law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment. If, however, this is not the true law relating the aggregate demand and supply functions, there is a vitally important chapter of economic theory which remains to be written and without which all discussion concerning the volume of aggregate employment are futile.” (The Principal of Effective Demand, p26)
Thus, imbalances behind production and consumption remain at the centre of economic debate today. But instead of the economic mainstream accepting that there cannot be a general glut in a free market as was accepted between 1850—1936 (the latter was the date Keynes published his General Theory), the issue has been turned upside down. The majority of today’s economists argue on the basis of their neo-Keynesian textbooks and observations of managed economies that a general glut is endemic to free markets, and that the state has a role in creating a balancing demand, for fear of unemployment.
While settling this question is always important, it is particularly so today because it is commonly agreed that most advanced economies face a recession, or at the very least will find it hard to avoid. There are subsidiary issues as well, particularly as to the causes of inflation of prices, economic cycles, and the role of money and credit.
Defining Say’s law
Jean-Baptiste Say never defined the law named after him: that was left to others. The essence of it was described in Book 1 On Production in his Principals. In Chapter 15 he wrote the following which captures the essence of it:
“Should a tradesman say, ‘I do not want other products for my woollens, I want money,’ there could be little difficulty in convincing him that his customers could not pay him in money, without having first procured it by the sale of some other commodities of their own. ‘Yonder farmer,’ he may be told, ‘will buy your woollens, if his crops be good, and will buy more or less according to their abundance or scantiness; he can buy none at all, if his crops fail altogether. Neither can you buy his wool nor his corn yourself, unless you contrive to get woollens or some other article to buy withal. You say, you only want money; I say, you want other commodities, and not money. For what, in point of fact, do you want the money? Is it not for the purchase of raw materials or stock for your trade, or victuals for your support? Wherefore, it is products that you want, and not money.’”[i]
And in a footnote to this passage, he adds:
“Even when money is obtained with a view to hoard or bury it, the ultimate object is always to employ it in a purchase of some kind. The heir of the lucky finder uses it in that way, if the miser does not; for money, as money, has no other use than to buy with.”
Say is describing the division of labour and drawing the obvious conclusion that production is inextricably linked to consumption. What is true for the farmer is true for the tradesman as well. It is as true of consumption for production as it is for final consumption. And in the footnote to it, Say makes it clear that the role of money is to facilitate the division of labour by being the bridge between production and consumption. And importantly, whether money is used immediately or hoarded or saved makes no difference.
Because Say’s law was never written down as such, Keynes was able to produce his own version without widespread contradiction: “that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment”. This is a deliberate misrepresentation. He followed this with a suggestion to nudge the reader into his desired direction: “If, however, this is not the true law relating the aggregate demand and supply functions…” But if the reader of his General Theory took the trouble to read Say’s Principals, he would know that Say also described the conditions that could undermine an economy at some length — including Keynes’s proposals which followed in his General Theory.
While clearly demonstrating that there is no such thing as a general overproduction relative to consumption, Say tells us that overproduction of individual products can and do exist. They result from miscalculations on the part of producers overestimating demand for their products, either through their own errors or because consumers’ desires have changed. When this happens and those employed in overestimated production lose the fruits of their labour, they also lose their ability to consume. While values for individual goods will vary (and indeed do so all the time) it will be clear that overall, the relationship between total production and total consumption is maintained.
Even malinvestments don’t upset this equilibrium. The inefficient deployment of all forms of capital are a separate issue, restricting the potential of the whole economy. And anyone who does not produce in order to consume must be subsidised by someone who does. Housewives, children, and the elderly all have to be supported by others in their family groups. Welfare ultimately comes from someone else’s production, whether through charity or taxes. And if consumption is funded through government deficit spending, it is a hidden tax on production. While government intervention in this manner causes temporary imbalances which are ironed out as markets for goods and services adjust, the balance between production and its funding of consumption is a fact of life.
Say’s law and commodities
We must also make a distinction between prices that reflect changes in production and consumption, and prices that are reflected in changes in the overall price level. The former case is covered by Say’s writings entirely.
The confusion comes when a recession, or a slump in an economy develops. Macroeconomists expect falls in prices due to a slump in demand: in other words, they anticipate a surplus of production — a Malthusian glut. There might be a negative price effect from inventory liquidation, but that is only a short-term effect and does not necessarily explain the extent of an actual decline in the general price level reflected in the value of the circulating medium. While production still funds consumption and the balance between them is maintained, it is the
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