Law is Back
Professor of Economics, Rollins College
and misrepresented Say’s Law…This is Keynes’s most enduring legacy and it
is a legacy which has disfigured economic theory to this day.” – Steven
In researching my forthcoming book, The
Story of Modern Economics (now
available), I came across a remarkable new work by Australian economist Steven
Kates, Say’s Law and the Keynesian Revolution. According to Kates, John Maynard Keynes created a straw man in
order to produce a revolution in economics.
The straw man was Jean Baptiste Say and his famous law of markets.
Steven Kates calls The General Theory “a book-length attempt to
refute Say’s Law.”
But to refute Say’s Law, Keynes gravely
distorted it. As Kates states,
“Keynes was wrong in his interpretation of Say’s Law and, more importantly,
he was wrong about its economic implications.”2
And Kates is sympathetic to Keynesian economics!
Keynes Got It Wrong
In the introduction to the 1939 French
edition of The General Theory, Keynes focused on Say’s Law as the
central issue of macroeconomics. “I
believe that economics everywhere up to recent times has been dominated…by the
doctrines associated with the name of J. B. Say.
It is true that his ‘law of markets’ has long been abandoned by most
economists; but they have not extricated themselves from his basic assumptions
and particularly from his fallacy that demand is created by supply…Yet a
theory so based is clearly incompetent to tackle the problems of unemployment
and of the trade cycle.”
Unfortunately, Keynes failed to understand
Say’s Law. By incorrectly stating
it as “supply creates its own demand,” he proposed, in effect, that Say
meant that everything produced is automatically bought.
Hence, Say’s Law cannot explain the business cycle.3
Keynes went on to say that the classical
model under Say’s Law “assumes
full employment.” Other
Keynesians have continued to make this point, but nothing could be further from
the truth. Conditions of unemployment do not prohibit production and
sales from taking place that form the basis of new income and new demand.
Moreover, Say’s Law specifically formed
the basis of a classical theory of the business cycle and unemployment.
As Kates states, “The classical position was that involuntary
unemployment was not only possible, but occurred often, and with serious
consequences for the unemployed.”4
Exactly what is Say’s Law?
Chapter 15 of Say’s A Treatise on Political Economy describes
his famous law of markets: “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.”5 When a seller produces and sells a product, the seller
instantly becomes a buyer who has spendable income.
To buy, one must first sell. In
other words, production is the cause of consumption, and increased output leads
to higher consumer spending.
In short, Say’s Law is this:
The supply (sale) of X creates the demand for (purchase of) Y.
Say illustrated his law with the case of a
good harvest by a farmer. “The
greater the crop, the larger are the purchases of the growers.
A bad harvest, on the contrary, hurts the sale of commodities at
Say has a point.
According to business-cycle statistics, when a downturn starts,
production is the first to decline, ahead of consumption.
And when the economy begins to recover, it’s because production starts
up, followed by consumption. Economic
growth begins with an increase in productivity, new products, and new markets.
Hence, production spending is always ahead of consumption spending.
We can see why this is the case on an individual basis. The key to a higher standard of living is, first, an increase
in your income, that is, your productivity, either by getting a raise, changing
jobs, going back to school, or starting a money-making business.
It would be foolish to achieve a higher standard of living by spending
savings or going into debt to buy a bigger house or new automobile before you
increase your productivity. You may
be able to live high on the hog for a while, but eventually you will have to pay
the piper…or the credit card bill.
According to Say, the same principle
applies to nations. The creation of
new and better products opens up new markets and increases consumption. Hence, “the encouragement of mere consumption is no benefit
to commerce; for the difficulty lies in supplying the means, not in stimulating
the desire of consumption; and we have seen that production alone, furnishes
those means.” Then Say added,
“Thus, it is the aim of good government to stimulate production, of bad
government to encourage consumption.”7
Cause of the Business Cycle
Say’s Law states that recessions are not caused by failure of demand
(Keynes’s thesis), but by failure in the structure of supply and demand.
Recession is precipitated by producers miscalculating what consumers wish
to buy, thus causing unsold goods to pile up, production to be cut back, income
to fall, and finally consumer spending to drop.
As Kates elucidates, “Classical theory explained recessions by showing
how errors in production might arise during cyclical upturns which would cause
some goods to remain unsold at cost-covering prices.”
The classical model was a “high-sophisticated theory of recession and
unemployment” that with one fell swoop by the illustrious Keynes was
In his broad-based book, Kates highlights
other classical economists, including David Ricardo, James Mill, Robert Torrens,
Henry Clay, Frederick Lavington, and Wilhelm Ropke, who extended Say’s Law. Many classical economists focused on how monetary inflation
exacerbated the business cycle. They
were precursors of the Austrians Ludwig von Mises and F.A. Hayek.
Free-market economists, such as W.H. Hutt
and Thomas Sowell, have tried to rehabilitate Say’s Law, but none carries the
punch of Steven Kates.
Home - Top of Page
Kates, Say’s Law and the Keynesian Revolution (Northampton, Mass:
Edward Elgar, 1998), p.1.
Maynard Keynes, The General Theory of Employment, Interest and Money
(London: Macmillan, 1936), pp. 25–26.
Say, A Treatise on Political Economy (Augustus M. Kelley, 1971
pp. 18, 19, 20.