Say's law
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Say's law is an economic principle attributed to Jean-Baptiste Say and stating that there can be no demand without supply. A profound facet of Say's law is that recession does not occur because of failure in demand or lack of money.
In 1803 Say wrote:
- "It is not the abundance of money but the abundance of other products in general that facilitates sales... Money performs no more than the role of a conduit in this double exchange. When the exchanges have been completed, it will be found that one has paid for products with products."
Say's position was targeted against claims that business was suffering because people didn't have enough money and more money should be printed. Say saw that the power to purchase could only be increased by more production. John Stuart Mill used Say's law against those who sought to give economy a boost by creating unproductive consumption.
It is important to note that Say himself never used many of the later short definitions of Say's law and that Say's law actually matured by many of his contemporaries and those who came after him. The work of Mill, David Ricardo, and others evolved into what is sometimes called the "law of markets" which was the framework of macroeconomics from mid 1800's until the 1930's.
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Recession and unemployment
Keynes (see more below) claimed that according to Say's law involuntary unemployment cannot exist. This interpretation was unsupported by the 19th century economists, and the classical economists actually used Say's law to understand and explain even long-term unemployment and recession.
Recession was explained as rising from production not meeting demand in quality. While in general more isn't produced than there could be demand for, some particular products are produced too much and consequently other products too little. This would lead to a producer not being able to sell the products in cost-covering prices. Hence he will be lacking in the capability to buy and this will cause contraction in other parts of industry, too.
Such economic losses and unemployment were seen as an intrisic property of the capitalistic system. Division of labour leads to a situation where one always has to anticipate what others will be willing to buy, and this will lead to miscalculations.
Modern Interpretations
A modern way of expressing Say's Law is that there can never be a general glut.[1] (http://cepa.newschool.edu/het/essays/classic/glut.htm) Instead of there being an excess supply (glut or surplus) of goods in general, there may be an excess supply of one or more goods, but only when balanced by an excess demand (shortage) of yet other goods. Thus, there may be a glut of labor ("cyclical" unemployment), but that is balanced by an excess demand for produced goods. Modern advocates of Say's Law see market forces as working quickly -- via price adjustment -- to abolish both gluts and shortages. The exception would be the case where the government or other non-market forces prevent price changes.
According to Keynes, the implication of Say's "law" is that a free-market economy is always at what the Keynesian economists call full employment. Thus, Say's law is part of the general world-view of laissez-faire economics, i.e., that free markets can solve the economy's problems automatically (here the problems are recessions, stagnation, depression, and involuntary unemployment). There is no need for any intervention by the government or the central bank (such as the U.S. Federal Reserve) to help the economy attain full employment. All that the central bank needs to be concerned with is the prevention of inflation.
In fact, some proponents of Say's law argue that such intervention is always counterproductive. Consider Keynesian-type policies aimed at stimulating the economy. Increased government purchases of goods (or lowered taxes) merely "crowds out" the private sector's production and purchase of goods. To contradict this, Arthur Cecil Pigou, who, according to himself, followed Say's law, wrote 1932 a letter signed by five other economists (among them Keynes) calling for more public spending to alleviate high levels of unemployment.
From a modern macroeconomic viewpoint Say's law is subject to dispute. John Maynard Keynes and many other critics of Say's law have paraphrased it as saying that "supply creates its own demand". Under this definition, once a producer has created a supply of a product, consumers will inevitably start to demand it. This interpretation allowed for Keynes to introduce his alternative perspective that "demand creates its own supply" (up to, but not beyond, full employment). Some call this "Keynes' law".
Keynes vs. Say
Keynesian economics places central importance on demand, believing that on the macroeconomic level, the amount supplied is primarily determined by effective demand or aggregate demand. For example, without sufficient demand for the products of labor, the availability of jobs will be low; without enough jobs, working people will receive inadequate income, implying insufficient demand for products. Thus, an aggregate demand failure involves a vicious circle: if I supply more of my labor-time (in order to buy more goods), I may be frustrated because no-one is hiring – because there is no increase in the demand for their products until after I get a job and earn an income. (Of course, most get paid after working, which occurs after some of the product is sold.) Note also that unlike the Say's law story above, there are interactions between different markets (and their gluts and shortages) that go beyond the simple price mechanism, to limit the quantity of jobs supplied and the quantity of products demanded.
Keynesian economists also stress the role of money in negating Say's Law. (Most would accept Say's Law as applying in a non-monetary or barter economy.) Suppose someone decides to sell a product without immediately buying another good. This would involve hoarding, increases in one's holdings of money (say, in a savings account). At the same time that it causes an increased demand for money, this would cause a fall in the demand for goods and services (an undesired increase in inventories (unsold goods) and thus a fall in production). This general glut would in turn cause a fall in the availability of jobs and the ability of working people to buy products. This recessionary process would be cancelled if at the same time there were dishoarding, in which someone uses money in his hoard to buy more products than he or she sells. (This would be a desired accumulation of inventories.)
Some classical economists suggested that hoarding would always be balanced by dishoarding. But Keynes and others argued that the hoarding decision are made by different people and for different reasons than the decisions to dishoard, so that hoarding and dishoarding are unlikely to be equal at all times. (More generally, this is seen in terms of the equality of saving (abstention from purchase of goods) and investment in goods.)
Some have argued that financial markets and especially interest rates could adjust to keep hoarding and dishoarding equal, so that Say's Law could be maintained. (See the discussion of "excess saving" under "Keynesian economics".) But Keynes argued that in order to play this role, interest rates would have to fall rapidly and that there were limits on how quickly and how low they could fall (as in the liquidity trap). To Keynes, in the short run, interest rates were determined more by the supply and demand for money than by saving and investment. Before interest rates could adjust sufficiently, excessive hoarding would cause the vicious circle of falling aggregate production (recession). The recession itself would lower incomes so that hoarding (and saving) and dishoarding (and real investment) could attain balance below full employment.
Worse, a recession would hurt private real investment, by hurting profitability and business confidence, in what is called the accelerator effect. This means that the balance between hoarding and dishoarding would be even further below the full employment level of production.
Keynesians believe that this kind of vicious circle can be broken by stimulating the aggregate demand for products using various macroeconomic policies mentioned in the introduction above. Increases in the demand for products leads to increased supply (production) and an increased availability of jobs, and thus further increases in demand and in production. This cumulative causation is called the multiplier process.
Most modern advocates of laissez-faire economics have rejected Say's Law, except perhaps in the long run. Instead, the emphasis is on the automatic adjustment of the labor market to get to full employment: if wages are allowed to fall, this increases the availability of jobs and allows full employment. Many advocates of laissez-faire economics (for example, economists at the International Monetary Fund) are quite activist in their approach, advocating the use of state power to destroy unions, minimum wage laws, and the like in order to make labor markets more "flexible" so that this idealized vision of labor markets can be attained.
Modern Adherents of Say's Law
See supply-side economics and Austrian school.
See also
External links
- Foundation for Economic Education: "Say's Law Is Back" (http://www.fee.org/vnews.php?nid=4405)
- The Proceedings of the Friesian School: "Say's Law and Supply Side Economics" (http://www.friesian.com/sayslaw.htm)
- Supply-Side University Economics Lesson #4 (http://www.wanniski.com/searchbase/fles4.html)
- Say's Law and Economic Growth (http://www.benbest.com/polecon/sayslaw.html)
Further reading
- Axel Leijonhufvud, 1968. On Keynesian Economics & the Economics of Keynes: A Study in Monetary Theory. Oxford University Press. ISBN 0195009487.
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