Say's Law is Back; M. Skousen

Economics on Trial AUGUST 1999 Say's Law Is Back by Mark Skousen "Keynes ... misunderstood 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 KATESl I n researching my forthcoming book, The Story of Modern Economics (to be pub lished by M. E. Sharpe next year), 1 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 eco nomic implications."2 And Kates is sympa thetic to Keynesian economics!

How Keynes Got It Wrong In the introduction to the 1939 French edi tion of The General Theory, Keynes focused on Say's Law as the central issue of macro economics. "1 believe that economics every where up to recent times has been dominated Mark Skousen (http://www.mskousen.com; mskousen @aol.com) is an economist at Rollins College, Depart ment ofEconomics, Winter Park, FL 32789, a Forbes columnist, and editor ofForecasts & Strategies. 54 . . . by the doctrines associated with the name of I-B. Say. It is true that his 'law of markets' has long been abandoned by most econo mists; 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 unem ployment 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 pro duced 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 contin ued to make this point, but nothing could be further from the truth. Conditions of unem ployment 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 conse quences for the unemployed."4 Production and Consumption Exactly what is Say's Law? Chapter 15 of Say's A Treatise on Political Economy desc~ibes his famous law of markets: "A prod uct IS no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value."5When a sell er produces and sells a product, the seller ~nstantly becomes a buyer who has spendable Income. To buy, one must first sell. In other ~ords, p~oduction is the cause of consump tIon, and Increased output leads to higher con sumer 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 grow ers. A bad harvest, on the contrary, hurts the sale of commodities at large."6 Say has a point. According to business cycle statistics, when a downturn starts, pro duction is the first to decline, ahead of con sumption. And when the economy begins to recover, it's because production starts up, fol lowed by consumption. Economic growth begins with an increase in productivity, new products, and new markets. Hence, produc tion spending is always ahead of consumption spending. We can see why this is the case on an indi vidual 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, ~hanging jobs, going back to school, or start Ing a moneymaking business. It would be foolish to achieve a higher standard of living by spending savings or going into debt to buy ~ bigger house or new automobile before you Increase your productivity. You may be able to live high on the hog for a while, but eventual ly 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 encour agement of mere consumption is no benefit to 55 commerce; for the difficulty lies in supplying the means, not in stimulating the desire of c.onsumption; and we have seen that produc tIon alone, furnishes those means." Then Say added, "Thus, it is the aim of good govern ment to stimulate production, of bad govern ment to encourage consumption."7 The 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 sup ply 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 produc tion 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 "obliterated."8 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 classi ~al e.conomists focused on how monetary InflatIon exacerbated the business cycle. They were precursors of the Austrians Ludwig von Mises and EA. Hayek.

Freemarket economists, such as W H. Hutt and Thomas Sowell, have tried to rehabilitate Say's Law, but none carries the punch of Steven Kates. D 1. Steven Kates, Say's Law and the Keynesian Revolution (Northampton, Mass.: Edward Elgar, 1998), p. 1 2. Ibid., p. 212. 3. John Maynard Keynes, The General Theory of Employment, Interest and Money (London: Macmillan, 1936), pp. 25-26. 4. Kates, p. 18. 5. Jean-Baptiste Say, A Treatise on Political Economy (Augustus M. Kelley, 1971 [1832]), p. 134. 6. Ibid., p. 135. 7. Ibid., p. 139. 8. Kates, pp. 18, 19,20.