A conversation with Steve Kates, for Man and the Economy


  steve_katesSteven Kates is Associate Professor of Economics at RMIT. He was chief economist for the Australian Chamber of Commerce for 24 years and a commissioner on the Productivity Commission. If he has a mission in life, it is to see Keynesian economic theory disappear from our textbooks and the return of the classical theory of the cycle as the guide to economic policy.

  He has written Free Market Economics: an Introduction for the General Reader (Edward Elgar 2011), which explains what economic theory looks like if the entrepreneur is placed at the centre of microeconomic analysis and in which Say’s Law is brought back as the core of macro.

  Grégoire Canlorbe: According to you, Say’s Law was the statement that demand would never fall short of properly proportioned supply. In other words, demand deficiency could never occur—except in the case of miscalculations on the side of supply.

  At first sight, this proposition is a tautology. By definition, so long as decisions by producers on what to produce coincide with decisions by buyers on what to buy, there prevails an equilibrium of supply and demand. In my opinion, the law of markets presupposes in fact something crucial, namely that the desire to buy goods is only limited by the nature of goods supplied. Although there may happen a global mismatch between the wishes of buyers and the composition of supply, the willingness to acquire (consumption or equipment) goods is otherwise infinite.

  Overproducing means here to produce something in excess with the demand of people or to sell it at a price that does not cover the costs of production. The classical proponents of the law of markets believed overproduction of everything could never occur—unless an outbreak of entrepreneurial mistakes concerning the public’s preferences or purchasing power. In this regard, what they fundamentally did was to castigate any theoretical explanation of crises holding the fluctuations in demand for a phenomenon totally independent of the structure of supply. The classics generally put it in these somewhat sybillin terms: while men err in their production, demand is infinite as such. While recessions happen, they are never caused by demand deficiency.

  In his posthumous Notes on Malthus, David Ricardo provided an eloquent summary of this precocious intuition of classical economics.

  “If the commodities produced be suited to the wants of the purchasers, they can not exist in such abundance as not to find a market. Mistakes may be made, and commodities not suited to the demand may be produced—of these they may be a glut; they may not sell at their usual price; but then this is owing to the mistake, and not to the want of demand for productions [per se].” [i]

Could you start by reminding us of the lines of force of the reasoning underlying this cumulative proposition on the part of Jean-Baptiste Say, James Mill and Robert Torrens?

  Steve Kates: There are a number of false assumptions on the nature and scope of Say’s Law that must be eliminated before we can have this conversation.

  The first and most important of these assumptions is that Say’s Law is a conception best understood by looking at economists from the early nineteenth century. And the reason this conception remains embedded in so much of the modern approach is that it is called “Say’s” Law, Jean-Baptiste Say, of course, having written the first edition of his Treatise in 1803. So let me begin by putting this discussion on Say’s Law into its proper context.

  The term “Say’s Law” was invented in the twentieth century. It was invented by the economist Fred Taylor, as he describes in his introductory text, Principles of Economics. The text was self-published in 1911 and distributed only to his own students at the University of Michigan, but was then published in 1921 by the Ronald Press in normal textbook form as the eighth edition for use beyond his own classrooms. And how do we know that Taylor invented this term? Because he says so. Chapter XV is titled “Say’s Law” and in it he discusses why he chose this name. Having explained how demand is constituted by supply, he wrote:

  “The points just brought out with respect to the relation between demand and the output of goods are so evident that some will consider it scarcely legitimate to give them the dignity derived from formal statement… I shall therefore put the proposition we have discussed in the form of a principle. The principle I have taken the liberty to designate Say’s Law; because though recognized by many earlier writer, it was particularly well brought out in the presentation of Say (1803)”. [ii] (My bolding)

  I particularly like the fact that for Taylor and his contemporaries the principles behind Say’s Law seemed so obvious that he hardly thought it even needed to be said. If you don’t believe it, look it up. Taylor had been using the phrase “Say’s Law” since 1909, always mentioning that he had invented the term. It is a phrase never used before it was coined by Taylor and came into common use on the American side of the Atlantic only after his text was formally published in 1921. The very embarrassing question that comes from this is, if this is a twentieth century term invented by Taylor, how did the words “Say’s Law” show up in The General Theory? Because once you realise that Keynes had to have been reading a literature that no one knows he had been reading, the provenance of The General Theory becomes very different from what we have up until now been taught.

  Nor does the embarrassment end there. Keynes’s definition of Say’s Law is “supply creates its own demand”, the only phrase within economics other than “the invisible hand” known to every economist. And that, too, comes from a twentieth century American text, Value Theory and Business Cycles, a work published in 1933 by an obscure and unknown American economist, Harlan Linneus McCracken. In a chapter on “Involuntary Failure of Demand” McCracken wrote:

  “The Automatic Production-Consumption Economists who insisted that supply created its own demand, that goods exchanged against goods and that a money economy was only refined and convenient indirect barter missed the significance of money economy entirely.” [iii] (My bolding)

  You won’t believe that either, since you rightly find it ridiculous that you should be hearing such significant facts about the origins of the most thoroughly investigated economics text in history only now, some eighty years after The General Theory was published and brought to your attention by someone as unknown to you as Harlan McCracken. But there you are, and there is no possibility of anyone refuting either of these two facts since neither the term “Say’s Law” nor its definition “supply creates its own demand” have ever been found anywhere within the economics literature of the nineteenth century. Neither the term “Say’s Law”, nor its definition “supply creates its own demand”, were ever part of the discourse among economists prior to the twentieth century. The question you need to ask is how did they get into The General Theory?

  Therefore, if you wish to understand the actual meaning of Say’s Law, it is worse than pointless to return to the economists of the early nineteenth century. It is to Taylor you must go since he specifically tells you what it means.

  “Principle – Say’s Law. The Ultimate Identity of Demand and Product

  “In the last analysis, the demand for goods produced for the market consists of goods produced for the market, i.e., the same goods are at once the demand for goods and the supply of goods; so that, if we can assume that producers have directed production in true accord with another’s wants, total demand must in the long run coincide with the total product or output of goods produced for the market.” [iv]

  But we must go a bit farther to understand why Taylor had gone to the trouble or writing his chapter, identifying this principle and giving it the name Say’s Law. All this is explained at the very start of the chapter.

  “General Demand Fallacies. – Among the fallacious notions in popular thinking that have gained very wide currency are to be found a number which grow out of misconceptions as to the real source of the general or total demand for goods, and as to the methods by which that demand is increased or diminished. Several types of these fallacious notions may be cited. Thus, government improvements of all kinds, including even those of questionable value, are often supported by businessmen and others on the ground that such improvements increase the total demand for goods… A true understanding of the nature of the total demand for goods will show that these notions are fundamentally unsound.” [v]

  Of course, that entire line of reasoning has utterly disappeared since the Keynesian Revolution. Everyone now believes what economics teaches, that government spending, even expenditure of questionable value, increases the total demand for goods and services, and therefore increases the total demand for labour. And while it may come as a shock to some to find that Keynes deceived his followers by hiding from them the research he had undertaken in writing his book, they will comfort themselves by arguing that at least he was right about these issues. But there is no denying the deception. Keynes lied about what he was reading and it is only these very faint traces that allow us to understand what he was actually doing. Of course, Taylor was also right about the economics and Keynes was wrong, as the consequences of the various stimulus packages should, by now, have made evident.

  And as an aside, if you interested in a more extended discussion on all of this, you should look at my article, “Influencing Keynes: The Intellectual Origins of the General Theory” which was published in 2010. It’s all there and in fine detail.

  So let me give you the proper definition of the principle that lies behind Taylor’s and this is from John Stuart Mill and from his Principles of Political Economy published in 1848. This is known as Mill’s Fourth Proposition on Capital, and it states:

  “Demand for commodities is not demand for labour.” [vi]

  The level of employment cannot be increased by increasing the demand for goods and services. It is Mill trying to tell us that a public sector stimulus will never reduce the level of unemployment. And while you might wish to deny that Mill is right about the theory, you cannot deny that, given his words, he would have foretold that the stimulus packages we have seen across the world since 2009 would with certainty fail. Just as each and every stimulus has done in each and every one of the countries in which it has been tried. The meaning of Say’s Law is thus found in the fact that the increased demand for goods and services by governments since the Global Financial Crisis has not led to an increase in employment in any country of the world. Instead, employment growth has been woeful, much worse than in any previous recovery since the Great Depression. It is thus unnecessary to go back to the nineteenth century to understand Say’s Law. All you need to do is look at the abysmal recoveries we have had and recognise that this is exactly what every classical economist would have told you would occur.

  And it is not as if the policy direction from Mill had been ignored. This was highlighted by Winston Churchill’s in his 1929 budget speech.

  “Churchill pointed to recent government expenditure on public works such as housing, roads, telephones, electricity supply, and agricultural development, and concluded that, although expenditure for these purposes had been justified: ‘for the purposes of curing unemployment the results have certainly been disappointing. They are, in fact, so meagre as to lend considerable colour to the orthodox Treasury doctrine which has been steadfastly held that, whatever might be the political or social advantages, very little additional employment and no permanent additional employment can in fact and as a general rule be created by State borrowing and State expenditure.’” [vii]

  These were, moreover, genuine value adding forms of spending and in no sense of the make-work variety. Yet even then, little if any additional employment had been seen to have occurred as a result. The same may be said of the various stimulus packages that have been adopted across the world after the Global Financial Crisis.

  Indeed, as a general rule, which has had no peace-time exceptions, increases in public expenditure do not and cannot lead to a permanent increase in employment. If anything, such expenditures will slow the recovery process and will inevitably keep unemployment higher than it would otherwise have been.

  This is the conclusion that comes from a proper understanding of Say’s Law. There has, moreover, never been a single exception to this rule during the entire eighty year period since the General Theory was published.

  Grégoire Canlorbe: In his 1936 General Theory, Keynes argued that acceptance of Say’s Law meant that one held recessions and involuntary unemployment for impossible. Indeed, Keynes understood Say’s Law as the statement that everything produced would be sold at prices that cover all costs of production. In this regard, he believed that overproduction crises and involuntary unemployment were a formal impossibility in the economic theories of his “classical” contemporaries, precisely because they had tacitly accepted Say’s Law as valid. In a nutshell, his answer was that hoarding might engender oversupply of investment goods and set in train a vicious circle of higher unemployment and lower consumption.

  If I do not misunderstand you, the law of markets was not intended to deny the possibility of overproduction as such. It was an argument against the idea that overproduction crises and recessions could happen in virtue of an intrinsic limit to the desire to buy goods. In this regard, acceptance of Say’s Law meant that one did not share the belief that demand deficiency could occur through endogenous factors on demand side—such as the Keynesian principle of “preference for liquidity” or his “fundamental psychological law of consumption”. While Keynes misunderstood the law of markets, his most enduring theoretical legacy was indeed an analytical framework inconsistent with Say’s Law, in which demand deficiency could, of itself, lead to a fall in economic activity and an increase in unemployment—apart from the composition of supply.

  Unlike the Keynesian doctrine, the classical theory of the business cycle, which we owe to authors such as Henry Clay, Frederick Lavington, Wilhelm Röpke or Gottfried Haberler, argued that there was no limit to production on the demand side as such and that recession and unemployment happened in virtue of an incorrect composition of goods for sale.

  As Wilhelm Röpke wrote in Crises and Cycles, published the same year as Keynes’s magnum opus, “there is no limit to profitable production as a whole, i.e., apart from the question of the correct composition of the total production.” [viii]

  Could you recapitulate the various reasons invoked by these classical theoreticians for the entrepreneurial mistakes arising during cyclical upturns and leading to a deficient aggregate demand? How did the Keynesian school of thought come to eclipse the tradition of Say’s Law?

  Steve Kates: So much of the difficulty in dealing with the problems caused by Keynesian theory is that no one any longer studies history, and more particularly, vanishingly few economists study the history of economic thought. And what is an absolute certainty is that 99% of economists have no idea what an economist believed about the business cycle prior to the publication of The General Theory. If economists actually believe that from 1776 till 1935, there was no theory of recession and involuntary unemployment, they are a very simple group of people. Since they must know there was something, what remains astonishing is that none of them know what it is. They believe, instead, that there was this entity called Say’s Law which meant that so far as economists were concerned, involuntary unemployment was theoretically impossible.

  Say’s Law did state that recessions could never be caused by demand deficiency. But once demand deficiency was ruled out, there were no end of theories to account for recessions and periods of mass unemployment. It is a matter of quite some astonishment that I can say to you that virtually all of these other explanations for recessions have been wiped from the slate and the only one that remains is the very theory that economists before Keynes were united in recognising as utterly fallacious.

  What is more astonishing still is that the classical theory of recession was based on an understanding of Say’s Law. People produce what they believe others wish to buy. The money received from selling what they have produced is then used to buy what others have produced, while those others are buying from them. As long as everyone is producing what others wish to buy, the process is endless and will continue forever. There is no level of demand that is beyond the collective desire of a community to buy. And if there is, we have not reached anywhere near it yet. We certainly had not reached it in 1936.

  Once you understand the operation of an exchange economy in this way, it becomes obvious why recessions might occur, and this is because sellers have, for some reason, produced what others do not wish to buy, or at least buy in sufficient quantity and at high enough prices to cover all of the costs of production. The classical theory of recession was based on working out what those reasons might be that sellers would produce what buyers did not wish to buy.

  That this happens all the time for individual businesses, even successful businesses, is hardly news. The more important issue was why it might happen across an entire economy. Why might the entire apparatus misfire to such an extent that the economy seizes up and many people lose their jobs all at once?

  The first of these recessions following the industrial revolution occurred at the end of the Napoleonic Wars. It was without precedence and it is quite interesting to listen in on the conversations among economists at the time. What has made this conversation of such importance to us even today is that in 1820, Thomas Robert Malthus, the most famous economist of his time, came up with the notion that the recessions that were then taking place were due to deficiency of demand. And it is not merely a coincidence that Keynes arrived at the same conclusion, since it was precisely because he was reading Malthus’s letters to Ricardo that he decided to write his own theory of recession based on Malthus’s conclusion. He came up with a different answer from the one Malthus had had, but the reason Keynes came up with the theory of demand deficiency was because he was reading Malthus. This, too, virtually no economist knows, and it is amazing how hard those who do know resist accepting the obvious since there is zero controversy over the fact that Keynes was not only reading those letters at the end of 1932 but was also reading Malthus’s Principles at the same time.

  What was quite clear to all and sundry, with Malthus the most notable exception, was that the recession had been caused by massive dislocations in the structure of production. Production for war had ceased, trade with the continent had again opened and many businesses that could thrive in the earlier environment could no longer survive in the newer one. The debate centred on the speed of adjustment and what actions a government could successfully take, but there was little doubt about where the problems lay. And overlaying it all had been failing grain harvests that had made the dislocations even worse.

  And through until 1936, the problems were centred on why such dislocations might occur. The most important, as it was eventually agreed, centred on the financial system. Disturbances in the money creation process and the system of credit were recognised as the frequent and prime cause of such disturbance. The very idea that from time to time the community would suddenly and for no reason stop spending and start saving was seen as an idiocy. Such ideas were left to the fringes. The reality was that something had gone wrong, there was suddenly a panic in financial markets, a rush to liquidity and the economy would topple over with much loss of jobs.

  What we saw before our eyes during the Global Financial Crisis was a perfect representation of the nature of recession as depicted in classical times. That everyone would become extremely cautious after the crisis and might remain so for perhaps even a year or more, was well known. Only we, in our less enlightened times, are bewildered by what befell us. A year is certainly a long time, and it weighs heavily on the unemployed and those who go bankrupt, but the notion that classical economists had no theories to account for what went on is absurd. You would have to be an idiot to think there had been no explanation of recessions and unemployment before Keynes wrote his General Theory. But that is what we teach.

  So to your second question, how did Keynes entrench his theory and eclipse the classical theory of the cycle based on Say’s Law?

  In part, just to give the benefit of the doubt to those at the head of the Keynesian Revolution, there would have been the charitable wish to do something, and Keynesian theory provided a remedy of sorts. It was a remedy that every classical economist understood as causing far more harm than any good. But there was that wish, and it is notorious that only the younger generation of economists – Paul Samuelson and Joan Robinson, for example – signed up without reservation. Those of Keynes’s own generation almost universally rejected in the harshest possible terms the theory he proposed.

  But you also have to see the dates in question. The Great Depression reached its trough in 1933. Keynes published The General Theory in 1936. Other than in the US, the Depression had been brought to an end using classical means. So when the book was published, there was no actual opportunity to try it out. It just sounded good, there had undoubtedly been a Great Depression and it was time for something more centrally directed. The New Deal, incredibly, has ever since also been enlisted as evidence of the value of public spending as a means to end recession even while recessionary conditions in the United States persisted all the way into the 1940s. And with the coming of War, the absolute disappearance of the last trace of recession, supposedly added to the weight of evidence, as misleading as a war situation might be, especially with a massive proportion of the male labour force under 30 being conscripted into the military.

  But there were also theoretical developments. There are many that could be listed, but the two most important in my view were the publication of John Hicks’s IS-LM apparatus in 1937 and the first edition of Paul Samuelson’s introductory text, Economics, in 1948. With Samuelson’s text also came the single most convincing explanation, his Keynesian-cross diagram, based on the now-universally taught equation Y=C+I+G+(X-M).

  And finally, there was Keynes’s fame. He was more than just some academic with his head buried in his books at Cambridge, but as well-known across the world as anyone you could imagine. The Jean-Paul Sartre of economics if you will. I don’t think there has been an economist before or since who was as well-known as he was. And he was at Cambridge, the centre of the economics world. And he was the editor of The Economic Journal and was therefore able to choose which articles to publish in the most important economics journal of his time.

  So between the supposedly disastrous classical theory that led to the Great Depression, the depths that the recession had gone into, the fact that the theory he had come up with was the single-most believed fallacy of classical times, the supposed confirmation of his theoretical perspective during the War and in the United States during the New Deal, his own pre-eminence in his own time, the easy-to-understand theoretical models that entered into the textbooks as explanations for his approach to policy, the desire to take an active role in reversing recession, the general drift in attitudes towards centralised decision making that followed the revolution in Russia, and the arrival of a new generation of economists who replaced—“funeral by funeral”—the generation brought up on classical theory, all that combined to usher in the Keynesian era, which we are still very much in the midst of.

  Grégoire Canlorbe: Along with Steve Kates and William Harold Hutt, Thomas Sowell is the modern author most closely associated with Say’s Law. He devoted his doctoral thesis to the law of markets, which was published in 1972 under the title of Say’s Law: An Historical Analysis. Additionally, he provided, in 1987, the entries in the New Palgrave on both J.B. Say and Say’s Law, and in his Classical Economics Reconsidered, first edited in 1974, he included a long discussion of Say’s Law. His imprint on the meaning of Say’s Law carries an important measure of authority.

  In his Historical Analysis, Sowell clearly states that “the classical economists were never guilty of the absurdity sometimes attributed to them of denying the existence of depressions, unsold goods, and unemployment, but their explanation was not the modern one of deficient aggregate demand, even in the short run”. According to them, “miscalculations which affect internal proportions [could] also affect aggregate output” and lead to a global decline in activity. [ix]

  Could you specify and develop your opinion on Thomas Sowell’s book? To what extent did it enrich our knowledge of classical economics in general and of the law of markets in particular?

  Steve Kates: There are few whose practical politics and economic judgement on policy matters I admire more than Thomas Sowell. Yet it is also clear to me that everything he writes about Say’s Law is wrongly based and poorly conceived. The two most important discussions are found in his book and the article on Say’s Law he did for the New Palgrave. Although he sees the point of the classical model, even so, when he came to write on the specifics of Say’s Law, he missed the mark and by a very wide distance.

  His book-length discussion of Say’s Law, which he published in 1972, was his PhD thesis. He was not then who he became. His PhD supervisor was George Stigler, someone else I have great respect for. But the period of the late 1960s and early 1970s was, in many ways, the high point of Keynesian theory. It was more than just the mainstream. It was seen as among the greatest triumphs economists had ever achieved. The neo-classical synthesis, that combined the marginalists with Keynes, was untouchable. It would have been impossible to go against this consensus and come away with a PhD.

  It being his thesis, it would also have been impossible for Sowell to go against the views either of his supervisor or his thesis examiners. Let me therefore note this from the “Acknowledgements” to his Say’s Law, dated November 22, 1971:

  “I am indebted to Professor George J. Stigler of the University of Chicago, whose interest in (including opposition to) many of the ideas developed in this work has led me to redefine and reformulate my concepts over the years.” [x] (My bolding)

  This is Thomas Sowell’s only truly bad book. Given how accurate what he has written elsewhere about other issues, I have always assumed Stigler’s imprint ruined Sowell’s ability to say what he really meant. I discuss Sowell in my own Say’s Law and the Keynesian Revolution, published in 1998, where I reach this conclusion:

  “The orthodoxy had, until 1936, accepted its conclusion that demand deficiency (i.e. over-production or a general glut) would not cause recession. With the publication of the General Theory, this settled conclusion was overturned and replaced by the opposite conclusion which Say’s Law had originally been devised to deny. Sowell is oblivious to all of this because he does not understand the nature of the debate over the law of markets. Therefore, while he is able to discuss intelligently many of the surrounding issues, and to refute many of the incorrect collateral statements made about Say’s Law, he is not able to provide an account of what the Law meant to classical economists or why they considered it as important as they obviously did.” [xi]

  I believe, but it is only my own conjecture, that the framework put forward by Sowell was imposed on him by Stigler. That he begins with Keynes’s definition in the very first line of the very first page—“that supply creates its own demand”—had only meant that he was locked into what was the fashionable opinion of the time. And it may well have been the case that any other interpretation would have seen his thesis rejected since virtually no one else at the time would have accepted any other approach. That he did not then, nor has since, ever stated that Keynes was wrong or the classical economists were right makes me feel he has washed his hands of the issue since it would be gruesome to have to go back and repudiate one’s first published work. That he used a Y=C+I framework to discuss Say’s Law highlights how far from an appreciation of the fact that aggregate demand has no place in a classical model.

  Most importantly, Sowell’s framework has never been adopted by anyone else who has looked at Say’s Law. He wrote:

  “Implicit in this issue is the more basic question whether there is such a thing as an equilibrium level of aggregate real income… While the concept of an equilibrium national income does not contradict the essential logic of Say’s Law, it was perceived as a threat by the defenders of Say’s Law as it had developed historically.” [xii]

  This is a construction Sowell put on the original debates since you may be sure no one at the time, nor during the whole of the nineteenth century, was ever concerned whether or not there could be an equilibrium level of national income. And then when it is seen, as Sowell stresses himself, that on the issue of an equilibrium level of incomes, Keynes would have had to have been counted on the same side as those who had defended Say’s Law in the nineteenth century, it ought to be clear how poorly conceived Sowell’s approach is.

  And I do find it unfortunate that Sowell in his On Classical Economics published in 2006 continues to frame the issue in the same way (pp. 23-29), as a debate over the existence of an equilibrium national income. It is a conception that no amount of wrestling with will help anyone make sense of the actual issues that matter, either then or now.

  The sad fact is that Sowell has never criticised Keynesian economic theory at any time so far as I am aware. I have had a look at the fifth edition of his Basic Economics published in 2014, and this is what he said:

  “Keynesian economics began to be developed and presented with concepts, definitions, graphs and equations found nowhere in the writings of John Maynard Keynes, as other leading economists extended the analysis of Keynesian economics to the profession in scholarly writings, and its presentation to students in textbooks, using devices that Keynes himself never used or conceived.” [xiii]

  In the same book, he again discussed Say’s Law in which he argues that Say’s Law was merely an attempt to point out that an economy could not produce so much that the level of demand would fall short of the level of supply.

  “What Say’s Law did preclude was the recurrent popular fear that the sheer rapid growth of output, with the rise of modern industry, would reach a point where output would become so great that it would be impossible to buy it all.” [xiv]

  But, on the issue of demand deficiency, he takes the same side as Keynes:

  “This, of course, did not preclude the possibility that, as of any given time, consumers or investors might not choose to exercise all the aggregate demand that was in their power.” [xv]

  You therefore find that Sowell took the same side as Keynes, that demand deficiency was a realistic possibility. For whatever reason, Sowell never understood Say’s Law and unfortunately everything he has written on it is vastly misleading if not actually completely wrong.

  Grégoire Canlorbe: According to William Spence and Thomas Malthus, a chronic overproduction of consumer goods could happen in virtue of people’s preference for capital goods. In other words, Malthus and Spence argued that too much saving would lead to oversupply of consumption goods—and trigger recession. The remedy, they believed, was to diminish “productive consumption”, i.e., demand for investment goods, and to increase “unproductive consumption”, i.e., demand for consumption goods.

  Keynes’s and Malthus’s respective insights are generally treated on an equal footing: at first sight, they are far from saying the same thing. While Keynes subscribed to the “paradox of thrift” highlighted by Malthus, his prime sticking point with the law of markets and Ricardian economics dealt with the (alleged) assumption that all savings would be invested. In this regard, Malthus and Spence were specifically concerned with oversupply of consumer goods, while Keynes’s preoccupation was overproduction of both capital and consumption goods.

  In other words, Malthus’s aim was to show how an increase in savings might render consumption levels insufficient to keep up and increase the exchangeable value of the whole production of consumer goods, thus engendering a global decline in activity. But Keynes’s worry was to elucidate the behavior of interest rates against the backdrop of a marked preference for liquidity and the causal chain between their disproportionate rise, the shrinkage of solvable demand for capital goods, the “multiplier effect” and the glut of consumption goods.

  In this regard, what Malthus had done was to develop a kind of miscalculation argument. From his point of view, recessions were due to an incorrect assortment of goods and services. Because entrepreneurs had overestimated the demand of people for consumption goods, their sales were lower than expected and insufficient to cover the costs of production. While disagreeing with Ricardo and Say on the issue to know whether an increase in saving might erode solvable outlets for consumer goods, Malthus was apparently not a “demand-side” economist: he was far from neglecting, as Keynes would do, the composition of supply (compared with the composition of demand) in his analysis of overproduction crises.

  What would be your shock argument in favor of the thesis of a strong intellectual filiation between Malthus and Keynes?

  Steve Kates: There is no doubt that Keynes wrote The General Theory because he had been reading Malthus in late 1932. He had been reading Malthus because he was putting together his Essay’s in Biography that was published in early 1933. One of the biographies he included was of Malthus, the world’s first professional economist and a graduate of Cambridge. In completing his biography, he asked his colleague, Piero Sraffa, for access to Malthus’s letters to Ricardo which had been lost for a century until discovered by Sraffa in 1930. They would remain unpublished until after the War, so in 1932 Keynes was very privileged to have these at hand. In reading these letters he discovered Malthus’s views on demand deficiency.

  Keynes never accepted Malthus’s explanation for why demand deficiency occurred, but he did accept the challenge of demonstrating that Malthus had been right after all. The certainty is that Keynes would never have written a book explaining recessions as a consequence of demand deficiency and over-saving had he not read Malthus first. Since Keynes never discussed either prior to his reading these letters, and then went forward after that with all the zeal of a new convert, it is hard to see how it could be otherwise, but there are plenty around who will say that it was.

  In many ways I am sympathetic to Malthus’s approach. Although the tendency is to read Malthus as a proto-Keynesian, my suspicion would be that were he around in 1936, he would have sided with Ricardo against Keynes. It would require much too much detail to unpick all of this (but let me suggest T. Peach’s 1993 Interpreting Ricardo for some elucidation). Ricardo and Malthus basically worked from the same classical framework in which saving was conceptualised in real terms—money never entered into the discussion—so that saving always equalled investment. There is a great, great deal more that might be said.

  But it is as you say yourself. Malthus had also developed a miscalculation model. It would be preposterous to have argued in 1820 that there had been insufficient demand for output. But it was not preposterous to argue that production had been misdirected. It was also not preposterous to have wondered whether an increase in consumer demand might not have benefited employment even if it did slow the rate of accumulation. I don’t think he was right, nor did anyone else at the time, but I also don’t think his arguments are without interest.

  And I will just further mention that the terms “productive” and “unproductive” expenditure are terms that no one today will understand unless they are properly grounded in classical terminology. The best I can do is suggest that the difference is between “value adding” and “non-value-adding”. Assisting the unemployed with value-adding public works during recession had become the norm by the end of the nineteenth century, recommended by textbook writers almost across the board. But these were recognised as palliatives.

  What made Keynes’s approach so different was that he did not just think there should be some effort to employ the unemployed during recession, he thought of increases in public spending as the very means to end recessions and he was almost indifferent as to whether the expenditure was value adding or not. If you spend enough, between the initial spending and the multiplier, a recession can be brought to an end and full employment restored. Every classical economist would have seen that as utterly deranged, a full-measure of crackpot theory. The consequences of our stimulus packages seems to indicate that the classicals were right. No peace-time economy has ever been brought from recession to recovery through public spending. Debt and deficits are a catastrophic residue from our own recent stimulus packages. But why that is cannot be found in the pages of any modern economic text.

  Grégoire Canlorbe: The core meaning of “Say’s Identity”, namely the law of markets as it is nowadays generally understood, in particular among Austrian economists, can be expressed as follows.

  Some particular goods can be produced in excess, but never all goods simultaneously—reason commonly invoked is that any commodity oversupplied implies another commodity undersupplied; however, the array of goods and services produced necessarily ends up coinciding with the array of goods and services demanded after a rapid adjustment process. In a nutshell, there can be no general overproduction but there can be a provisory and rapid excess of some definite commodities. Overproducing means here to produce something in excess with the demand of people. By reducing the unitary selling price of a commodity in excess, demand quickly adjusts itself to supply. But the equilibrium price thus discovered, whose level is insufficient to cover the costs previously endured, does not fit the expectations of entrepreneurs.

  In other words, although overproduction (of some specific goods) may temporarily occur, any good supplied must sooner or later sell itself at an equilibrium price, but not necessarily at a cost-covering price. In virtue of the law of supply and demand, it is assumed that no transaction will occur at a disequilibrium price.

  According to Murray Rothbard’s own words in his 1962 treatise on economics, “the market process always tends to eliminate such shortages and surpluses and establish a price where demanders can find a supply, and suppliers a demand”. There is no doubt that “generally, a market tends to “clear itself” quickly by establishing its equilibrium price, after which a certain number of exchanges take place.”[xvi] In his discussion of Say’s Law in his posthumous Austrian perspective on the history of economic thought, Rothbard reiterates the same point: “There can never be any problem of “overproduction” or “underconsumption” on the free market because prices can always fall until the markets are cleared… There is never any genuine unsold surplus, or “glut”, whether specific or general over the whole economy, if prices are free to fall to clear the market and eliminate the surplus.” [xvii]

  In my humble opinion, this contemporary acceptation of Say’s Law constitutes an implicit pillar of the Austrian theory of business cycle. On the one hand, this theory assumes that everything produced can be sold at an equilibrium price (at least, in an unregulated market): the challenge of entrepreneurs is not in first place to sell all their merchandise but to do so at a cost-covering price. Overproduction cannot occur, except as an ephemeral and self-liquidating phenomenon; but what may occur, and in fact regularly occurs, is a narrow form of miscalculation: an erroneous prevision of equilibrium prices. On the other hand, even for a short period, there can be no general overproduction: only some definite goods can be overabundant at the price initially proposed by their sellers. This amounts to saying that forecasting errors cannot be universal: some entrepreneurs correctly anticipate the market clearing prices while others fail to do so.

  The essence of all these considerations is that economic crises are due to a massive spread of entrepreneurial forecasting errors. In a time of crisis, a disproportionally high number of entrepreneurs—but not all of them—suffers losses due to their inaccurate anticipation of ongoing equilibrium prices. Austrian theory explains these collective mistakes as the result of artificially low interest rates that have created the illusion of a greater pool of savings than actual consumer time preferences would have justified. Investment decisions have inadequately privileged the capital goods industries rather than the consumer good industries.

  Although “Say’s Identity” does not capture the classical meaning of the law of markets, would you say this proposition, per se, has some theoretical pertinence? More generally, how would you assess the defects and merits of the Austrian theory of boom and bust in the light of the classical approach of the economic cycle?

  Steve Kates: Austrian theory is the closest we have in the modern age to the classical theory of the cycle. Murray Rothbard’s approach on the technical description of the cycle is very near my own. But what has concerned me has been how unique he is among Austrian economists.

  Say’s Law is at best a distant feature within most versions of Austrian economics and almost entirely ignored by others. An example is found in the excellent Advanced Introduction to the Austrian School of Economics by Randall Holcombe and published in 2014, which never mentions Say’s Law at all. Ludwig von Mises mentioned Say’s Law on only two occasions that I am aware of, in two short articles published in the 1950s. Hayek never mentioned it at all so far as I am aware. Austrians are sympathetic to the approach embedded in Say’s Law as may be seen from my own presentation to the Mises Institute in 2010 which I gave under the title, “Why Your Grandfather’s Economics is Better than Yours”. Yet however sympathetic they are, they never adopt it for themselves.

  “Overproduction” is an important technical word that has to be understood properly. No one has ever denied that there may be overproduction of particular goods or services. That was described in classical times as a “particular glut”, with glut being the ancient term for excess supply. But what there could never be is overproduction of goods and services in general, what was described as a “general glut”. The idea that an economy would fall into recession because there was too much of everything so that people stopped buying was recognised as nonsensical, which it is. It is unimaginable so long as there are individuals who are still making decisions not to buy things because they cannot be afforded, which near enough everyone of us does almost every time we enter a shop.

  Overproduction of individual goods and services when it becomes a general case is the start of recession. Distortions in the structure of production can lead to a reduction in demand for some goods and services that will have further repercussions on the industries supplying inputs as well as on those who sell to the suddenly unemployed workers in the affected industries. In other words, in virtue of the interdependence among all enterprises, the inability of an initial group of entrepreneurs to sell and earn incomes can lead to a fall in demand for the products of other industries, and so on through the entire economy. Thus, there can be a downturn in production as sales across an economy turn out to be lower than originally anticipated. The more general the downturn, the slower the economy becomes and the higher the level of unemployment reaches.

  The healing process then takes time. Nothing of this kind can be fixed immediately. The post-Napoleonic recessions were in fact three separate problems that occurred between 1815 and 1820. On this matter, allow me to recommend you “The historical context of the general glut controversy” by Timothy Davis, chapter 8 in Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, edited by myself and published in 2003. The Great Depression, in spite of the massive mishandling of events, such as by the imposition of massive increases in tariffs and a failure to allow wage rates to adjust, even then only lasted from the end of 1929 till around 1933. These are not short periods of time, but these were exceptionally unusual times. The contrast with the deep inflationary recession that followed World War I, where Harding cut spending and raised taxes on the way to a full recovery within 15 months, was more typical. The adjustment process happens naturally. I just would not use the word “quickly”. A year is not short if you are without work. It is only preferable to being out of work for two years or even more, which is the typical experience that follows a Keynesian solution, as we saw during the 1980s, in Japan since the 1990s, and now, following the GFC—Global Financial Crisis.

  But getting back to Austrian theory, its weakness in my view is its concentration on only a single cause for the dislocations that occur in markets. As you noted, Austrian theory explains these dislocations as the result of monetary disorganization and artificially low interest rates. This is much too narrow. It was one of the explanations for recessions in pre-Keynesian times but was hardly the most important. Many things can upset the applecart for businesses besides poorly designed monetary policies.

  The major cause of recession in the 1970s was initiated by two separate OPEC oil blockades in 1973 and 1979 which created havoc within markets across the Western world. No prior monetary policies could have forestalled any of this. The GFC, similarly, can be attributed to poor decisions by the Fed in the United States, but this cannot be described as a domestic issue in any of the other economies across the world which were affected by a crisis that originated in the US. For everyone else, it was a disturbance in the financial system that had nothing to do with an illusion of a greater pool of savings than actually existed.

  To understand the classical theory of the cycle, I can only think of two places where you can find it spelt out. The first is in Gottfried Haberler’s Prosperity and Depression (Geneva: League of Nations 1937), which provides an overview of all of the major theories of recession that were then in existence. But only the first edition will do this, since by the time the second edition was published in 1939, Keynesian theory had infiltrated the arguments, and by the time the third edition was published in 1941, trying to isolate Haberler’s original intent becomes the work of scholarship, which no casual reader can do.

  The other place, therefore, that an understanding of classical theory may be found is in Chapter XIV of my own text, Free Market Economics: an Introduction for the General Reader (2nd edn Elgar 2014, with a 3rd edn either this year or next). It is my own synthesis of Haberler, expanding on the analysis provided above. I actually despair that more than a handful will ever see what classical theory said, but I find myself compelled to try to get others to see the point.

  Grégoire Canlorbe: In Money, Bank Credit, and Monetary Cycles, Jesús Huerta de Soto holds Say’s Law for profoundly incompatible with the Austrian tradition in economics. In the lineage of Keynes, he formulates Say’s Law as the ambiguous statement that “supply creates its own demand”. Unlike Keynes, he claims that the Austrian theory of the economic cycle explains why, under certain circumstances, and as a consequence of credit expansion, “Say’s Law repetitively fails to hold true”.

  “John Maynard Keynes begins his book, The General Theory, by condemning Say’s law as one of the fundamental principles upon which the classical analysis rests. Nonetheless Keynes overlooked the fact that the analysis carried out by Austrian School theorists (Mises and Hayek) had already revealed that processes of credit and monetary expansion ultimately distort the productive structure and create a situation in which the supply of capital goods and consumer goods and services no longer corresponds with economic agents’ demand for them. In other words a temporal maladjustment in the economic system results.”

  A few lines later, Huerta de Soto states further: “It is not surprising that the absence of an elaborate capital theory in Marshallian economics and Keynes’s ignorance of Austrian contributions led Keynes to criticize all classical economists for assuming that “supply must always automatically create its own demand.” Indeed, according to Keynes, classical economists are “fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption; … whereas the motives which determine the latter are not linked in any simple way with the motives which determine the former.” Although this assertion may be justified with respect to the neoclassical economics of Keynes’s time, it in no way applies to Austrian economics, if we consider the level of development Austrians had already reached with their theory of capital and cycles when The General Theory was published.”

  Huerta de Soto thinks in particular of Friedrich A. von Hayek, who, “aided by Mises’s subjective theory of money, capital and cycles”, had “closely analyzed the extent to which Say’s law is temporally unsound and had studied the disruptive effect on the economic system of regular, credit-related attacks.” [xviii]

  Could you mark off and develop the germ of truth contained by this analysis?

  Steve Kates: The classical theory of recession is the general case with the Austrian theory a particular version of the classical explanation for recession. The question is, why does an economy go into recession? The classical answer, in general, was that producers for some reason did not produce what buyers wished to buy. And in this, we are not just discussing producers of final consumer goods, but producers of every kind of input as well.

  The “temporal maladjustment in the economic system” was recognised early on among classical economists. It was a shared perspective for Ricardo and Malthus. It is found unmistakeably in Mill and his followers. It is even found in Marshall if you know where to look. Mises and Hayek had nothing to teach anyone on that score.

  But what this highlights is the absence of a proper understanding among many Austrians of the classical theory of the cycle, which their own analysis is one example of. But what is truly distressing is that Huerta de Soto takes Keynes’s side against classical theory. This is unforgiveable. There is more than enough “capital theory” to go round in Mill, none of which has been improved on nor superseded by the later Austrian analysis.

  Things may, in fact, be worse than this. One of the supposed “puzzles” is why Hayek did not attack The General Theory immediately in 1936. He has stated that he had expected Keynes to recant and recast his theory, as he had done with The Treatise on Money published in 1930. That is possible. You become arm weary after a while attacking the same errors over and over. And I accept that to some extent it is a puzzle since Hayek had written a major critique of under-consumptionism in a massive paper published on Foster and Catchings in 1931. What is even more notable is that in the very first para of the article, Hayek invokes J.-B. Say, as in Say’s Law, in noting that mainstream criticism of under-consumptionist theory had a long history. Given this bit of history, I had always wondered why he didn’t get back into the fight right away.

  And the reason I think Hayek stayed out of this particular battle was because he agreed with Keynes on the need for public spending to reduce unemployment in the midst of recessions. I realise that what I am about to argue will seem like a very thin reed, but I take you to Appendix IV in his Pure Theory of Capital, published in 1941. Here he discusses Mill’s Fourth Fundamental Proposition on Capital, that “demand for commodities is not demand for labour”.

  Since I know no one is going to check this out, let me just assert that there we find Hayek disputing Mill’s statement, arguing that while it is true when the economy is going well, no one had ever thought it was true during times of recession and high unemployment. But that was exactly the point that Mill had been making. What sense would it make to state that it is useless to encourage demand when there is already full employment. What Mill was arguing was that such an approach to lowering unemployment could not work even if unemployment were high. I have discussed this in an article you are welcome to read for yourself, “Mill’s fourth fundamental proposition on capital: a paradox explained”, published in March 2015 in Journal of the History of Economic Thought.

  The fact remains that Say’s Law is a proposition that is never suspended and on no occasion in the operation of an economy is it unsound, either temporarily or otherwise. And it does distress me to see that even such brilliant scholars as Huerta de Soto are unaware of any of this.

  Grégoire Canlorbe: John Ramsay McCulloch defined the law of market as follows:

  “We may increase the power of production ten or twenty times, and be as free of all excess as if we diminished it in the same proportion. A glut never originates in an increase of production; but is, in every case, a consequence of the misapplication of the ability to produce, that is, of the producers not properly adapting their means to their ends.” [xix]

  In other words, every increase of production creates, or rather constitutes, its own demand, so long as the array of goods and services produced coincides with the array of goods and services demanded. It is the classical meaning of Say’s Law and it is not quite the same thing as “Say’s Identity” or “Walras’s Law”. Yet, the initial elaborations of James Mill were very similar to what “Say’s Identity” would come to argue more than a century later.

  Mill did not contend that a general glut could only occur as a consequence of entrepreneurial miscalculations. His point was that a general glut could simply never occur: while some definite goods might be overproduced at some time, such mistakes could never affect the whole of production simultaneously. Any commodity oversupplied—that is to say, offered in excess with the demand of people or compelled to sell itself at a loss—would necessarily coincide with another commodity in short supply. More precisely, any commodity oversupplied would find itself in this situation in virtue of defective means of payment; and this lack of purchasing power would be necessarily the result of some other commodity insufficiently provided.

  “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.” [xx]

  In my humble opinion, James Mill is strictly irrelevant. On the one hand, it is found by experience that the power to purchase does not necessarily involve a proportionate will to purchase: a glut, whether partial or general, is not necessarily due to a lack in purchasing power, the will to buy can also be defective. On the other hand, as the classical theory of the economic cycle points out, a partial overproduction may lead to a general glutting of markets—by reason of the mutual interdependence of all producers.

  In this regard, the classical tradition in the study of economic cycles did not extend Mill’s analysis to demonstrate what had been implicit in his arguments: what it did was to relativize and enrich his initial perspective. By showing how disharmonies created by partial gluts were likely to engender a deficient aggregate demand, it developed “a revised and corrected version” of James Mill’s law of markets.

  What would you retort in defense of Mill’s intellectual depth and his historical rank of Founding Father of the classical theory of the business cycle?

  Steve Kates: Let me first repeat James Mill’s perfectly summed up analysis, but also at the same time add in the date of publication: first edition1807.

  “It may be necessary, however, to remark, that a nation may easily have more than enough of any one commodity, though she can never have more than enough of commodities in general. The quantity of any one commodity may easily be carried beyond its due proportion; but by that very circumstance is implied that some other commodity is not provided in sufficient proportion. 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.” [xxi]

  Here he is stating the standard argument of classical economists: that you can have a particular glut of individual goods or services even while a general glut is impossible. You can never produce so much that a community will run out of demands. Think how much more abundant goods and services are today compared with the start of the nineteenth century, and even so what he wrote then would apply just as much to the present and to any imaginable future we might contemplate. You have to be compulsorily mis-educated into accepting Keynesian theory to believe that demand deficiency is a realistic possibility. This was just as perfectly stated by McCulloch.

  Recessions are possible but not because of a deficiency of demand. That is the first half of Say’s Law. The second half adds that unemployment cannot be lowered by increasing the level of demand. Even if I cannot convince anyone that this is economically valid, I hope that I can at least convince them that this is what classical economists believed. From that they can decide for themselves, especially in the light of recent experience, how valid this classical belief actually is.

  As for James Mill’s relevance, perhaps I should leave it to his son to adjudicate. John Stuart Mill wrote at the end of his chapter in the Principles outlining Say’s Law (Mill [1871] 1921: Book III – Chapter XV – final para):

  “It is but justice to two eminent names to call attention to the fact, that the merit of having placed this most important point in its true light belongs principally, on the Continent, to the judicious J. B. Say, and in this country to Mr. [James] Mill; who (besides the conclusive exposition which he gave of the subject in his Elements of Political Economy) had set forth the correct doctrine with great force and clearness in an early pamphlet, called forth by a temporary controversy, and entitled, Commerce Defended; the first of his writings which attained any celebrity, and which he prized more as having been his first introduction to the friendship of David Ricardo, the most valued and most intimate friendship of his life.” [xxii]

  The first proper statement of Say’s Law is, in my view, found in Mill’s Commerce Defended since it is the first time someone had controverted someone else’s argument that increasing demand could create economic growth and employment. But if JSM is willing to split the laurel and award it to both, I am happy to go along. But it would be quite unjust to leave out James Mill who was the first to isolate one of most important economic propositions ever discovered.

  Grégoire Canlorbe: “Say’s Equality”, the second modern interpretation of Say’s Law, argues that in virtue of variations in the demand for money, the demand for (consumption and equipment) goods may temporarily move out of equilibrium with the supply of goods—but the processes of the economy will rapidly bring the two back into equilibrium. Here again, overproducing means to supply something in excess with the demand of people: this definition precludes the fact to sell a good at a price that does not cover the costs of production.

  The belief that demand, as such, was insatiable was universally admitted among the classical economists, including, paradoxically, the despisers of the law of markets. Sismondi, Spence, Malthus, Maitland did not argue that in virtue of an intrinsic limit to the desire to consume (either productively or unproductively), incomes might be hoarded instead of being reinjected in the purchase of consumption or equipment goods. According to them, demand deficiency could be due to all sorts of reasons, such as a lack of purchasing power (on the part of wage-earners) or a global mismatch between consumer goods for sales and the expectations of people—but variations in the demand for money were never held for a correct explanation.

  It is highly revelatory in this regard that John Stuart Mill, when trying to recapitulate the reasons developed by the opponents of the law of markets, evoked, on the first hand, the idea that there might occur “a deficiency of demand for all commodities for want of the means of payment”; and on the other hand, the idea that “the general produce of industry [might] be greater than the community desires to consume—the part, at least, of the community which has an equivalent to give.” Yet, he did not castigate the argument of hoarding. A couple of pages further on, he even endorsed it personally—in spite of his assertion that the desire to spend one’s own income was limitless.

  “At such times there is really an excess of all commodities above the money demand. […] Almost everybody therefore is a seller, and there are scarcely any buyers. But it is a great error to suppose [like Malthus or Sismondi] that a commercial crisis is the effect of a general excess of production. It is simply the consequence of an excess of speculative purchases. It is not a gradual advent of low prices, but a sudden recoil from prices extravagantly high: its immediate cause is a contraction of credit, and the remedy is, not a diminution of supply, but the restoration of confidence.” [xxiii]

  Although such analysis echoes the Keynesian principle of preference for liquidity, Stuart Mill meant it as a counter-argument towards demand-side economics. In practice, what he did was veritably to show how variations in the demand for money might engender a crisis of overproduction: this was a typical case of demand-side explanation for recessions and unemployment. In contradiction with their own belief that the desire to consume (either unproductively or productively) was insatiable, Robert Torrens, John Ramsay McCulloch, Alfred Marshall or even Wilhelm Röpke were also convinced that such variations in the demand for money might occur. Unlike Stuart Mill, they held these variations for an aggravating factor, not a triggering event. In their view, hoarding was nothing more than a symptom of crises: in no case, it could interlock them.

  While “Say’s Equality” is not utterly faithful to what John Stuart Mill had in mind, there is no doubt that it was paradoxically the classical proponents of the law of markets—rather than its opponents—who acknowledged hoarding to be a cause of recession, or at least an aggravating factor. But did they not do it at the cost of intellectual coherence?

  Steve Kates: The idea that hoarding money is a cause of recession is nonsensical. No classical economist of any importance ever thought such a thing. Certainly no recession has ever been caused by a sudden desire by a population under a cloudless blue sky to stop spending and keep their money under the mattress. There is always something that has triggered the rush to liquidity. Whatever that trigger is, that is the cause of the crisis and subsequent recession.

  To think of hoarding as a classical issue is to misunderstand in the most profound way the points that classical economists, and Mill in particular, were trying to make. Keynesian demand-side concerns are the absolute antithesis of classical economic thought. Look at what Mill says:

  “It is a great error to suppose that a commercial crisis is the effect of a general excess of production. It is simply the consequence of [something else].” [xxiv] (My bolding)

  The classical theory of recession revolved around thinking what that something else might be, but a sudden desire to save rather than spend was not among the realistic possibilities every envisaged. Who can doubt that once an economy reaches some crisis, everyone becomes more wary and there is a flight to liquidity. That is what Mill is saying.

  Once the recession began, the process of recovery could take quite some time to work its way through. It takes time for businesses to get their bearings under the changed market conditions that prevail after a crisis. Business confidence—Keynes’s animal spirits—takes time to rebuild, but not infinite time. Let me take you to a passage written by Alfred Marshall in a book co-authored with his wife in 1879. The notion that it required Keynes to introduce uncertainty into economics is shown as yet another example of claiming for Keynes what had always been explicit within economic theory.

  The passage also repeats Mill’s recognition that once an economy is heading onto the rocks, there is a rush to liquidity—hoarding cash if you will. The recovery is then a slow process as businesses emerge one by one from within their shells. And note that something has happened to shake confidence, which is thus the actual cause of the downturn, and not the slowdown in the turnover of money. It should also be quite clear that there is plenty of involuntary unemployment going on once the recession begins.

  “But though men have the power to purchase they may not choose to use it. For when confidence has been shaken by failures, capital cannot be got to start new companies or extend old ones. Projects for new railways meet with no favour, ships lie idle, and there are no orders for new ships. There is scarcely any demand for the work of navies, and not much for the work of the building and the engine-making trades. In short there is but little occupation in any of the trades which make Fixed capital. Those whose skill and capital is specialised in these trades are earning little, and therefore buying little of the produce of other trades. Other trades, finding a poor market for their goods, produce less; they earn less, and therefore they buy less; the diminution of the demand for their wares makes them demand less of other trades. Thus commercial disorganization spreads, the disorganization of one trade throws others out of gear, and they react on it and increase its disorganization.

  The chief cause of the evil is a want of confidence. The greater part of it could be removed almost in an instant if confidence could return, touch all industries with her magic wand, and make them continue their production and their demand for the wares of others. If all trades which make goods for direct consumption agreed to work on and to buy each other’s goods as in ordinary times, they would supply one another with the means of earning a moderate rate of profits and of wages. The trades which make fixed capital might have to wait a little longer, but they too would get employment when confidence had revived so far that those who had capital to invest had made up their minds how to invest it. Confidence by growing would cause itself to grow; credit would give increased means of purchase, and thus prices would recover. Those in trade already would make good profits, new companies would be started, old businesses would be extended; and soon there would be a good demand even for the work of those who make Fixed capital. There is of course no formal agreement between the different trades to begin again to work full times and so make a market for each other’s wares. But the revival of industry comes about through the gradual and often simultaneous growth of confidence among many various trades; it begins as soon as traders think that prices will not continue to fall: and with a revival of industry prices rise.” [xxv]

  This is the classical theory of the cycle perfectly explained. And so much did Marshall find this an accurate statement of the reality of recessions and the process of recovery, he took the entire passage into his Principles of Economics in the 1905 revision, the single most used economics text of the late nineteenth and early twentieth centuries, where it has remained ever since.

  Grégoire Canlorbe: In his renowned Wealth and Poverty, George Gilder develops an iconoclastic perspective according to which John Maynard Keynes would not be that much extraneous to supply-side economics in some aspects.

  “It may be said, George Gilder writes, that the alleged refutation of Say’s Law by Keynes was the crucial event of modern economics since it affirmed emphatically in the economics of the whole society (macroeconomics) the more insidious triumphs of demand in the economics of the individual and the firm (microeconomics). Yet the actual works of Keynes, even in relation to Say’s Law and the role of supply, are far more favorable to supply-side economic policy than current Keynesians comprehend…

  Keynes attributed [investment decisions] to two considerations beyond mere animal spirits; one he called the “marginal efficiency of capital,” and the other “effective demand.” Eschewing a lot of needless Bloomsbury complexities, these two concepts reduce to an affirmation of Say’s Law in yet another sense, a firm assertion of the primacy of supply.

  Both effective demand and the marginal efficiency of capital depend on anticipated profits, on “the proceeds that entrepreneurs expect to receive.” Demand, we discover, even in the works of Keynes, is mostly in the mind of the supplier. He does not invest in a productive plant because he is assured of buyers for his goods; he cannot be certain that new inventions or changing tastes will not make his factory worthless. If his product is new, it may create demand, perhaps over time. But the demand does not already exist, except in the imagination of the entrepreneur.”

  By making the individual investor the central figure in economics, Keynes overthrew the simplistic and mechanistic neoclassical models. Although he is nowadays “known as an advocate of expanded spending—of enlarged aggregate demand—as the answer to all economic distress”, his conviction was that “income earners would spend and save their money in relatively fixed proportions and that what mattered was assuring enough investment.” What he did was to break “in a rightward direction, from the classical assumption that if savings were sufficient, investment would take care of itself. As the key act of capitalism, he replaced the measurable and passive setting aside of money with the active and aggressive investment of it.

  Keynes thus restored to a position of appropriate centrality in economic thought the vital role and activity of the individual capitalist. It is free men rather than abstract forces or mechanisms that impel the Keynesian economy. In his view, the key to material progress lies not in the workings of automatic accumulation or in passive thrift and savings or in a benign tendency toward general equilibrium, but in “skilled investment” designed “to defeat the dark forces of time and ignorance which envelop our future.”[xxvi] Because the Keynesian world is not rational and predictable, the true message of Keynes cannot be reduced to mathematics or a scheme of reliable planning.”

  Ultimately, Keynes was “as disdainful of Marxism as of laissez-faire” and “rejected all systems that saw the economy as a mechanism, whether of dialectics or markets. He offered for the economy a hierarchical ideal. The creative center of the system was the skilled entrepreneur and the goal of policy was to cultivate his skills and ensure his inducement to invest. This today is the theme of the editorial page of the Wall Street Journal and the rhetoric, at least, of the Republican Party in America.” [xxvii]

  Do you agree, at least in part, with George Gilder?

  Steve Kates: The degree to which Keynes has changed the nature of economic theory since the publication of The General Theory is a phenomenon, and almost all of the changes have been for the worse. But to understand what has changed you first have to know what came before. Mainstream economists today have no idea whatsoever about what an economist in 1925, to choose a date, would have believed about the operation of an economy. They don’t care and have no conception why it might matter.

  What makes George Gilder so exceptional is that he focuses on two of the most important elements that are ignored by a modern text and almost the whole of modern theory. These are the role of the entrepreneur and Say’s Law.

  I did a study one time on the use of the term “entrepreneur” in modern introductory economics texts. These are books that are frequently 800 pages or more of double column texts. And yet, in all of that, the word “entrepreneur” does not show up in half of them and in the other half you might get an oblique reference on a page, or at most two, somewhere in the middle of the text, unrelated to anything remotely associated with understanding how an economy works. Nothing in modern theory is focused on the single most important driver of economic activity in any modern economy. You would get the impression that so far as what makes an economy grow, the people who open and run businesses have no role worth mentioning.

  George Gilder is, of course, one of the central figures in the supply-side revolution of the 1980s. There is no greater enemy of Keynesian economics. To make fun of Keynesians in the way described—to suggest that they are really supply siders—is a joke on them. The quote from Gilder, on the back cover of the 2012 edition, makes it very clear what he thought about the role of government in an economy:

  “The United States over the last decade has witnessed a classic confrontation between the forces of entrepreneurial capitalism and those of established institutions claiming a higher virtue, expertise and political standing. One side subsists on unforced profits of enterprise; the other on rents and tools and privileges at the Treasury, the Federal Reserve and the White House.” [xxviii]

  Say’s Law is about individual decision-making entrepreneurs, the suppliers without whose efforts demand is an impossibility. This is what is meant by “the primacy of supply”. So much of economics is today running a line through a set of data from the past to project some kind of regularity onto the future. And the data often used are such ridiculous abstractions that it is impossible to extract any serious meaning from the numbers that pour out.

  Suppose there is a figure for the annual rate of growth in GDP over a thirty-year period. Let us say it’s been two percent a year per head of population and the compound growth rate has led to a doubling of per capita GDP. And then let us specify that the thirty-year period went from 1890 to 1920. What serious use would such a figure be? During that time, there was the invention and commercialisation of the automobile, the cinema, the radio, the airplane, electrical generation, the light bulb and so much more that it impossible to make any comparisons between the two end points that can be reduced to some number.

  Economics is now flat and empty. The actual world we live in was precisely what classical economists thought about and looked at. They actually thought about real people doing actual things to improve their own material selves and in this way, but acting in an entrepreneurial way, improving the material lives of others. That was the supply-side economics of the classics. The supply side is the actual world of enterprise and labour. That is the vision we have lost. That is what is invisible in any modern text. It is all abstraction, numbers and equations. To shift from reading the great classical economists to reading a modern journal or text is to shift from listening to a symphony orchestra to a penny whistle. There is no comparison. Modern economics is a poor excuse for the great science political economy had once been but no longer is.

  Grégoire Canlorbe: Thanks for your time and your insights. Would you like to add anything else?

  Steve Kates: I have to say, that having gone through the questions, I can see just how well they were put together. They really do get into every nook and cranny of these issues as they now are. It has even made me realise at the end an entire new area that needs to be investigated, but that is for later.

  There’s not much else I feel the need to add but there is this. You raised the very technical issues of Say’s Identity and Say’s Equality as part of your questions, but there really is no point going down such a dry and technical road in a discussion such as this. But these concepts, along with the notion of Walras’ Law, were part of a very important study undertaken by two young economists in 1952, Gary Becker and William Baumol. Unfortunately, this trilogy of concepts is the official version of Say’s Law within economic theory today.

  But what they also concluded in their paper is seldom mentioned by others, but is of major significance. The paper is about the nature of Say’s Law and classical monetary theory. This is their answer to the question whether economists today have a better grasp of the theory of money than the classics. Their answer focuses on John Stuart Mill’s 1844 essay on Say’s Law, about which they write:

  “It is all there and explicitly – Walras’ Law, Say’s Identity which Mill points out holds only for a barter economy, the ‘utility of money’ which consists in permitting purchases to be made only when convenient, the possibility of (temporary) oversupply of commodities when money is in excess demand, and Say’s Equality which makes this only a temporary possibility. Indeed, in reading it one is led to wonder why so much of the subsequent literature (this paper included) had to be written at all.” [xxix]

  To put it simply, Becker and Baumol absolve classical economists of every charge made against them by Keynes and the Keynesians in relation to monetary theory and Say’s Law. Both became in later life among the greatest economists of our time, and this was a very focused article that was the work of both. Baumol has even written many further articles on Say’s Law to clarify these issues.

  Say’s Law remains what it had always been, among the most clarifying concepts ever developed by economists. It is impossible to think straight about economic issues without it. I will close with a quote from Mill from the chapter in which he discussed the impossibility of demand failure as a realistic explanation for recession. These are words that apply as much today as they did then.

  “I know not of any economical facts… which can have given occasion to the opinion that a general over-production of commodities ever presented itself in actual experience. I am convinced that there is no fact in commercial affairs which, in order to its explanation, stands in need of that chimerical supposition.

  The point is fundamental; any difference of opinion on it involves radically different conceptions of Political Economy, especially in its practical aspect. On the one view, we have only to consider how a sufficient production may be combined with the best possible distribution; but, on the other, there is a third thing to be considered—how a market can be created for produce, or how production can be limited to the capabilities of the market. Besides, a theory so essentially self-contradictory cannot intrude itself without carrying confusion into the very heart of the subject, and making it impossible even to conceive with any distinctness many of the more complicated economical workings of society. This error has been, I conceive, fatal to the systems, as systems, of the three distinguished economists to whom I before referred, Malthus, Chalmers, and Sismondi; all of whom have admirably conceived and explained several of the elementary theorems of political economy, but this fatal misconception has spread itself like a veil between them and the more difficult portions of the subject, not suffering one ray of light to penetrate. Still more is this same confused idea constantly crossing and bewildering the speculations of minds inferior to theirs.” [xxx]

  This self-contradictory confused idea—now referred to as Keynesian economics—is still bewildering minds across the economics community and beyond. The belief that an economy can be driven from the demand side is literally ruining our economies. Economists once knew better, but since the publication of The General Theory, they do not. Yet as Mill said, the point is fundamental. You either accept Say’s Law or you do not. And if you do not, as Mill wrote, it is impossible to conceive with any distinctness many of the more complicated economical workings of society. That is, if you do not understand Say’s Law, you have almost no genuine ability to understand how an economy actually works in the real world.


  That conversation was originally published in the 2016 issue of Man and the Economy, founded by Nobel Prize winning economist Ronald Coase


  [i] Ricardo, David 1951–73. The works and correspondence of David Ricardo, 11 vols. Ed. by P. Sraffa with M.H. Dobb. Cambridge: Cambridge University Press. Vol. II: Notes on Malthus s principles of political economy.

  [ii] Taylor, Fred Manville ([1911] 1925, 9th ed.). Principles of Economics.

  [iii] McCracken, Harlan Linneus 1933. Value theory and business cycles. Binghampton, N.Y.: Falcon Press.

  [iv] F.M. Taylor ([1911] 1925, 9th ed.). Principles of Economics.

  [v] Ibid.

  [vi] Mill, John Stuart [1871] 1921. Principles of political economy with some of their applications to social philosophy, 7th edn. ed. with an introduction by Sir W.J. Ashley. London: Longmans, Green

  [vii] Peden, George C. 1996. “The Treasury View of the Interwar Period: An Example of Political Economy?”, in Unemployment and the Economists, edited by B. Corry, Cheltenham: Edward Elgar

  [viii] Röpke, Wilhelm 1936. Crises and cycles, adapted from the German and rev. Vera C. Smith. London: William Hodge.

  [ix] Sowell, Thomas 1972. Say’s Law: an historical analysis. Princeton N.J.: Princeton University Press.

  [x] Ibid

  [xi] Kates, Steve 1998. Say’s Law and the Keynesian revolution: how macroeconomic theory lost its way. Edward Elgard Publishing Limited.

  [xii] Sowell, Thomas 1972. Say’s Law: an historical analysis. Princeton N.J.: Princeton University Press.

  [xiii] Sowell, Thomas [2000] 2014. Basic Economics: A Common Sense Guide to the Economy. Basic books.

  [xiv] Ibid.

  [xv] Ibid.

  [xvi] Rothbard, Murray 1962. Man, Economy, and State: A Treatise on Economic Principles, 2 vols. New York: D. Van Nostrand.

  [xvii] Rothbard, Murray 1995. Economic Thought Before Adam Smith: An Austrian Perspective on the History of Economic Thought, Volume I. Edward Elgar Publishing Ltd.

  [xviii] Huerta de Soto, Jesús [1998] 2012. Money, bank credit, and economic cycles, Auburn, AL: Ludwig von Mises Institute.

  [xix] McCulloch, J.R. [1864] 1965. The principles of political economy, with some inquiries respecting their application, 5th edn. New York: Augustus M. Kelley.

  [xx] Mill, James [1808] 1966. Commerce defended, 2nd edn. In Winch, Donald (ed.)

  [xxi] Ibid.

  [xxii] Mill, John Stuart [1871] 1921. Principles of political economy with some of their applications to social philosophy, 7th edn. ed. with an introduction by Sir W.J. Ashley. London: Longmans, Green.

  [xxiii] Ibid.

  [xxiv] Ibid

  [xxv] Marshall, Alfred and Marshall, Mary Paley [1879] 1881. The economics of industry, 2nd edn. London: Macmillan.

  [xxvi] Keynes, John Maynard [1936] 2012. The collected writings of John Maynard Keynes. Edited by Donald Moggridge. London: The Macmillan Press Ltd. Vol. VII: The general theory of employment, interest and money.

  [xxvii] Gilder, George [1981] 2012. Wealth and poverty, 2nd edn. Regnery Publishing.

  [xxviii] Ibid.

  [xxix] Becker, Gary and Baumol, William J. 1952. “The classical economic theory: the outcome of the discussion.” Economica, vol. 19, pp. 355–76.

  [xxx] Mill, John Stuart [1871] 1921. Principles of political economy with some of their applications to social philosophy, 7th edn. ed. with an introduction by Sir W.J. Ashley. London: Longmans, Green.

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