Man and the Economy

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  Steven 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.

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