One of my regular readers has raised the important subject of Say’s law, the denial of which both Keynesian and modern monetarists are emphatic. They need this fundamental axiom to be untrue to justify state stimulation of aggregate demand. Either Say’s law is right and state intervention is economically disruptive, or if it’s wrong modern economists are right to ignore it and progress their science beyond it.

The basis of post-Keynesian economic stimulation assumes a breakdown between consumption and production can occur, and the correct response is for government to step in and revive failing demand. It is the favoured explanation of the 1930s slump. Obviously, Say’s law would have to be discarded.

This article revisits this subject, explains where Keynes went wrong, redefines the law to include money as a good, and explains why supply-side is less destructive than demand management. Say’s law is crucial to understanding why increasing state intervention to revive economic demand cannot work, and has led us into the current crisis.

A little history

Say’s law was first credited to the French businessman and economist, Jean-Baptiste Say, who wrote in the early-1800s, that:

“It is worth-while to remark, that a product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus, the mere circumstance of the creation of one product immediately opens a vent for other products.”[i]

The circumstances behind Say’s knowledge are worth recalling. He not only lived through the French revolution and the Napoleonic wars, but he also experienced not one, but two hyperinflationary money collapses, first assignats, and then mandats. France had also suffered the collapse of John Law’s paper money in 1720. Therefore, Say was very much aware that money can be highly perishable, and he will have observed that people used it only as the temporary bridge between their production and their consumption. Hence the context in this quote about getting rid of money.

Say’s law does not require conditions of a gold standard or sound money, as some might think. It is a fundamental tenet of all humanity that their economies are characterised by the division of labour, the condition behind the law. The market is a loose term for exchanges of goods and services generally, which is why Say’s law is sometimes referred to as the law of the markets, but it should be noted that it even applies in a command economy that supresses personal freedom.

The first attempt to escape from the straight-jacket of Say’s law was by Malthus in his Principles of Political Economy (1820). That was successfully refuted by David Ricardo and others, so Say’s law became widely accepted thereafter. The one economist who eventually overturned it to the satisfaction of his followers was Keynes, and indeed the whole of his General Theory[ii] depended on Say’s law being disproved. Keynes faced up to this reality and attacked it early on in his book, dismissing it in about four pages (Chapter 3.1).

Keynes’s assumptions

Keynes first attacked Say’s law indirectly in what he called the classical theory of employment, which he said was based on two postulates. The first was the wage is equal to the marginal product of labour, and the second, that the utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment. But the veracity, or otherwise, of these statements has nothing to do with Say’s law. What Keynes did was take us off at a tangent to avoid addressing the central issue by addressing a different subject.

When we get onto his next subject, the principal of effective demand (Chapter 3.1), he then concludes his attack by claiming that,

“Thus Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment.”

This wholly misrepresents Say’s law. It was not about aggregate demand price of output, aggregate supply price for all volumes of output, or even employment. Keynes put up a straw man to knock it down. It is appropriate to restate what Say’s law really means for absence of all doubt, in language a child can understand and an ivory-tower economist cannot deny. Here is my modified version:

“In every transaction, there is a buyer and seller. Therefore, an economy must be comprised equally of buyers and sellers. Money is a commodity that facilitates their transactions, and it allows them to sell their goods, services and labour to buy other things. The quantity of money is irrelevant to this iron law, because it is a functional good just like anything else that’s bought and sold”

It is factual. Note that my modified definition includes money as an economic good, whereas Say’s original did not, but its inclusion does not invalidate his law. If anything it strengthens it by making it clear there are no exceptions. Say’s treatment of money, as something to be disposed of quickly, would certainly have been true in his lifetime. This overlooks the fact that money itself has a use-value, in the same way as any other economic good, in this case representing the temporary storage of effort and labour.

It also makes a nonsense of Keynes’s simplistic description of Say’s law, which excludes money entirely. However, under normal circumstances, the public’s holdings of physical cash are stable in aggregate, meaning that the non-cash element of the economy can be regarded as a pass-through of product into consumption. The circumstances where this might change are actually quite limited, with people opting instead to increase bank balances instead of physical cash in the event of an economic downturn. And bank balances, of course, are recycled to borrowers who will spend it. If that doesn’t happen it is a banking or commercial problem, usually arising from the destruction of false credit, and not a problem with Say’s law.

Demand versus supply management

There is a fundamental difference between goosing the economy by stimulating demand, which was Keynes’s approach, and stimulating supply. Stimulating demand by monetary inflation may have a temporary beneficial effect, which is reversed over the credit cycle. Monetary inflation aimed at getting people to spend more amounts to fooling all of the people, which as the adage goes, you can’t do all of the time.

Attempts to do so end up setting off a credit-induced business cycle, where boom is followed by bust. The boom is the people being fooled, and the bust the realisation they have been taken for suckers. While governments can play these games and demonstrate that at one part of the credit cycle they have stimulated consumption and that therefore Say’s law appears invalid, taken over the whole cycle Say’s law turns out to be valid after all.

These repetitive interventions have never been abandoned since Keynes’s day, despite post-war economists insisting that they are improving their economic understanding and management of demand over time. It is these same economists who refuse to reconsider their denial of Say’s law. It is now no longer a realistic option for them, because the economic consequences of re-embracing the law are now likely to collapse the entire financial system as a deliberate act of policy.

Alternatively, stimulating production by government spending works with Say’s law, and not against it, because the state clearly becomes a customer of the private sector. The transfer of goods is from producers to government as a consumer. We can question the wisdom of government spending, and the assumption that it is a good deployment of national resources. We can criticise make-work programmes and the bridges to nowhere, and we know that what is often referred to as supply-side policies is flawed on other grounds. But as a means of economic intervention it is preferable to attempts to manage demand, if only on the basis it does not conflict with Say’s law.

Supply-side policies on their own do not automatically lead to a credit-induced business cycle, while with demand management this outcome is virtually guaranteed. But it does raise the question of a Plan B, and how the government can reduce involvement in infrastructure, defence spending and similar interventions without adverse consequences. But that is a matter beyond Say’s law.

Further implications

It should be much clearer from my simplified definition of Say’s law that the task of denial Keynes set himself was impossible, and that the whole basis of his new economics is built on a fundamental fallacy, on what amounts to a denial of the unquestionable fact that in every transaction there is a buyer and a seller, and the implications that follow. It goes without saying that a properly functioning economy depends on buyers and sellers being genuine, the goods as described and the money paid in exchange, acceptable. Having established that point, we can move on to the implications for further clarification, which can be summarised in the following propositions.

1. We produce goods and services we may consume ourselves, and the surplus we will sell to others, to enable us to acquire the things we do not produce.
2. We need not consume any of our own production, but can sell it all to others, so that we may acquire the goods and services we need or desire.
3. Consumption includes deferred consumption, and the portion that is deferred is irrelevant to the law, because the proceeds of production are spent by someone else.
4. Money does not need to be involved, and the law covers barter as well.
5. Anyone who acquires goods and services from others, without producing something to pay for it, must acquire the wherewithal from someone else, who has produced goods and services in excess of his own consumption.
6. Say’s law applies to all economic actors, including the state.

These propositions should be self-evidently true. To amplify on Proposition 6, it is worth noting that Say’s law also applies in a command economy as much as in a market economy. If the state acts as the channel for the production and distribution of goods, it cannot get away from the fact that state-directed production is bound by Say’s law, just as much as the free market, because the state cannot override the reality of the division of labour.

Keynes may have been aware of his contradictions, because he shifted his attack to savers for withholding their consumption. Spending is not withheld (Proposition 3 above), because money saved is recycled through the financial system to someone else who borrows it to spend. The money is spent on other things, that is all.

Post-Keynesian consequences

By taking one subset of the economy, employees and their role in it, Keynes ignores the law’s wider application. Without this artifice, he would have been unable to separate aggregate demand from aggregate consumption, and therefore claim conditions where aggregate demand was insufficient for potential supply. At its root, this was his explanation for the great depression of the 1930s, and his underlying motivation for writing his General Theory. As mentioned earlier, he falsely argued that if Say’s law was valid, there could not have been mass unemployment at that time.

We have already addressed Keynes’s assumption that Say’s law is about employment or the lack of it. The reason for the mass unemployment in the 1930s had nothing to do with Say’s law, and the cause lies elsewhere. It was the natural consequence of credit expansion in the previous decade. However, total consumption obviously declined, but so did total supply. Even though statistical measuring can never capture the complete picture, the evidence was that Say’s law remained true throughout that time of massive unemployment.

The unemployed it was true, were in straitened circumstances, but they were never absent from the economy, as Keynes implied (see Proposition 5 above). They still spent what little that came their way. Soup kitchens and similar gifts of necessities were produced and consumed without money (Proposition 4). Charity is the process by which the proceeds of production of one sort or another are distributed for consumption by the poor (Proposition 5 again). Equally, distributions of welfare by the state (Proposition 5) are funded from the production of others through taxation and monetary debasement. Always, the transfer from production to consumption applies, with or without money.

Mainstream economists today who deny the truth enunciated by Say live in cloud-cuckoo land. The truth, exposed by Hayek who knew him personally, is that Keynes actually knew little about economics.[iii] His General Theory, on Hayek’s evidence and the analysis in this article, amounts to an enormous hoax, which the establishment has embraced because of its promise. The political class has been fully taken in, seeing it as a life-line justifying positive economic intervention by the state. Mainstream economists see it as justification for their employment as more and more papers are written to justify Keynesian and monetary economics in the face of gathering negative evidence.

It is particularly sad that France has turned its back on Say’s wisdom, along with her other remarkable nineteenth century French economists, opting instead for a lethal cocktail of Marx and Keynes.

Denying the reality of Say’s law became the foundation for government and central bank policies of today, worldwide. In that denial lies the principal reason these policies are demonstrably failing.

i A Treatise on Political Economy – J-B Say, 1803, translated by CR Princep, 1855. http://www.econlib.org/library/Say/sayT15.html

ii The General Theory of Employment, Interest and Money, Keynes 1936.

iii See Hayek’s interview with Leo Rosten, September 1975. https://www.youtube.com/watch?v=y8l47ilD0II