A Rebuttal of Say’s Law

This blog is in response to Free Market Economics: an Introduction for the General Reader and its comments.  Who knew I had another post in me?  The blog post says:

A book dealing with macroeconomic issues without a discussion of aggregate demand will be a novelty

David Leyonhjelm asks the pertinent question:

…but I thought aggregate demand was a fundamental economic principle…Do I need to read your book to understand, or is it simple to explain?

To which another commenter answers: “Say’s Law“.

I began to type the following as a comment in reply to the blog post:

Say’s Law says supply creates its own demand, right?

According to latest statistics with  five per cent (5%)  unemployed, broadly speaking twelve percent (12%) underemployed and according to the way the statistics are taken in Australia, you only count as unemployed if your looking for a job – that is if you actually want one.  That is to go through the rigmarole of seeking-work tests according to legislation.

Today’s Labour Force figures shows unemployment static – so either you’re calling roughly 1.4 million Australians a liar or Say’s Law is wrong.  Otherwise there would  be jobs for them after all supply creates its own demand.

And if there is  no aggregate demand than there is no fallacy of composition (paradox of thrift) either?

Empirical evidence doesn’t seem to win that argument either as Europe and the United States of America shows in the case of each of their respective economies.

If no one is spending, no one is selling, which means jobs are lost and unemployment rises.

Of course you could counter argue that labour is not a product or a commodity. After all, products are paid with products.  However, the treatment of labour as buffer stock as has been done with diamonds, wool, copper, says otherwise.  All have been price stabilisation mechanisms just as a buffer stock of the commodity known as labour is an attempt to control the mythical NAIRU.

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11 responses to “A Rebuttal of Say’s Law

  1. The basic idea behind Say’s Law predates JB Say.

    In fact, Wealth of Nations (Chapter III. Of the accumulation of capital, or of productive and unproductive labour) contains a clear foretaste for what would later be known as Say’s Law.

    Smith was discussing his theory of capital accumulation. For Smith, the foremost feature of an economy was its capacity to grow, to produce surplus (i.e. outputs in excess of inputs). But, why do capitals grow?

    “Capitals are increased by parsimony, and diminished by prodigality and misconduct.

    “Whatever a person saves from his revenue he adds to his capital, and either employs it himself in maintaining an additional number of productive hands, or enables some other person to do so (…).”

    So, savings was, in Smith’s view, what makes capital grow (i.e. to accumulate): what’s not consumed, is saved.

    However, “what is annually saved, is as regularly consumed as what is annually spent, and nearly in the same time too: but it is consumed by a different set of people. That portion of his revenue which a rich man
    annually spends, is, in most cases, consumed by idle guests and menial servants, who leave nothing behind them in return for their consumption. That portion which he annually saves, as, for the sake of the profit, it is immediately employed as a capital, is consumed in the same manner, and nearly in the same time too, but by a different set of people: by labourers, manufacturers, and artificers, who reproduce, with a profit, the value of their annual consumption.”

    So, in Smith’s view, there were only two uses for profits: (1) investment, funded by savings; (2) idle consumption.

    Whether invested or consumed, profits are used to pay for labour, goods and services, but money invested goes to increase production; thus, the labour involved is said to be productive. So, you see why the chapter referred to unproductive and productive labour (i.e. labour employed to increase production).

    If idle consumption were excessive, there would be little left for investment, and the economy would not grow.

    However, are there just two uses for profit? What about hoarding?

    Smith apparently would have answered that hoarding was always, invariably, irrational and, thus, outside economic theorizing.

    But if in Smith the answer can be only inferred, in Say (A Treatise in Political Economy, Book I, Chaper XV) it is given explicitly:

    “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.”

    That’s why Say considered “that it is production which opens a demand for products”: “money performs but a momentary function in this double exchange; and when the transaction is finally closed, it will always be found, that one kind of commodity has been exchanged for another.”

    So, for Say it was out of the question that a producer would hoard produce: it was perishable and could lose value. It was also out of the question to hoard money: it could devalue.

    Unlike some critics claim, Say was not literally talking about a barter economy. He considered a monetary economy. In practice, however, this monetary economy acted like a barter economy, because it was irrational to hold money balances: money (and stocks of goods) was hot potatoes, and no one wants to hold a hot potato for long.

    Now, let’s go back to Smith and ask yourself this question: aren’t seemingly rational investors currently hoarding gold, silver and sundry commodities? See here: Gold as an Investment. Wikipedia. http://en.wikipedia.org/wiki/Gold_as_an_investment

    The money people employ in this kind of speculation is not generating any additional production (i.e. is not investment in the sense Smith considered) and is not being consumed. If it isn’t invested or consumed, isn’t it simply hoarded? Aren’t these investors hoarding claims on produce?

  2. Hola – I incorporated your ideas into my issuer-user paradigm. Let me know what you think DollarMonopoly.com

  3. The key piece you seem to be missing is “price.”

    Here is Say’s Law:

    It is worthwhile 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 creation of one product immediately opens a vent for other products.

    Notice the qualification he adds to the end of the first sentence: “to the full extent of its own value.”

    So, for example, it would not be correct to build a thousand broken bicycles (which presumably have no value to anyone because they’re BROKEN — we’re assuming for purposes of the discussion they have no scrap or artistic value, either) and then say, “Well, I built all these broken bicycles and whaddayaknow, my supply doesn’t seem to be creating any demand! Say’s Law is broken.”

    The reason is because the bicycles have no value to anyone else in exchange.

    Now, let’s say you build a thousand bicycles (not broken) and you can’t get any buyers still. You quickly shout, “A ha! Say’s Law is broken (again)!”

    But wait. What price are you charging for the bicycles?

    Markets clear. If prices are allowed to adjust, you will be able to liquidate your supply. Perhaps not at the price you would’ve liked, but you can do it (if people value bicycles at a certain money/barter exchange rate). The key is figuring out the market clearing exchange rate.

    This is what Say is referring to when he says “to the full extent of its value.” Something may have no value at any price whatsoever (broken bicycle) or it might have value only when priced a particular way (overpriced bicycle).

    Now, let’s examine your empirical “rebuttal” of Say’s Law regarding mass unemployment. Left unexamined in your analysis is, “What price are people charging [or can they legally charge] for their labor, and what price are employers offering [or can they legally charge]?”

    There may be many things preventing this labor market from clearing. One obvious one to provide an example with would be a minimum wage. If the minimum wage in the area is legally dictated at $10/hr, but no employer is willing to hire anyone at more than $9/hr, then there will be many individuals who will not be able to find employment because wages can not adjust to reflect the “full extent of the value” of the labor they’re willing to supply.

    And what is that labor worth, you might ask? Well, that’s up to the two willing parties in the transaction, the potential employee and the potential employer, to agree to on their own. It’s not up to the government. Value is subjective.

    • Prices are left unexamined because they’re discussed in the link posts about buffer stocks and job guarantees. Surely we all value more people employed than unemployed. Public Works programs in the aftermath of World War II show it can be done.
      I think you’ll find unemployment quite low in a few Scandinavian countries and Australia compared to the US. The former two having a high min. wage in comparison.
      Thanks for your reply.

  4. Forget I mentioned it. If you see no qualitative difference between producing something you value (or producing something in order to exchange for something you value) and simply stealing that which you “value”, I can’t be of any help here.

    Good luck!

    • I do not accept theft in any form.

      • Senexx,

        I define theft as “the use of force by one individual to acquire the goods and/or services of another individual.” It is the opposite of a voluntary exchange, in which two individuals mutually agree to an exchange of values. Theft is characterized by one individual giving up their property to another without granting permission.

        Governments acquire resources differently than (non-criminal) individuals do. Whereas individuals must produce that which they value, or else produce something in order to voluntarily exchange it with another for something they value, government simply takes. The punishment for resisting government taking is violence (fines, then prison, then death– coercion all). Therefore, government acquires its resources via theft.

        In your example with Public Works Programs and Scandinavian governments, for example, the resources with which these government actors seek to create employment are stolen from others. The governments do not produce anything themselves which they then use to employ people. Other individuals produce the wealth and then the government appropriates it.

        It is not correct to claim that the enacting of a Public Works or other government program is a demonstration of individuals or the public “valuing” employment, because the resources expended on these programs are not expended in a voluntary manner. We can only determine what a person values by examining, ex post, a voluntary action or exchange.

        Observing the government taking from one group to redistribute to another via a government program is not a demonstration of “value”, just as it wouldn’t be a demonstration of value if I broken into somebody’s Ferrari and took off down the street. It would be nonsensical in an economic sense to observe my carjacking and say, “Clearly, Taylor values a Ferrari quite a bit!” Not only did I not exchange for this good nor do any work to produce it, but it was TAKEN from someone who did– what I gained, they lost. That person does not “value” having their Ferrari stolen.

        I hope that makes sense.

  5. @Senexx and Taylor,

    For what’s worth, I believe Taylor has got things wrong here:

    “Now, let’s say you build a thousand bicycles (not broken) and you can’t get any buyers still. You quickly shout, ‘A ha! Say’s Law is broken (again)!’

    “But wait. What price are you charging for the bicycles?

    “Markets clear. If prices are allowed to adjust, you will be able to liquidate your supply. Perhaps not at the price you would’ve liked, but you can do it (if people value bicycles at a certain money/barter exchange rate). The key is figuring out the market clearing exchange rate.”

    The problem with this defense is that by assuming on an a priori basis that markets clear (as it was done here) it seems we are also assuming that Say’s Law is valid, which means that markets clear, which means that Say’s Law is valid… But I am sure you both get the idea.

    Further, that defense ignores the idea that hoarding (even after market cleared, if it did clear) is either not necessarily irrational, or producers are not necessarily rational: you sold your 1,000 good bykes, but you kept the profit realized, instead of investing it in producing 1,100 new good bykes.

  6. And speaking of hoarding money:

    “As the government struggled to reach an agreement on raising the debt ceiling, the US Treasury’s cash balance fell to $US74 billion this week. That’s less than the $US76 billion that Apple now has in cash.

    (…)

    “Still, Apple’s reasons for keeping such a giant cash stockpile may well be related to worries about the stability of the US government’s finances.”

    David Sarno. “Apple has more cash than US government”. August 1, 2011. SMH.

    http://www.smh.com.au/technology/biz-tech/apple-has-more-cash-than-us-government-20110801-1i6x6.html#ixzz1TjPvkdPY

  7. I read the author’s synopsis and of course the final lines about property rights.

    If the book was a sliced loaf sandwitch then missing out Marx, Keynes, Minsky and others as filling leaves only bread that sticks to your teeth.

    And it would take more than spam from rentiers to make me swallow.

  8. “Say’s Law says supply creates its own demand, right?”

    Wrong. Say’s Law does not state that producing apples creates demand for apples (i.e. supply creates its own demand). It states that producing apples allows the producer of the apples to demand other goods and services to the extent the apples are considered desirable by others.

    To put it another way, the wrong version (supply creates demand) is as follows: If Smith makes something, Jones will automatically demand it. Supply by Smith creates demand by Jones. Patently absurd.

    The correct versions is in fact this: If Smith makes something marketable, that gives Smith the power to demand things from Jones, because Smith has something to offer in exchange. Supply by Smith creates demand by Smith. This is patently true.

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