Over at Macrobusiness we find the quite accurate statement by Rumplestatskin that “Say’s law seems to be making a resurgence”. He does not regard this as a positive step but nevertheless he does take note that there are a few of us around who seem to look on this development with favour. He even crosses to a post of my own which really only disappoints since nothing I have written seems to make the slightest dent. Such is life.

And to tell the truth I’m not all that keen to get into this yet again. How stupid these people must believe our ancestral economists to have been to make such obvious blunders that even they can see them. The things they say economists used to believe are quite incredible. But I am drawn back in because I received in the post today a book I had ordered that I didn’t even recall having asked for but how wise I was to make the purchase. It is a reprint of John McVickar’s Outlines of Political Economy, the first American text in economics, published in 1825. And the very first bit I read was about value added and the nature of the production process, the very thing I had been teaching my class today, having first noted that nothing like this is found in any textbook of the modern era. Economic theory has so regressed in the past 200 years that we are now more primitive than the mercantilists that Adam Smith used to make fun of. We disguise our ignorance by putting it all into maths.

Mt Statskin, of course, has no idea what Say’s Law is about so goes about comprehensively demolishing a construction of his own devices. But if he is ever to work out what the real meaning is, what he needs to do is recognise that the following two statements are 100% compatible and if you understand Say’s Law, 100% valid:

. a general glut is impossible
. recessions are not uncommon and when they occur last a long time.

Let me therefore quote a bit from Mr McVickar which seems relevant to economics today. Were he to have advised our political leaders it might have been possible to constrain their headlong rush into useless, unproductive spending, and we might have been spared the many years in the wildnerness we are about to endure. This is McVickar writing in 1825 (pages 167-68):

It is a fallacy and an absurdity to suppose that production can ever be encouraged by a wasteful consumption of the products of industry. A man is stimulated to produce when he finds a ready market for the produce of his labour, that is, when he can readily exchange them for other products. And hence the true and only encouragement of industry consists, not in the increase of wasteful and improvident consumption, but in the increase in [value adding] production. (Italics in the original)

Mr Statskin, whose beliefs are as fallacious and absurd as the rest of his crowd, seems to believe that such views represent an “ideology, because these writers cannot translate their beliefs into practice.” Oh but we can. Try this for some practical advice. Governments must reduce their spending, balance their budgets and never attempt to revive an economy from the demand side. Seems practical enough to me but no doubt everything Mr McVickar is trying to explain will fly right over Mr Statskin’s head. But nevertheless, Say’s Law will continue its resurgence whether he likes it or not, whether he understands it or not.

In reply to John Papola’s article on Say’s Law on the PBS News Hour website, there is an article also on PBS by an historian, John Livingston. I will leave John Papola to fight his own battles, but here would be my own response to Professor Livingston, I presume:

I often wonder when the actual events of the world will begin to make some impression on Keynesian thinking but the evidence from what John Livingston had to write makes it seem that such a time is a very long way away. Should we argue theory? Should we argue the empirics? What will make an impression is almost impossible to know since nothing so far has made any dent in present thinking at all.

We are in the midst of the worst recovery since the Great Depression. Employment levels and employment growth are abysmal. The economy is going nowhere, even having contracted in December some four years after the fiscal stimulus was supposed to have done its work. That is all obvious beyond argument and unless Livingston grabs for the it-would-have-been-worse-without-the-stimulus excuse there is really nothing for him to argue so far as the empirics actually go. There has been a stimulus and the economy not only remains extraordinarily subdued but there is a mountain of debt that now needs to be repaid.

But to enter into the realm of Say’s Law is to enter into the world of theory. Say’s Law is an abstract statement about the nature of the world. It says that at the aggregate level, demand is constituted by supply. A community can only buy what it has produced. It is production which simultaneously creates the incomes that are used to buy the output. If you pay people to dig holes and refill them they may have money in their hands but the economy has not produced anything that this money can be used to buy.

Meanwhile those on the Keynesian side argue that the subdued level of economic activity is because people choose to save rather than spend. It’s the saving that’s the problem. If only we had more consumption and government spending to soak up those savings all would be well.

But of course it was not an increase in saving that caused the recession. Whatever else one might say about the Global Financial Crisis and the recession that followed immediately thereafter, it would be implausible in the extreme to argue that the problem was caused by a sudden desire to save. Right up until the financial crisis began economies were in some kind of boom, racing ahead in every direction. There was no lack of demand, consumer or otherwise, when almost overnight the bottom fell out of the boom and a recessionary period began. I just say to Professor Livingston that if he wants to argue that the recession began because of a fall in demand as everyone suddenly decided to start saving instead of spending, he is welcome to try to defend that ground. Nonsensical though the notion may be, he is welcome to try to prove what is obviously untrue.

What did happen was that a boom that had run on speculative investment in housing financed by an excessive creation of credit ran headlong into reality. Lenders found that an increasing number of borrowers could no longer repay their debts and the homes they had bought were falling in value. The housing bubble burst, the industry and all of the feeder industries into the housing market collapsed and the financial system of the world teetered on a knife edge for six months before some kind of stability returned.

The problems were thus in no way due to a fall off in demand but to a problem with the structure of the economy. Vast areas of the American economy suddenly found that the products they were producing could no longer be sold at cost covering prices. If you asked these producers what the problem was, they would no doubt have told you that there had been a fall in demand. But while that would have been how they experienced the problem, that is not that the actual problem was. The problem was that they had been misled into producing a specific form of output – that is, they had been misled into producing housing – that could no longer be sold at prices that covered their production costs. This, of course, also affected the demand for the inputs into the industry, including the demand for labour.

Meanwhile the financial system, whose assets were bound up in an immense volume of mortgage backed securities – covered as hey were by a housing stock that no longer delivered the revenue stream expected and where the underlying assets could no longer be sold at the prices they were originally borrowed against – found their balance sheets quite unbalanced. They could not call in their loans and could not meet their own debt obligations. The world’s entire system of finance then unraveled as loans were withdrawn and finance fell away. We thus experienced a financial panic as described time and again throughout the classical business cycle literature that existed before Keynes wrote his General Theory, a literature which is unfortunately no longer consulted by anyone in trying to think through our present problems. To pretend that the GFC was caused by a fall in demand rather than a structural disaster in both the real and financial sides of the economy is to be utterly blind to reality.

So to come back to Say’s Law. Its most basic statement is that demand is constituted by supply. You must be able to produce, sell and earn money to spend before you can buy. Looked at from an economy wide perspective, there must be an increase in real value adding production before the real level of demand can increase. But as the level of value adding production contracted during the GFC, the real level of demand also contracted. To describe this as decisions to save would be ridiculous.

A Keynesian would, nevertheless, insist that the problem was too little demand and would therefore argue that the answer to a problem that had been caused by a fall off in value adding production would be even more non-value adding production. A classical economist on the other hand would argue that since the problem was the fall in value adding production, the only solution was to increase the level of value adding output through a shift in the structure of production away from activities that were no longer profitable towards others which were. Not an instantaneous process by any means, but a year or so would have seen recovery well in place had policies been adopted to encourage the private sector to look for and expand value adding forms of production.

But instead we had the stimulus which consisted of nearly a trillion dollars worth of unproductive expenditure that could only make things worse and of course did. There were also efforts made to hamstring the financial sector in its efforts to redirect savings into productive enterprises. And there were – and still are – efforts being made to raise taxation on just those businesses you need to encourage growth. Every one of these policy decisions is guaranteed to slow recovery, and so far as the economic direction of the United States is concerned there has not been a single major policy put in place that will hasten recovery.

Even low interest rates, which are supposed to encourage investment – another demand side solution – merely misdirects those savings that are generated while at the same time keeping the level of saving lower than it would otherwise have been. The one certainty with interest rates near zero is that there will be less saving than there would have been had rates been higher. Less saving inevitably means a lower standard of living.

So to consumer demand and recovery. Livingston’s argument puts the consumption cart before the production horse. To doubt that people would spend more if they could afford more is ridiculous. The cause of low consumer demand is low real incomes. The cause of low real incomes is the absence of growth in value adding areas of production in which people can be hired and earn an income.

That we are in the hands of someone with only a limited understanding of how an economy works when dealing with Livingston is shown by his use of the phrase “surplus capital”. You almost have to cringe at reading such words. The notion that there is capital that their owners would not happily see put to use if the risks were commensurate with the expected returns is quite astounding. To think in such terms is almost to have a death wish for the future of the American economy. There is never enough capital. Surplus capital is never a realistic problem – if only it were. There are always more things you can produce that others would gladly buy if they could afford them when they reached the market. To believe instead, as he seems to do, that there is a mass of capital being left to lie fallow that could not find a productive purpose if economic momentum were again restored is bizarre given just how desperate the unemployment situation is.

Livingston’s plain ignorance of Say’s Law as it was stated by the classical economists is painful to read. To act as if they had argued people were living in a barter economy without money is such a colossal evidence of a failure to have read anything at all about classical views is par for the course in modern economic discourse but is still a disgrace. If you want to discuss Say’s Law it helps to at least understand something about what classical economists actually said and not parrot the inanities spread by Keynes. Let me therefore take you to Say’s first statement of Say’s Law published in 1803 and we’ll see whether he was discussing a barter economy:

“It is not the abundance of money but the abundance of other products in general that facilitates sales. . . . Money performs no more than a conduit in this double exchange. When the exchange has been completed, it will be found that one has paid for products with products.” (Say 1803, quoted in Kates 1998: 23)

Products buy products through the intermediation of money. Demand is constituted by supply. One’s own products or one’s labour time are exchanged for sums of money and then the money received is exchanged for other products. Livingston’s conclusion, that “consumer spending rather than investment seems to be the key to growth,” is no more sound or coherent than his view that Say’s Law ignored money.

Classical economists understood something that modern economics does not. They understood that you cannot drive an economy from the demand side, only from the supply side. Consumption is the payoff from value adding production. If you want growth and employment, then you need to increase the level of value adding production first. To believe anything else, and to try to make an economy succeed in any other way, is the very fallacy that is creating the enormous economic problems that now exist, problems that will never be fixed unless unproductive public spending is reduced and value adding private sector production returns in its place. That is the conclusion that Say’s Law tries to explain. It is the great tragedy of modern economics that Say’s Law has disappeared as a guide to policy because without it we will surely continue to drive our economies into the ground in the belief that we are doing ourselves some economic good. That we are not doing so should have become very evident by now to all by those who are willfully blind to the dismal economic reality that is now found everywhere you turn.

An article by John Papola – you know, the chap who did the Macro Follies video and the Keynes-Hayek Rap – on the impossibility of consuming one’s way to prosperity. He has taken Say’s Law to places it has never been before, in this case into the PBS News Hour in the US. Many great observations but I will restrict myself to this:

As John Stuart Mill put it two centuries ago, ‘the demand for commodities is not the demand for labor.’ Consumer demand does not necessarily translate into increased employment. That’s because ‘consumers’ don’t employ people. Businesses do.

Since new hires are a risky and costly investment with unknown future returns, employers must rely on their expectations about the future and weigh those decisions very carefully. Economic historian Robert Higgs’ pioneering work on the Great Depression suggests that increased uncertainty can depress job growth even in the face of booming consumption. Consumer demand that appears to be driven by temporary or unsustainable policies is unlikely to induce businesses to hire.

Increased investment drives economic growth, while retrenched investment leads to recession and reduced employment — and it always has. John Maynard Keynes, like most business cycle theorists before him and since, paid particular attention to this boom and bust in investment, blaming volatility on the ‘animal spirits’ of businessmen. This observation about the importance of ‘confidence’ is surely true, if somewhat obvious.

Unfortunately, Keynes and his successors focus on aggregate levels of spending and often explicitly disregard the details of how money is spent and resources are employed. This led him and the profession down a dark road to the defunct underconsumptionist ideas of the early 1800s which haunt us to this day. Keynes repeatedly asserts throughout his famous tome, The General Theory, that even wasteful expenditures could increase the wealth of society.

Is it any wonder that so many of our policies are focused on consuming and sometimes even destroying wealth rather than creating it?

Do you ever wonder whether the mainstream economic establishment will ever begin to wonder whether this theory they have been peddling for three quarters of a century may be wrong.

I have an article at Mises Daily today with the title, “The Errors of Keynes’s Critics”. I wrote it in reply to an article published a few weeks ago with the title, The Errors of Keynes. Goodness knows there are enough of such errors and it is a blessing to find someone else taking the Keynesian apparatus on. But if it is to be done, it needs to be done with care, and if you are going to invoke Say’s Law as this article did, it is essential in my view to get the central point right. The problem with this critque of Keynesian economics, which was a review of a book written in Spanish by Juan Ramón Rallo which had made the same points, was that it used Keynesian arguments as a means to refute Keynes. What I wrote was this:

Rallo thus attempts to controvert Keynes by confirming everything he wrote. People really do hoard, Rallo argues, and store money rather than spend. There really is a deficiency of demand in the short-to-medium term that may finally work itself out in the long run, in three-to-five years perhaps. Overproduction is impossible, but only ‘ultimately,’ and in the meantime it can occur. Involuntary unemployment does apparently occur because of some problem on the demand side of the economy due to hoarding. However, rather than this deficiency of demand being a bad thing, it’s a good thing, since the hoarding allows business to think about what to do next.

All very well, but as I pointed out, if you are Keynesian such as Krugman, once you agree that demand deficiency is a problem and people actually do hoard then it also licenses the government to come to the rescue with a stimulus package that will short-circuit the time period between income earned and income spent. Here is not the place to explain what’s wrong with the argument, but that there is something wrong with the theor is a conclusion that ought to have become more evident with each passing day as we bear witness to the immense damage the stimulus has caused. My conclusion:

If you want to get to the essence of Say’s Law you must never think in terms of aggregate demand and aggregate supply. Just drop it from all conceptual discussions of the economy and I think, although I can’t be sure, you will find yourself necessarily thinking about issues in the same way as the Classical economists. As I have argued in my Say’s Law and the Keynesian Revolution (Elgar 1998), if you want to defeat Keynesian economics, you need to wage war on the very notion of aggregate demand. Nothing else will do.

Really, nothing else will do. There are austerity packages in place but they are half-hearted and uncertain. There is little serious understanding of the economics that lies beneath the need to eliminate unproductive public spending if recovery is going to take hold. Maybe there is some other way to think it through and reach not just the right conclusions but also allow policy makers to explain with confidence why what they are doing needs to be done. Maybe. But to me unless you war on the very idea that demand for anything at all can help move an economy out of recession, I do not see how this Keynesian blight can ever be removed.

And let me finally express my gratitude to the editors at Mises Daily. Not everyone is as open to such discussions as they have very clearly shown themselves to be.