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In classical economics, Say's law, or the law of markets, is the claim
that the production of a product creates demand for another product by
providing something of value which can be exchanged for that other product. So,
production is the source of demand. In his principal work, A Treatise on
Political Economy (Traité d'économie politique, 1803),
Jean-Baptiste Say wrote: "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." And also, "As each of us can only purchase the productions of
others with his own productions – as the value we can buy is equal to the
value we can produce, the more men can produce, the more they will
purchase." Some say that Say further argued that this law of markets
implies that a general glut (a widespread excess of supply over demand) cannot
occur. If there is a surplus of one good, there must be unmet demand for
another: "If certain goods remain unsold, it is because other goods are
not produced." However, according to Petur Jonsson, Say does not claim a
general glut cannot occur and in fact acknowledges that they can occur. Say's
law has been one of the principal doctrines used to support the laissez-faire
belief that a capitalist economy will naturally tend toward full employment and
prosperity without government intervention.
Over the years, at least two objections to Say's law have been raised: General
gluts do occur, particularly during recessions and depressions. Economic agents
may collectively choose to increase the amount of money they hold, thereby
reducing demand but not supply. Say's law was generally accepted throughout the
19th century, though modified to incorporate the idea of a
"boom-and-bust" cycle. During the worldwide Great Depression of the
1930s, the theories of Keynesian economics disputed Say's conclusions. Scholars
disagree on the question of whether it was Say who first stated the principle,
but by convention, Say's law has been another name for the law of markets ever
since John Maynard Keynes used the term in the 1930s.
History Say's formulation:
Say argued that economic agents offer goods and services for sale so that they
can spend the money they expect to obtain. Therefore, the fact that a quantity
of goods and services is offered for sale is evidence of an equal quantity of
demand. Essentially Say's argument was that money is just a medium, people pay
for goods and services with other goods and services. This claim is often
summarized as "supply creates its own demand", although that phrase
does not appear in Say's writings. Explaining his point at length, he wrote: 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. Say further argued
that because production necessarily creates demand, a "general glut"
of unsold goods of all kinds is impossible. If there is an excess supply of one
good, there must be a shortage of another: "The superabundance of goods of
one description arises from the deficiency of goods of another
description." To further clarify, he wrote: "Sales cannot be said to
be dull because money is scarce, but because other products are so. ... To use
a more hackneyed phrase, people have bought less, because they have made less
profit." Say's law should therefore be formulated as: Supply of X creates
demand for Y, subject to people being interested in buying X. The producer of X
is able to buy Y, if his products are demanded. Say rejected the possibility
that money obtained from the sale of goods could remain unspent, thereby
reducing demand below supply. He viewed money only as a temporary medium of
exchange. 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.
Early opinions:
Early writers on political economy held a variety of opinions on what we now
call Say's law. James Mill and David Ricardo both supported the law in full.
Thomas Malthus and John Stuart Mill questioned the doctrine that general gluts
cannot occur. James Mill and David Ricardo restated and developed Say's law.
Mill wrote, "The production of commodities creates, and is the one and
universal cause which creates, a market for the commodities produced."
Ricardo wrote, "Demand depends only on supply." Thomas Malthus, on
the other hand, rejected Say's law because he saw evidence of general gluts. We
hear of glutted markets, falling prices, and cotton goods selling at Kamschatka
lower than the costs of production. It may be said, perhaps, that the cotton
trade happens to be glutted; and it is a tenet of the new doctrine on profits
and demand, that if one trade be overstocked with capital, it is a certain sign
that some other trade is understocked. But where, I would ask, is there any
considerable trade that is confessedly under-stocked, and where high profits
have been long pleading in vain for additional capital? John Stuart Mill also
recognized general gluts. He argued that during a general glut, there is
insufficient demand for all non-monetary commodities and excess demand for
money. When there is a general anxiety to sell, and a general disinclination to
buy, commodities of all kinds remain for a long time unsold, and those which
find an immediate market, do so at a very low price... At periods such as we
have described... persons in general... liked better to possess money than any
other commodity. Money, consequently, was in request, and all other commodities
were in comparative disrepute... As there may be a temporary excess of any one
article considered separately, so may there of commodities generally, not in
consequence of over-production, but of a want of commercial confidence. Mill
rescued the claim that there cannot be a simultaneous glut of all commodities
by including money as one of the commodities. In order to render the argument
for the impossibility of an excess of all commodities applicable... money must
itself be considered as a commodity. It must, undoubtedly, be admitted that
there cannot be an excess of all other commodities, and an excess of money at
the same time. Contemporary economist Brad DeLong believes that Mill's argument
refutes the assertions that a general glut cannot occur, and that a market
economy naturally tends towards an equilibrium in which general gluts do not
occur. What remains of Say's law, after Mill's modification, are a few less
controversial assertions:
In the long run, the ability to produce does not outstrip the desire to
consume. In a barter economy, a general glut cannot occur. In a monetary
economy, a general glut occurs not because sellers produce more commodities of
every kind than buyers wish to purchase, but because buyers increase their
desire to hold money. Say himself never used many of the later, short
definitions of Say's law, and thus the law actually developed through the work
of many of his contemporaries and successors.
The work of James Mill, David Ricardo, John Stuart Mill, and others evolved
Say's law into what is sometimes called law of markets, which was a key element
of the framework of macroeconomics from the mid-19th century until the 1930s.
The Great Depression:
The Great Depression posed a challenge to Say's law. In the United States,
unemployment rose to 25%. The quarter of the labor force that was unemployed
constituted a supply of labor for which the demand predicted by Say's law did
not exist. John Maynard Keynes argued in 1936 that Say's law is simply not
true, and that demand, rather than supply, is the key variable that determines
the overall level of economic activity. According to Keynes, demand depends on
the propensity of individuals to consume and on the propensity of businesses to
invest, both of which vary throughout the business cycle. There is no reason to
expect enough aggregate demand to produce full employment.
Today Steven Kates, although a proponent of Say's Law, writes: Before the
Keynesian Revolution, [the] denial of the validity of Say's Law placed an
economist amongst the crackpots, people with no idea whatsoever about how an
economy works. That the vast majority of the economics profession today would
have been classified as crackpots in the 1930s and before is just how it is.
Keynesian economists, such as Paul Krugman, stress the role of money in
negating Say's law: Money that is hoarded (held as cash or analogous financial
instruments) is not spent on products. To increase monetary holdings, someone
may sell products or labor without immediately spending the proceeds. This can
be a general phenomenon: from time to time, in response to changing economic
circumstances, households and businesses in aggregate seek to increase net
savings and thus decrease net debt. To increase net savings requires earning
more than is spent—contrary to Say's law, which postulates that supply
(sales, earning income) equals demand (purchases, requiring spending).
Keynesian economists argue that the failure of Say's law, through an increased
demand for monetary holdings, can result in a general glut due to falling
demand for goods and services. Many economists today maintain that supply does
not create its own demand, but instead, especially during recessions, demand
creates its own supply. Paul Krugman writes: Not only doesn't supply create its
own demand; experience since 2008 suggests, if anything, that the reverse is
largely true -- specifically, that inadequate demand destroys supply. Economies
with persistently weak demand seem to suffer large declines in potential as
well as actual output. Olivier Blanchard and Larry Summers, observing
persistently high and increasing unemployment rates in Europe in the 1970s and
1980s, argued that adverse demand shocks can lead to persistently high
unemployment, therefore persistently reducing the supply of goods and services.
Antonio Fatás and Larry Summers argued that shortfalls in demand,
resulting both from the global economic downturn of 2008 and 2009 and from
subsequent attempts by governments to reduce government spending, have had
large negative effects on both actual and potential world economic output. A
minority of economists still support Say's Law. Some proponents of the
heterodox Austrian school of economics maintain that the economy tends to
full-employment equilibrium, and that recessions and depressions are the result
of government intervention in the economy. Some proponents of real business
cycle theory maintain that high unemployment is due to a reduced labor supply
rather than reduced demand. In other words, people choose to work less when
economic conditions are poor, so that involuntary unemployment does not
actually exist.
While economists have abandoned Say's law as a true law that must always hold,
most still consider Say's Law to be a useful rule of thumb which the economy
will tend towards in the long run, so long as it is allowed to adjust to shocks
such as financial crises without being exposed to any further such shocks. The
applicability of Say's law in theoretical long-run conditions is one motivation
behind the study of general equilibrium theory in economics, which studies
economies in the context where Say's law holds true.
Consequences :
A number of laissez-faire consequences have been drawn from interpretations of
Say's law. However, Say himself advocated public works to remedy unemployment
and criticized Ricardo for neglecting the possibility of hoarding if there was
a lack of investment opportunities.
Recession and unemployment:
Say argued against claims that businesses suffer because people do not have
enough money. He argued that the power to purchase can only be increased
through more production. James Mill used Say's law against those who sought to
give the economy a boost via unproductive consumption. In his view, consumption
destroys wealth, in contrast to production, which is the source of economic
growth. The demand for a product determines the price of the product. According
to Keynes (see more below), if Say's law is correct, widespread involuntary
unemployment (caused by inadequate demand) cannot occur. Classical economists
in the context of Say's law explain unemployment as arising from insufficient
demand for specialized labour—that is, the supply of viable labour exceeds
demand in some segments of the economy. When more goods are produced by firms
than are demanded in certain sectors, the suppliers in those sectors lose
revenue as result. This loss of revenue, which would in turn have been used to
purchase other goods from other firms, lowers demand for the products of firms
in other sectors, causing an overall general reduction in output and thus
lowering the demand for labour. This results in what contemporary
macroeconomics call structural unemployment, the presumed mismatch between the
overall demand for labour in jobs offered and the individual job skills and
location of labour. This differs from the Keynesian concept of cyclical
unemployment, which is presumed to arise because of inadequate aggregate
demand. Such economic losses and unemployment were seen by some economists,
such as Marx and Keynes himself, as an intrinsic property of the capitalist
system. The division of labor leads to a situation where one always has to
anticipate what others will be willing to buy, and this leads to
miscalculations.
Assumptions and criticisms:
Say's law did not posit that (as per the Keynesian formulation) "supply
creates its own demand". Nor was it based on the idea that everything that
is saved will be exchanged. Rather, Say sought to refute the idea that
production and employment were limited by low consumption. Thus Say's law, in
its original concept, was not intrinsically linked nor logically reliant on the
neutrality of money (as has been alleged by those who wish to disagree with
it), because the key proposition of the law is that no matter how much people
save, production is still a possibility, as it is the prerequisite for the
attainment of any additional consumption goods.
Say's law states that in a market economy, goods and services are produced for
exchange with other goods and services—"employment multipliers"
therefore arise from production and not exchange alone—and that in the
process a sufficient level of real income is created to purchase the economy's
entire output, due to the truism that the means of consumption are limited ex
vi termini by the level of production. That is, with regard to the exchange of
products within a division of labour, the total supply of goods and services in
a market economy will equal the total demand derived from consumption during
any given time period. In modern terms, "general gluts cannot exist",
although there may be local imbalances, with gluts in some markets balanced out
by shortages in others. Nevertheless, for some neoclassical economists, Say's
law implies that economy is always at its full employment level. This is not
necessarily what Say proposed. In the Keynesian interpretation, the assumptions
of Say's law are: a barter model of money ("products are paid for with
products"); flexible prices—that is, all prices can rapidly adjust
upwards or downwards; and no government intervention. Under these assumptions,
Say's law implies that there cannot be a general glut, so that a persistent
state cannot exist in which demand is generally less than productive capacity
and high unemployment results.
Keynesians therefore argued that the Great Depression demonstrated that Say's
law is incorrect. Keynes, in his General Theory, argued that a country could go
into a recession because of "lack of aggregate demand".[citation
needed] Because historically there have been many persistent economic crises,
one may reject one or more of the assumptions of Say's law, its reasoning, or
its conclusions. Taking the assumptions in turn: Circuitists and some
post-Keynesians dispute the barter model of money, arguing that money is
fundamentally different from commodities and that credit bubbles can and do
cause depressions. Notably, the debt owed does not change because the economy
has changed. Keynes argued that prices are not flexible; for example, workers
may not take pay cuts if the result is starvation.
Laissez-faire economists argue that government intervention is the cause of
economic crises, and that left to its devices, the market will adjust
efficiently. As for the implication that dislocations cannot cause persistent
unemployment, some theories of economic cycles accept Say's law and seek to
explain high unemployment in other ways, considering depressed demand for
labour as a form of local dislocation. For example, advocates of Real Business
Cycle Theory argue that real shocks cause recessions and that the market
responds efficiently to these real economic shocks.
Paul Krugman dismisses Say's law as, "at best, a useless tautology when
individuals have the option of accumulating money rather than purchasing real
goods and services". Role of money It is not easy to say what exactly
Say's law says about the role of money apart from the claim that recession is
not caused by lack of money. The phrase "products are paid for with
products" is taken to mean that Say has a barter model of money; contrast
with circuitist and post-Keynesian monetary theory. One can read Say as stating
simply that money is completely neutral, although he did not state this
explicitly, and in fact did not concern himself with this subject. Say's
central notion concerning money was that if one has money, it is irrational to
hoard it. The assumption that hoarding is irrational was attacked by
underconsumptionist economists, such as John M. Robertson, in his 1892 book,
The Fallacy of Saving, where he called Say's law: a tenacious fallacy,
consequent on the inveterate evasion of the plain fact that men want for their
goods, not merely some other goods to consume, but further, some credit or
abstract claim to future wealth, goods, or services. This all want as a surplus
or bonus, and this surplus cannot be represented for all in present goods.
—?John M. Robertson, The Fallacy of Saving, p. 98
Here Robertson identifies his critique as based on Say's theory of money:
people wish to accumulate a "claim to future wealth", not simply
present goods, and thus the hoarding of wealth may be rational. For Say, as for
other classical economists, it is possible for there to be a glut (excess
supply, market surplus) for one product alongside a shortage (excess demand) of
others. But there is no "general glut" in Say's view, since the gluts
and shortages cancel out for the economy as a whole. But what if the excess
demand is for money, because people are hoarding it? This creates an excess
supply for all products, a general glut. Say's answer is simple: there is no
reason to engage in hoarding money. According to Say, the only reason to have
money is to buy products. It would not be a mistake, in his view, to treat the
economy as if it were a barter economy. To quote Say: Nor is [an individual]
less anxious to dispose of the money he may get ... But the only way of getting
rid of money is in the purchase of some product or other. In Keynesian terms,
followers of Say's law would argue that on the aggregate level, there is only a
transactions demand for money. That is, there is no precautionary, finance, or
speculative demand for money. Money is held for spending, and increases in
money supplies lead to increased spending. Some classical economists did see
that a loss of confidence in business or a collapse of credit will increase the
demand for money, which will decrease the demand for goods. This view was
expressed both by Robert Torrens and John Stuart Mill. This would lead demand
and supply to move out of phase and lead to an economic downturn in the same
way that miscalculation in productions would, as described by William H.
Beveridge in 1909. However, in classical economics, there was no reason for
such a collapse to persist. In this view, persistent depressions, such as that
of the 1930s, are impossible in a free market organized according to
laissez-faire principles. The flexibility of markets under laissez faire allows
prices, wages, and interest rates to adjust so as to abolish all excess
supplies and demands; however, since all economies are a mixture of regulation
and free-market elements, laissez-faire principles (which require a free market
environment) cannot adjust effectively to excess supply and demand.
As a theoretical point of departure:
The whole of neoclassical equilibrium analysis implies that Say's law in the
first place functioned to bring a market into this state: that is, Say's law is
the mechanism through which markets equilibrate uniquely. Equilibrium analysis
and its derivatives of optimization and efficiency in exchange live or die with
Say's law. This is one of the major, fundamental points of contention between
the neoclassical tradition, Keynes, and Marxians. Ultimately, from Say's law
they deduced vastly different conclusions regarding the functioning of
capitalist production. The former, not to be confused with "new
Keynesian" and the many offsprings and syntheses of the General Theory,
take the fact that a commodity–commodity economy is substantially altered
once it becomes a commodity–money–commodity economy, or once money
becomes not only a facilitator of exchange (its only function in marginalist
theory) but also a store of value and a means of payment. What this means is
that money can be (and must be) hoarded: it may not re-enter the circulatory
process for some time, and thus a general glut is not only possible but, to the
extent that money is not rapidly turned over, probable. A response to this in
defense of Say's law (echoing the debates between Ricardo and Malthus, in which
the former denied the possibility of a general glut on its grounds) is that
consumption that is abstained from through hoarding is simply transferred to a
different consumer—overwhelmingly to factor (investment) markets, which,
through financial institutions, function through the rate of interest. Keynes'
innovation in this regard was twofold: First, he was to turn the mechanism that
regulates savings and investment, the rate of interest, into a shell of its
former self (relegating it to the price of money) by showing that supply and
investment were not independent of one another and thus could not be related
uniquely in terms of the balancing of disutility and utility. Second, after
Say's law was dealt with and shown to be theoretically inconsistent, there was
a gap to be filled. If Say's law was the logic by which we thought financial
markets came to a unique position in the long run, and if Say's law were to be
discarded, what were the real "rules of the game" of the financial
markets? How did they function and remain stable?
To this Keynes responded with his famous notion of "animal spirits":
markets are ruled by speculative behavior, influenced not only by one's own
personal equation but also by one's perceptions of the speculative behavior of
others. In turn, others' behavior is motivated by their perceptions of others'
behavior, and so on. Without Say's law keeping them in balance, financial
markets are thus inherently unstable. Through this identification, Keynes
deduced the consequences for the macroeconomy of long-run equilibrium being
attained not at only one unique position that represented a "Pareto
Optima" (a special case), but through a possible range of many equilibria
that could significantly under-employ human and natural resources (the general
case). For the Marxian critique, which is more fundamental, one must start at
Marx's initial distinction between use value and exchange value—use value
being the use somebody has for a commodity, and exchange value being what an
item is traded for on a market. In Marx's theory, there is a gap between the
creation of surplus value in production and the realization of that surplus
value via a sale. To realize a sale, a commodity must have a use value for
someone, so that they purchase the commodity and complete the cycle
M–C–M'. Capitalism, which is interested in value (money as wealth),
must create use value. The capitalist has no control over whether or not the
value contained in the product is realized through the market mechanism. This
gap between production and realization creates the possibility for capitalist
crisis, but only if the value of any item is realised through the difference
between its cost and final price. As the realization of capital is only
possible through a market, Marx criticized other economists, such as David
Ricardo, who argued that capital is realized via production. Thus, in Marx's
theory, there can be general overproductive crises within capitalism. Given
these concepts and their implications, Say's law does not hold in the Marxian
framework. Moreover, the theoretical core of the Marxian framework contrasts
with that of the neoclassical and Austrian traditions. Conceptually, the
distinction between Keynes and Marx is that for Keynes the theory is but a
special case of his general theory, whereas for Marx it never existed at all.
Modern interpretations:
A modern way of expressing Say's law is that there can never be a general glut.
Instead of there being an excess supply (glut or surplus) of goods in general,
there may be an excess supply of one or more goods, but only when balanced by
an excess demand (shortage) of yet other goods. Thus, there may be a glut of
labor ("cyclical" unemployment), but this is balanced by an excess
demand for produced goods. Modern advocates of Say's law see market forces as
working quickly, via price adjustments, to abolish both gluts and shortages.
The exception is when governments or other non-market forces prevent price
adjustments. According to Keynes, the implication of Say's law is that a
free-market economy is always at what Keynesian economists call full employment
(see also Walras' law). Thus, Say's law is part of the general world view of
laissez-faire economics—that is, that free markets can solve the economy's
problems automatically. (These problems are recessions, stagnation, depression,
and involuntary unemployment.) Some proponents of Say's law argue that such
intervention is always counterproductive. Consider Keynesian-type policies
aimed at stimulating the economy. Increased government purchases of goods (or
lowered taxes) merely "crowd out" the production and purchase of
goods by the private sector. Contradicting this view, Arthur Cecil Pigou, a
self-proclaimed follower of Say's law, wrote a letter in 1932 signed by five
other economists (among them Keynes) calling for more public spending to
alleviate high levels of unemployment. Keynes versus Say Keynes summarized
Say's law as "supply creates its own demand", or the assumption
"that the whole of the costs of production must necessarily be spent in
the aggregate, directly or indirectly, on purchasing the product" (from
chapter 2 of his General Theory). See the article on The General Theory of
Employment, Interest and Money for a summary of Keynes's view. Although
hoarding of money was not a direct cause of unemployment in Keynes's theory,
his concept of saving was unclear and some readers have filled the gap by
assigning to hoarding the role Keynes gave to saving. An early example was
Jacob Viner, who in his 1936 review of the General Theory said of hoarding that
Keynes' attaches great importance to it as a barrier to "full"
employment' (p152) while denying (pp158f) that it was capable of having that
effect.[41] The theory that hoarding is a cause of unemployment has been the
subject of discussion. Some classical economists[who?] suggested that hoarding
(increases in money-equivalent holdings) would always be balanced by
dis-hoarding. This requires equality of saving (abstention from purchase of
goods) and investment (the purchase of capital goods). However, Keynes and
others argued that hoarding decisions are made by different people and for
different reasons than are decisions to dis-hoard, so that hoarding and
dis-hoarding are unlikely to be equal at all times, as indeed they are not.
Decreasing demand (consumption) does not necessarily stimulate capital spending
(investment). Some[who?] have argued that financial markets, and especially
interest rates, could adjust to keep hoarding and dis-hoarding equal, so that
Say's law could be maintained, or that prices could simply fall, to prevent a
decrease in production. But Keynes argued that to play this role, interest
rates would have to fall rapidly, and that there are limits on how quickly and
how low they can fall (as in the liquidity trap, where interest rates approach
zero and cannot fall further). To Keynes, in the short run, interest rates are
determined more by the supply and demand for money than by saving and
investment. Before interest rates can adjust sufficiently, excessive hoarding
causes the vicious circle of falling aggregate production (recession). The
recession itself lowers incomes so that hoarding (and saving) and dis-hoarding
(and real investment) can reach a state of balance below full employment.
Worse, a recession would hurt private real investment—by hurting
profitability and business confidence—through what is called the
accelerator effect. This means that the balance between hoarding and
dis-hoarding would be pushed even further below the full-employment level of
production. Keynes treats a fall in marginal efficiency of capital and an
increase in the degree of liquidity preference (demand for money) as sparks
leading to an insufficiency of effective demand. A decrease in MEC causes a
reduction in investment, which reduces aggregate expenditure and income. A
decline in the interest rate would offset the decline in investment, and
stimulate propensity to consume.
See also
See also Demand side economics, the New Keynesian perspective Fiscal policy
List of eponymous laws Parable of the broken window Treasury view, a related
critical view of fiscal policy Walras' law
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