My Posts on Say’s Law

My links on the history of Say’s law, its different versions, and the criticisms that can be made against it:

“The Myth of Say’s Law,” October 7, 2010.

“F. H. Hahn in a Candid Moment on Neo-Walrasian Equilibrium ,” January 29, 2011.

“Say’s Law Presupposes Aggregate Demand as a Meaningful Concept,” May 28, 2011.

“Say Repudiated Say’s Law,” December 1, 2011.

“Jean Baptiste Say on Failures of Aggregate Demand,” December 1, 2011.

“Jean-Baptiste Say and “Say’s Law,” September 14, 2012.

“The Origin of Say’s Law in Adam Smith and James Mill,” September 14, 2012.

“Bibliography on Say’s Law,” September 16, 2012.

“A Note on Prices and Say’s Law,” December 11, 2012.

“World GDP versus Total Value of Financial Asset Market Exchanges,” February 21, 2013.

“Say’s Law: An Overview and Bibliography,” April 13, 2013.

“Matias Vernengo on Say’s Law,” February 11, 2014.

“A Puzzle about Say’s Law,” June 29, 2014.

Matias Vernengo on Say’s Law

Matias Vernengo has an interesting post here on Say’s law and the difference between the Classical and neoclassical versions:

Matias Vernengo, “Say’s Law of Markets: Classical and Neoclassical Versions,” February 10, 2014.

Say’s Law: An Overview and Bibliography

I think an overview is in order in light of Robert Murphy’s confusing post here, which seems (as far as I can see) to agree that a “general glut” or failure of aggregate demand is possible, contrary to the extreme form of Say’s law, but in a bizarre argument invoking “present and future goods” and the notion that “leisure is a present consumption good.”

Say’s law of course is defined in various ways, but the two main definitions are as follows:

(1) Say’s Identity
According to Baumol (1977: 146), this

“is the assertion that no one ever wants to hold money for any significant amount of time, so that, as a result, every offer (supply) of a quantity of goods automatically constitutes a demand for a bundle of some other items of equal market value”; and

(2) Say’s Equality
Again, according to Baumol (1977: 146), Say’s Equality

“admits the possibility of (brief) periods of disequilibrium during which the total demand for goods may fall short of the total supply, but maintains that there exist reliable equilibrating forces that must soon bring the two together.”

The issue of how Jean-Baptiste Say (1767–1832) himself defined the law is complicated by the fact that Say produced various editions of his Treatise on Political Economy and different treatments of the law, as follows:

(1) the first edition of Say’s Traité d’économie politique (1803; or the Treatise on Political Economy in English) has only a brief and not properly formulated version of the law;

(2) the second edition of Traité d’économie politique/Treatise on Political Economy (published in 1814) has the first proper formulation of Say’s law (Baumol 1977: 147).

(3) a summary of the law appears in Say’s Catechism of Political Economy (1816: 103–105).

(4) in the fourth edition of Traité d’économie politique/Treatise on Political Economy (1819) Say revised his remarks on the law in important ways (Heertje 2004: 41).

It seems widely accepted today that Say’s role in formulating the law is overrated. That is, both Thweatt (1979: 92–93) and Baumol (2003: 46) conclude that Adam Smith was in fact the real father of what is recognisably Say’s law in Classical economics, with the major work in developing the idea conducted by James Mill (1808), not necessarily Jean-Baptiste Say himself.

So let us look at how Say’s law was formulated by the Classical economists, as defined by Thomas Sowell (1994: 39–41). Sowell defines it as these propositions:

“(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill].

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

(3) Investment is only an internal transfer, not a net reduction, of aggregate demand. The same amount that could have been spent by the thrifty consumer will be spent by the capitalists and/or the workers in the investment goods sector [John Stuart Mill].

(4) In real terms, supply equals demand ex ante [= “before the event”], since each individual produces only because of, and to the extent of, his demand for other goods. (Sometimes this doctrine was supported by demonstrating that supply equals demand ex post.) [James Mill.]

(5) A higher rate of savings will cause a higher rate of subsequent growth in aggregate output [James Mill and Adam Smith].

(6) Disequilibrium in the economy can exist only because the internal proportions of output differ from consumer’s preferred mix—not because output is excessive in the aggregate” [Say, Ricardo, Torrens, James Mill] (Sowell 1994: 39–41).

Why is Say’s law false?

One fatal flaw is the underlying assumption, which is clear in the work of Jean-Baptiste Say himself, that money cannot provide direct utility:

“For, after all, money is but the agent of the transfer of values. Its whole utility has consisted in conveying to your hands the value of the commodities, which your customer has sold, for the purpose of buying again from you; and the very next purchase you make, it will again convey to a third person the value of the products you may have sold to others.” (Say 1821a: 164–165).

This is made clear to us by Say’s statement: “[sc. the] whole utility [sc. of money] has consisted in conveying to your hands the value of the commodities.” This is a world where nobody holds money for significant periods of time because money can have no utility, except in what it can purchase in terms of commodities. But that is not the world we live in. We live in a world of uncertainty. In the face of uncertainty, money can yield direct utility (Graziani 2003: 11). Therefore people can and do hold money for significant periods!

First, “Say’s Identity” simply ignores the reality of people holding money without purchasing goods and services because of uncertainty (Keynes’s precautionary motive), or what Keynes called idle money hoards. It also ignores the spending of money on secondary financial or real asset markets or holding of money idle for this reason (Keynes’s speculative motive).

In any real world economy, money from income streams from production, either to capitalists or workers, can become diverted to asset markets and may not be spent on goods. For this reason alone, Say’s law is a grossly unrealistic picture of market economies. Capitalists themselves have subjective expectations about the future and the future profitability of investment, and when their expectations are shattered, they will not necessarily invest out of retained earnings.

Secondly, a further serious problem with both versions of Say’s law is the assumption of universal or near universal flexprice markets, when vast numbers of industrial, service, retail and even capital goods markets are fixprice, and administered prices are the norm. In modern capitalist economies, supply and demand are equated by changes in employment and output, not by flexible prices. (And also the whole simplistic economic model of Say’s law does not have a place for endogenous money and banks that create credit money for investment.)

Lastly, as a matter of historical interest, eventually it appears that Jean-Baptiste Say actually repudiated the strong form of Say’s law we call “Say’s Identity” in his letters to Malthus, and seems to have admitted the existence of failures of aggregate demand.

More detailed discussion is here:

“The Myth of Say’s Law,” October 7, 2010.

“F. H. Hahn in a Candid Moment on Neo-Walrasian Equilibrium ,” January 29, 2011.

“Say’s Law Presupposes Aggregate Demand as a Meaningful Concept,” May 28, 2011.

“Say Repudiated Say’s Law,” December 1, 2011.

“Jean Baptiste Say on Failures of Aggregate Demand,” December 1, 2011.

“Jean-Baptiste Say and “Say’s Law,” September 14, 2012.

“The Origin of Say’s Law in Adam Smith and James Mill,” September 14, 2012.

“Bibliography on Say’s Law,” September 16, 2012.

“A Note on Prices and Say’s Law,” December 11, 2012.

“World GDP versus Total Value of Financial Asset Market Exchanges,” February 21, 2013.

I also reproduce my extended bibliography on Say’s law below.

BIBLIOGRAPHY

Anderson, William L. 2009. “Say’s Law and the Austrian Theory of the Business Cycle,” Quarterly Journal of Austrian Economics 12.2: 47–59.

Aspromourgos, Tony. 2009. The Science of Wealth: Adam Smith and the Framing of Political Economy. Routledge, London.

Balassa, Bela A. 1959. “John Stuart Mill and the Law of Markets,” Quarterly Journal of Economics 73.2: 263–274.

Baumol, William J. 1977. “Say’s (at Least) Eight Laws, or What Say and James Mill May Really Have Meant,” Economica n.s. 44.174: 145–161.

Baumol, William J. 1999. “Retrospectives: Say’s Law,” Journal of Economic Perspectives 13.1: 195–204.

Baumol, William J. 2003. “Retrospectives: Say’s Law,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, Edward Elgar Pub, Cheltenham and Northampton, Mass. 39–49.

Becker, Gary and William J. Baumol. 1952. “The Classical Economic Theory: The Outcome of the Discussion,” Economica 19: 355–376.

Blaug, M. 1996. Economic Theory in Retrospect (5th edn). Cambridge University Press, Cambridge.

Blaug, Mark. 1997. “Say’s Law of Markets: What did it mean and Why should We Care?,” Eastern Economic Journal 23.2: 231–235.

Clower, Robert W. and Leijonhufvud, Axel. 1973. “Say’s Principle, What It Means and Doesn’t Mean,” Intermountain Economic Review 4: 1–16.

Clower, Robert W. and Leijonhufvud, Axel. 1984. “Say’s Principle, What it Means and Doesn’t Mean,” in Donald A. Walker (ed.), Money and Markets: Essays by Robert W. Clower. Cambridge University Press, Cambridge. 145–165.

Cottrell, Allin. 1998. “Keynes, Ricardo, Malthus and Say’s Law,” in James C.W. Ahiakpor (ed.), Keynes and the Classics Reconsidered. Kluwer Academic, Boston, Mass. and London. 63–75.

“Debunking Economics, Part VIII: Macroeconomics, or Applied Microeconomics?,” Unlearning Economics, 26 August, 2012.
http://unlearningeconomics.wordpress.com/2012/08/26/debunking-economics-part-viii-macroeconomics-or-applied-microeconomics/

Gootzeit, M. 2003. “Savings, Hoarding and Say’s Law,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle. Edward Elgar, Cheltenham and Northampton, Mass. 168–186.

Gordon, B. J. 1965. “Say’s Law, Effective Demand, and the Contemporary British Periodicals, 1820–1850,” Economica 32: 438–446.

Graziani, A. 2003. The Monetary Theory of Production. Cambridge University Press, Cambridge.

Groenewegen, P. D. 1977. The Economics of A. R. J. Turgot. Martinus Nijhoff, The Hague.

Heertje, A. 2004. “On Say’s Law,” in Tony Aspromourgos and John Lodewijks (eds.), History and Political Economy. Essays in Honour of P.D. Groenewegen. Routledge, London. 44–56.

Hollander, S. 2005. “Review of Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle,” History of Political Economy 37.2: 382–385.

Horwitz, Steven. 2003. “Say’s Law of Markets: An Austrian Appreciation,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle. Elgar, Cheltenham, UK and Northampton, Mass. 82–98.

Hutt, William Harold. 1974. A Rehabilitation of Say’s Law. Ohio U.P., Athens, Ohio.

Johnson, Ivan C. 2001. “A Reappraisal of the Say’s Law Controversy,” Quarterly Journal of Austrian Economics 4.4: 25–53.

Jonsson, Petur O. 1995. “On the Economics of Say and Keynes’ Interpretation of Says’s Law,” Eastern Economic Journal 21.2: 147–155.

Jonsson, Petur O. 1997. “On Gluts, Effective Demand, and the True Meaning of Say’s Law,” Eastern Economic Journal 23.2: 203–218.

Jonsson, Petur O. 1998. “Keynes, Ricardo, Malthus and Say’s Law: Comment,” in James C.W. Ahiakpor (ed.), Keynes and the Classics Reconsidered. Kluwer Academic, Boston, Mass. and London.75–84.

Kates, Steven. 1994. “The Malthusian Origins of the General Theory or How Keynes came to write a Book about Say’s Law and Effective Demand,” History of Economics Review 21: 10–20.

Kates, Steven. 1995. “Crucial Influences on Keynes’s Understanding of Say’s Law,” History of Economics Review 23: 74–82.

Kates, Steven. 1996. “Keynes, Say’s Law and the Theory of the Business Cycle,” History of Economics Review 25: 119–126.

Kates, Steven. 1997. “A Discussion of Say’s Law: The Outcome of the Symposium,”Eastern Economic Journal 23.2: 237–239.

Kates, Steven. 1997. “On the True Meaning of Say’s Law,” Eastern Economic Journal 23.2: 191–202.

Kates, Steven. 2002. “Economic Management and the Keynesian Revolution: The Policy Consequences of the Disappearance of Say’s Law,” International Journal of Applied Economics and Econometrics 10.3: 463–479.

Kates, Steven (ed.). 2003. Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, Edward Elgar Pub, Cheltenham; Northampton, Mass.

Kates, Steven. 2005. “‘Supply Creates Its Own Demand’: A Discussion of the Origins of the Phrase and of its Adequacy as an Interpretation of Say’s Law of Markets,” History of Economics Review 41: 49–60.

Kates, Steven. 2007. “Mill, McCracken and the Modern Interpretation of Say’s Law,” History of Economics Review 46: 32–38.

Kates, Steven. 2008. “A Letter from Keynes to Harlan McCracken dated 31st August 1933: Why the Standard Story on the Origins of the General Theory needs to be Rewritten,” History of Economics Review 47: 39–53.

Kates, Steven. 2010. “Why Your Grandfather’s Economics was better than yours: On the Catastrophic Disappearance of Say’s Law,” Quarterly Journal of Austrian Economics 13.4: 3–28.

Keen, S. 2003. “Nudge Nudge, Wink Wink, Say No More,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle. Elgar, Cheltenham, UK and Northampton, Mass. 199–209.
http://www.debtdeflation.com/blogs/wp-content/uploads/papers/KeenNudgeNudgeWinkWinkSayNoMore.pdf

Kent, Richard J. 2005. “Keynes and Say’s Law,” History of Economics Review 41: 61–76.

Lange, O. 1942. “Say’s Law: A Restatement and Criticism,” in O. Lange, F. McIntyre and T. O. Matema (eds), Studies in Mathematical Economics and Econometrics: In Memory of Henry Schultz. University of Chicago Press, Chicago. 49–68.

Lange, Oskar. 1994. “Say’s Law: A Restatement and Criticism,” in Tadeusz Kowalik (ed.), Economic Theory and Market Socialism: Selected Essays of Oskar Lange. Elgar, Aldershot, U.K. 213–232.

Mill, James. 1808. Commerce Defended. An Answer to the Arguments by which Mr. Spence, Mr. Cobbett, and Others, have Attempted to Prove that Commerce is not a Source of National Wealth. C. and R. Baldwin, London.

Mises, L. 2005 [1950], “Lord Keynes and Say’s Law,” Mises Daily, April 25, 2005, http://mises.org/daily/1803

Say, Jean Baptiste. 1803. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (1st edn.). De Chapelet, Paris.

Say, Jean Baptiste. 1814. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (2nd edn.). Antoine-Augustin Renouard, Paris.

Say, J. B. 1816. Catechism of Political Economy, or, Familiar Conversations on the Manner in which Wealth is Produced, Distributed, and Consumed in Society (trans. J. Richter). Sherwood, Neely, and Jones, London.

Say, Jean Baptiste. 1817. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (3rd edn.). Chez Deterville, Paris.

Say, Jean Baptiste. 1819. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (4th edn.). Deterville, Paris.

Say, Jean Baptiste. 1821. A Treatise on Political Economy, or, The Production, Distribution, and Consumption of Wealth (trans. from 4th edn by C.R. Prinsep with notes by the translator, with a translation of the introduction and additional notes by C. C. Biddle). Wells and Lilly, Boston.

Say, Jean Baptiste. 1821a. A Treatise on Political Economy, or, The Production, Distribution, and Consumption of Wealth (trans. from 4th edn by C.R. Prinsep). Longman, Hurst, Rees, Orne And Brown, London.

Say, J. B. 1821b. Letters to Mr. Malthus: On Several Subjects of Political Economy, and on the Cause of the General Stagnation of Commerce. To Which is added A Catechism of Political Economy, Sherwood, Neely, and Jones, London.

Say, Jean Baptiste. 1826. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (5th edn.). Rapilly, Paris.

Shoul, B. 1957. “Karl Marx and Say’s Law,” Quarterly Journal of Economics 71.4: 611–629.

Skinner, A. S. 1967. “Say’s Law: Origins and Content,” Economica 34: 153–166.

Silva, Antonio Carlos Macedo e. 2004. “From Say’s Law to Keynes, from Keynes to Walras’s Law: Some Ironies in the History of Economic Thought,” in L. Randall Wray and Mathew Forstater (eds.). Contemporary Post Keynesian Analysis. Edward Elgar, Cheltenham, UK and Northampton, Mass. 310–332.

Skinner, A. S. 1969. “Of Malthus, Lauderdale and Say’s Law, Lauderdale and Say’s Law,” Scottish Journal of Political Economy 16.2: 177–195.

Smith, A. 1811. An Inquiry into the Nature and Causes of the Wealth of Nations (11 edn; vol. 1), Oliver D. Cooke, Hartford.

Sowell, T. 1972. Say’s Law: An Historical Analysis. Princeton University Press, Princeton, N.J.

Sowell, T. 1974. Classical Economics Reconsidered. Princeton University Press, Princeton, N.J. and London.

Sowell, T. 1994. Classical Economics Reconsidered (2nd ed.). Princeton University Press, Princeton, N.J.

Spengler, Joseph J. 1945. “The Physiocrats and Say’s Law of Markets,” Journal of Political Economy 53: 193–211, 317-347.

Thweatt, W. O. 1979. “Early Formulators of Say’s Law,” Quarterly Review of Economics and Business 19: 79–96.

Thweatt, W. O. 1980. “Baumol and James Mill on ‘Say’s’ Law of Markets,” Economica n.s. 47.188: 467–469.

Bibliography on Say’s Law

Below is a bibliography on the origin, history and nature of Say’s law.

Jean-Baptiste Say (1767–1832) produced different versions of the law, in these works:

(1) the first edition of Say’s Traité d’économie politique (1803; or the Treatise on Political Economy in English) has only a brief and not properly formulated version of the law;

(2) the second edition of Traité d’économie politique/Treatise on Political Economy (published in 1814) has the first proper formulation of Say’s law (Baumol 1977: 147).

(3) a summary of the law appears in Say’s Catechism of Political Economy (1816: 103–105).

(4) in the fourth edition of Traité d’économie politique/Treatise on Political Economy (1819) Say revised his remarks on the law in important ways (Heertje 2004: 41).

Moreover, Thweatt (1979: 92–93) and Baumol (2003: 46) conclude that Adam Smith was in fact the real father of what is recognisably Say’s law in Classical economics, with the major work in developing the idea conducted by James Mill (1808), not necessarily Jean-Baptiste Say.

The major work on the law is Steven Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle (Edward Elgar, Cheltenham, 2003).



BIBLIOGRAPHY

Anderson, William L. 2009. “Say’s Law and the Austrian Theory of the Business Cycle,” Quarterly Journal of Austrian Economics 12.2: 47–59.

Aspromourgos, Tony. 2009. The Science of Wealth: Adam Smith and the Framing of Political Economy. Routledge, London.

Balassa, Bela A. 1959. “John Stuart Mill and the Law of Markets,” Quarterly Journal of Economics 73.2: 263–274.

Baumol, William J. 1977. “Say’s (at Least) Eight Laws, or What Say and James Mill May Really Have Meant,” Economica n.s. 44.174: 145–161.

Baumol, William J. 1999. “Retrospectives: Say’s Law,” Journal of Economic Perspectives 13.1: 195–204.

Baumol, William J. 2003. “Retrospectives: Say’s Law,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, Edward Elgar Pub, Cheltenham and Northampton, Mass. 39–49.

Becker, Gary and William J. Baumol. 1952. “The Classical Economic Theory: The Outcome of the Discussion,” Economica 19: 355–376.

Blaug, M. 1996. Economic Theory in Retrospect (5th edn). Cambridge University Press, Cambridge.

Blaug, Mark. 1997. “Say’s Law of Markets: What did it mean and Why should We Care?,” Eastern Economic Journal 23.2: 231–235.

Clower, Robert W. and Leijonhufvud, Axel. 1973. “Say’s Principle, What It Means and Doesn’t Mean,” Intermountain Economic Review 4: 1–16.

Clower, Robert W. and Leijonhufvud, Axel. 1984. “Say’s Principle, What it Means and Doesn’t Mean,” in Donald A. Walker (ed.), Money and Markets: Essays by Robert W. Clower. Cambridge University Press, Cambridge. 145–165.

Cottrell, Allin. 1998. “Keynes, Ricardo, Malthus and Say’s Law,” in James C.W. Ahiakpor (ed.), Keynes and the Classics Reconsidered. Kluwer Academic, Boston, Mass. and London. 63–75.

“Debunking Economics, Part VIII: Macroeconomics, or Applied Microeconomics?,” Unlearning Economics, 26 August, 2012.
http://unlearningeconomics.wordpress.com/2012/08/26/debunking-economics-part-viii-macroeconomics-or-applied-microeconomics/

Gootzeit, M. 2003. “Savings, Hoarding and Say’s Law,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle. Edward Elgar, Cheltenham and Northampton, Mass. 168–186.

Gordon, B. J. 1965. “Say’s Law, Effective Demand, and the Contemporary British Periodicals, 1820–1850,” Economica 32: 438–446.

Groenewegen, P. D. 1977. The Economics of A. R. J. Turgot. Martinus Nijhoff, The Hague.

Heertje, A. 2004. “On Say’s Law,” in Tony Aspromourgos and John Lodewijks (eds.), History and Political Economy. Essays in Honour of P.D. Groenewegen. Routledge, London. 44–56.

Hollander, S. 2005. “Review of Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle,” History of Political Economy 37.2: 382–385.

Horwitz, Steven. 2003. “Say’s Law of Markets: An Austrian Appreciation,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle. Elgar, Cheltenham, UK and Northampton, Mass. 82–98.

Hutt, William Harold. 1974. A Rehabilitation of Say’s Law. Ohio U.P., Athens, Ohio.

Johnson, Ivan C. 2001. “A Reappraisal of the Say’s Law Controversy,” Quarterly Journal of Austrian Economics 4.4: 25–53.

Jonsson, Petur O. 1995. “On the Economics of Say and Keynes’ Interpretation of Says’s Law,” Eastern Economic Journal 21.2: 147–155.

Jonsson, Petur O. 1997. “On Gluts, Effective Demand, and the True Meaning of Say’s Law,” Eastern Economic Journal 23.2: 203–218.

Jonsson, Petur O. 1998. “Keynes, Ricardo, Malthus and Say’s Law: Comment,” in James C.W. Ahiakpor (ed.), Keynes and the Classics Reconsidered. Kluwer Academic, Boston, Mass. and London.75–84.

Kates, Steven. 1994. “The Malthusian Origins of the General Theory or How Keynes came to write a Book about Say’s Law and Effective Demand,” History of Economics Review 21: 10–20.

Kates, Steven. 1995. “Crucial Influences on Keynes’s Understanding of Say’s Law,” History of Economics Review 23: 74–82.

Kates, Steven. 1996. “Keynes, Say’s Law and the Theory of the Business Cycle,” History of Economics Review 25: 119–126.

Kates, Steven. 1997. “A Discussion of Say’s Law: The Outcome of the Symposium,”Eastern Economic Journal 23.2: 237–239.

Kates, Steven. 1997. “On the True Meaning of Say’s Law,” Eastern Economic Journal 23.2: 191–202.

Kates, Steven. 2002. “Economic Management and the Keynesian Revolution: The Policy Consequences of the Disappearance of Say’s Law,” International Journal of Applied Economics and Econometrics 10.3: 463–479.

Kates, Steven (ed.). 2003. Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, Edward Elgar Pub, Cheltenham; Northampton, Mass.

Kates, Steven. 2005. “‘Supply Creates Its Own Demand’: A Discussion of the Origins of the Phrase and of its Adequacy as an Interpretation of Say’s Law of Markets,” History of Economics Review 41: 49–60.

Kates, Steven. 2007. “Mill, McCracken and the Modern Interpretation of Say’s Law,” History of Economics Review 46: 32–38.

Kates, Steven. 2008. “A Letter from Keynes to Harlan McCracken dated 31st August 1933: Why the Standard Story on the Origins of the General Theory needs to be Rewritten,” History of Economics Review 47: 39–53.

Kates, Steven. 2010. “Why Your Grandfather’s Economics was better than yours: On the Catastrophic Disappearance of Say’s Law,” Quarterly Journal of Austrian Economics 13.4: 3–28.

Keen, S. 2003. “Nudge Nudge, Wink Wink, Say No More,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle. Elgar, Cheltenham, UK and Northampton, Mass. 199–209.
http://www.debtdeflation.com/blogs/wp-content/uploads/papers/KeenNudgeNudgeWinkWinkSayNoMore.pdf

Kent, Richard J. 2005. “Keynes and Say’s Law,” History of Economics Review 41: 61–76.

Lange, O. 1942. “Say’s Law: A Restatement and Criticism,” in O. Lange, F. McIntyre and T. O. Matema (eds), Studies in Mathematical Economics and Econometrics: In Memory of Henry Schultz. University of Chicago Press, Chicago. 49–68.

Lange, Oskar. 1994. “Say’s Law: A Restatement and Criticism,” in Tadeusz Kowalik (ed.), Economic Theory and Market Socialism: Selected Essays of Oskar Lange. Elgar, Aldershot, U.K. 213–232.

Mill, James. 1808. Commerce Defended. An Answer to the Arguments by which Mr. Spence, Mr. Cobbett, and Others, have Attempted to Prove that Commerce is not a Source of National Wealth. C. and R. Baldwin, London.

Mises, L. 2005 [1950], “Lord Keynes and Say’s Law,” Mises Daily, April 25, 2005, http://mises.org/daily/1803

Say, Jean Baptiste. 1803. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (1st edn.). De Chapelet, Paris.

Say, Jean Baptiste. 1814. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (2nd edn.). Antoine-Augustin Renouard, Paris.

Say, Jean Baptiste. 1817. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (3rd edn.). Chez Deterville, Paris.

Say, Jean Baptiste. 1819. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (4th edn.). Deterville, Paris.

Say, Jean Baptiste. 1821. A Treatise on Political Economy, or, The Production, Distribution, and Consumption of Wealth (trans. from 4th edn by C.R. Prinsep with notes by the translator, with a translation of the introduction and additional notes by C. C. Biddle). Wells and Lilly, Boston.

Say, J. B. 1816. Catechism of Political Economy, or, Familiar Conversations on the Manner in which Wealth is Produced, Distributed, and Consumed in Society (trans. J. Richter). Sherwood, Neely, and Jones, London.

Say, J. B. 1821. Letters to Mr. Malthus: On Several Subjects of Political Economy, and on the Cause of the General Stagnation of Commerce. To Which is added A Catechism of Political Economy, Sherwood, Neely, and Jones, London.

Say, Jean Baptiste. 1826. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (5th edn.). Rapilly, Paris.

Shoul, B. 1957. “Karl Marx and Say’s Law,” Quarterly Journal of Economics 71.4: 611–629.

Skinner, A. S. 1967. “Say’s Law: Origins and Content,” Economica 34: 153–166.

Silva, Antonio Carlos Macedo e. 2004. “From Say’s Law to Keynes, from Keynes to Walras’s Law: Some Ironies in the History of Economic Thought,” in L. Randall Wray and Mathew Forstater (eds.). Contemporary Post Keynesian Analysis. Edward Elgar, Cheltenham, UK and Northampton, Mass. 310–332.

Skinner, A. S. 1969. “Of Malthus, Lauderdale and Say’s Law, Lauderdale and Say’s Law,” Scottish Journal of Political Economy 16.2: 177–195.

Smith, A. 1811. An Inquiry into the Nature and Causes of the Wealth of Nations (11 edn; vol. 1), Oliver D. Cooke, Hartford.

Sowell, T. 1972. Say’s Law: An Historical Analysis. Princeton University Press, Princeton, N.J.

Sowell, T. 1974. Classical Economics Reconsidered. Princeton University Press, Princeton, N.J. and London.

Sowell, T. 1994. Classical Economics Reconsidered (2nd ed.). Princeton University Press, Princeton, N.J.

Spengler, Joseph J. 1945. “The Physiocrats and Say’s Law of Markets,” Journal of Political Economy 53: 193–211, 317-347.

Thweatt, W. O. 1979. “Early Formulators of Say’s Law,” Quarterly Review of Economics and Business 19: 79–96.

Thweatt, W. O. 1980. “Baumol and James Mill on ‘Say’s’ Law of Markets,” Economica n.s. 47.188: 467–469.

The Origin of Say’s Law in Adam Smith and James Mill

Consider these passages from Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations (11 edn; 1811):

“In all countries where there is tolerable security, every man of common understanding will endeavour to employ whatever stock he can command, in procuring either present enjoyment or future profit. If it is employed in procuring present enjoyment, it is a stock reserved for immediate consumption. If it is employed in procuring future profit, it must procure this profit, either by staying with him, or by going from him. In the one case it is a fixed, in the other it is a circulating capital. A man must be perfectly crazy who, where there is tolerable security, does not employ all the stock which he commands, whether it be his own, or borrowed of other people, in some one or other of those three ways.” (Smith 1811: 198).

“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 re-produce with a profit the value of their annual consumption. His revenue, we shall suppose, is paid him in money. Had he spent the whole, the food, clothing, and lodging, which the whole could have purchased, would have been distributed among the former set of people. By saving a part of it, as that part is for the sake of the profit immediately employed as a capital either by himself or by some other person, the food, clothing, and lodging, which may be purchased with it, are necessarily reserved for the latter. The consumption is the same, but the consumers are different” (Smith 1811: 240).

Here we have the clear idea that money saved is spent again on capital goods investment and consumed by a different set of people: those to whom the invested money has now become income.

According to Smith, savings are “immediately employed as a capital” and thus consumed. That is to say, money not spent on consumption will be invested in capital goods projects and done so relatively quickly.

This we have here a version of Say’s law, at least as it was formulated by some of the later Classical economists.

Let us look at how Say’s law was formulated by the Classical economists, as defined by Thomas Sowell (1994: 39–41):

“(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill].

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

(3) Investment is only an internal transfer, not a net reduction, of aggregate demand. The same amount that could have been spent by the thrifty consumer will be spent by the capitalists and/or the workers in the investment goods sector [John Stuart Mill].

(4) In real terms, supply equals demand ex ante [= “before the event”], since each individual produces only because of, and to the extent of, his demand for other goods. (Sometimes this doctrine was supported by demonstrating that supply equals demand ex post.) [James Mill.]

(5) A higher rate of savings will cause a higher rate of subsequent growth in aggregate output [James Mill and Adam Smith].

(6) Disequilibrium in the economy can exist only because the internal proportions of output differ from consumer’s preferred mix—not because output is excessive in the aggregate” [Say, Ricardo, Torrens, James Mill] (Sowell 1994: 39–41).

Proposition 6 – that individual markets can be in disequilibrium, but the overall demand, including demand for commodities not fulfilled, is balanced with the value of aggregate supply – does not explicitly appear in Adam Smith, as far as I am aware.

Yet both propositions (2) and (3) appear to be quite clearly in Adam Smith already.

James Mill in his treatise Commerce Defended (1807) developed the ideas in Adam Smith and those he found in the first edition of Say’s Traité d’économie politique (1803). We can quote from Mill’s Commerce Defended:

“No proposition in political [economy] seems to be more certain than this which I am going to announce, how paradoxical soever it may at first sight appear; and if it be true, none undoubtedly can be deemed of more importance. The production of commodities creates, and is the one and universal cause which creates a market for the commodities produced. Let us but consider what is meant by a market.

Is any thing else understood by it than that something is ready to be exchanged for the commodity which we would dispose of? When goods are carried to market what is wanted is somebody to buy. But to buy, one must have wherewithal to pay. It is obviously therefore the collective means of payment which exist in the whole nation that constitute the entire market of the nation. But wherein consist the collective means of payment of the whole nation? Do they not consist in its annual produce, in the annual revenue of the general mass of its inhabitants? But if a nation’s power of purchasing is exactly measured by its annual produce, as it undoubtedly is; the more you increase the annual produce, the more by that very act you extend the national market, the power of purchasing and the actual purchases of the nation. Whatever be the additional quantity of goods therefore which is at any time created in any country, an additional power of purchasing, exactly equivalent, is at the same instant created; so that a nation can never be naturally overstocked either with capital or with commodities; as the very operation of capital makes a vent for its produce.

Thus to recur to the example which we have already analyzed; fresh goods to the amount of £5,500 were prepared for the market in consequence of the application of the £5000 saved by the landholder. But what then? have we not seen that the annual produce of the country was increased; that is, the market of the country widened, to the extent of £5,500, by the very same operations? Mr. Spence in one place advises his reader to consider the circumstances of a country in which all exchange should be in the way of barter, as the idea of money frequently tends to perplex. If he will follow his own advice on this occasion, he will easily perceive how necessarily production creates a market for produce. When money is laid out of the question, is it not in reality the different commodities of the country, that is to say, the different articles of the annual produce, which are annually exchanged against one another? Whether these commodities are in great quantities or in small, that is to say, whether the country is rich or poor, will not one half of them always balance the other? and is it not the barter of one half of them with the other which actually constitutes the annual purchases and sales of the country? Is it not the one half of the goods of a country which universally forms the market for the other half, and vice versa? And is this a market that can ever be overstocked? Or can it produce the least disorder in this market whether the goods are in great or in small quantity? All that here can ever be requisite is that the goods should be adapted to one another; that is to say, that every man who has goods to dispose of should always find all those different sorts of goods with which he wishes to supply himself in return.

What is the difference when the goods are in great quantity and when they are in small? Only this, that in the one case the people are liberally supplied with goods, in the other that they are scantily; in the one case that the country is rich, in the other that it is poor: but in the one case, as well as in the other, the whole of the goods will be exchanged, the one half against the other; and the market will always be equal to the supply. Thus it appears that the demand of a nation is always equal to the produce of a nation. This indeed must be so; for what is the demand of a nation? The demand of a nation is exactly its power of purchasing. But what is its power of purchasing? The extent undoubtedly of its annual produce. The extent of its demand therefore and the extent of its supply are always exactly commensurate. Every particle of the annual produce of a country falls as revenue to somebody. But every individual in the nation uniformly makes purchases, or does what is equivalent to making purchases, with every farthing’s worth which accrues to him. All that part which is destined for mere consumption is evidently employed in purchases. That too which is employed as capital is not less so. It is either paid as wages to labourers, who immediately buy with it food and other necessaries, or it is employed in the purchase of raw materials. The whole annual produce of the country, therefore, is employed in making purchases. But as it is the whole annual produce too which is offered to sale, it is visible that the one part of it is employed in purchasing the other; that how great soever that annual produce may be it always creates a market to itself; and that how great soever that portion of the annual produce which is destined to administer to reproduction, that is, how great soever the portion employed as capital, its effects always are to render the country richer, and its inhabitants more opulent, but never to confuse or to overload the national market. I own that nothing appears to me more completely demonstrative than this reasoning.

It may be necessary, however, to remark, that a nation may easily have more than enough of any one commodity, though she can never have more than enough of commodities in general. The quantity of any one commodity may easily be carried beyond its due proportion; but by that very circumstance is implied that some other commodity is not provided in sufficient proportion. What indeed is meant by a commodity's exceeding the market? Is it not that there is a portion of it for which there is nothing that can be had in exchange. But of those other things then the proportion is too small. A part of the means of production which had been applied to the preparation of this superabundant commodity, should have been applied to the preparation of those other commodities till the balance between them had been established. Whenever this balance is properly preserved, there can be no superfluity of commodities, none for which a market will not be ready. This balance too the natural order of things has so powerful a tendency to produce, that it will always be very exactly preserved where the injudicious tampering of government does not prevent, or those disorders in the intercourse of the world, produced by the wars into which the inoffending part of mankind are plunged, by the folly much more frequently than by the wisdom of their rulers.

This important, and as it appears demonstrative doctrine, affords a view of commerce which ought to be very consolatory to Mr. Spence. It shews that a nation always has within itself a market equal to all the commodities of which it can possibly have to dispose; that its power of purchasing is always equivalent to its power of producing, or at least to its actual produce; and that as it never can be greater, so it never can be less. Foreign commerce, therefore, is in all cases a matter of expediency rather than of necessity. The intention of it is not to furnish a vent for the produce of the industry of the country, because that industry always furnishes a vent for itself. The intention of it is to exchange a part of our own commodities for a part of the commodities which we prefer to our own of some other nation; to exchange a set of commodities which it peculiarly suits our country to produce for a set of commodities which it peculiarly suits that other country to produce. Its use and advantage is to promote a better distribution, division and application of the labour of the country than would otherwise take place, and by consequence to render it more productive. It affords us a better, a more convenient and more opulent supply of commodities than could have been obtained by the application of our labour within ourselves, exactly in the same manner as by the free interchange of commodities from province to province within the same country, its labour is better divided and rendered more productive.” (Mill 1808 [1807]).

Both Thweatt (1979: 92–93) and Baumol (2003: 46) conclude that Adam Smith was in fact the father of what is recognisably Say’s law in Classical economics, with the major work in developing the idea conducted by James Mill, not necessarily Jean-Baptiste Say.


BIBLIOGRAPHY

Baumol, W. J. 1977. “Say’s (at Least) Eight Laws, or What Say and James Mill May Really Have Meant,” Economica n.s. 44.174: 145–161.

Baumol, W. J. 1999. “Retrospectives: Say’s Law,” Journal of Economic Perspectives 13.1: 195–204.

Baumol, W. J. 2003. “Retrospectives: Say’s Law,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, Edward Elgar Pub, Cheltenham; Northampton, Mass. 39–49.

Mill, James. 1808 [1807]. Commerce Defended. An Answer to the Arguments by which Mr. Spence, Mr. Cobbett, and Others, have Attempted to Prove that Commerce is not a Source of National Wealth. C. and R. Baldwin, London.

Smith, A. 1811. An Inquiry into the Nature and Causes of the Wealth of Nations (11 edn; vol. 1), Oliver D. Cooke, Hartford.

Sowell, T. 1994. Classical Economics Reconsidered, Princeton University Press, Princeton, N.J.

Thweatt, W. O. 1979. “Early Formulators of Say’s Law,” Quarterly Review of Economics and Business 19: 79–96.

Jean-Baptiste Say and “Say’s Law”

I take my cue from this interesting post by Gene Callahan (“Did Keynes Mischaracterize Say’s Law?,” September 12, 2012).

So how did Jean-Baptiste Say (1767–1832) actually define his “law of markets” (or “loi des débouchés,” in French)?

Note that I am not talking about how later Classical economists defined or formulated Say’s Law, and it is possible to argue that they did so better than Say himself ever did. Thomas Sowell (1994: 39–41) argues that, in Classical economics, Say’s law can be expressed by these propositions:

“(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill].

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

(3) Investment is only an internal transfer, not a net reduction, of aggregate demand. The same amount that could have been spent by the thrifty consumer will be spent by the capitalists and/or the workers in the investment goods sector [John Stuart Mill].

(4) In real terms, supply equals demand ex ante [= “before the event”], since each individual produces only because of, and to the extent of, his demand for other goods. (Sometimes this doctrine was supported by demonstrating that supply equals demand ex post.) [James Mill.]

(5) A higher rate of savings will cause a higher rate of subsequent growth in aggregate output [James Mill and Adam Smith].

(6) Disequilibrium in the economy can exist only because the internal proportions of output differ from consumer’s preferred mix—not because output is excessive in the aggregate” [Say, Ricardo, Torrens, James Mill] (Sowell 1994: 39–41).

So this is Say’s law, according to the Classical economists.
But one will search in vain for anything as explicit and clear as these ideas in the writings of Say himself.

The question of how Say defined what was later called Say’s Law is complex, because Say produced different versions of the “law of markets” in different works, and even in different editions of the same work.

One can find the following versions of the law:

(1) in the first edition of Say’s Traité d’économie politique (1803; or the Treatise on Political Economy in English), where the “law of markets” is not completely or properly formulated;

(2) in the second edition of Traité d’économie politique/Treatise on Political Economy (published in 1814) where we have a revised version of Say’s law in its recognisable form (Baumol 1977: 147). It is unclear to me whether Say revised this even further in the 3rd edition (1817), 4th (1819), and 5th edition (1826) of the Treatise. The 6th edition, with Say’s final corrections, was edited by his son Horace Émile Say in 1846.

(3) a summary in Say’s Catechism of Political Economy (1816: 103–105).

So when anyone talks about how Jean-Baptiste Say defined Say’s law, one must ask: in what work and when?

For English speaking people, I suspect the most accessible version is the English translation of the 4th edition by C. R. Prinsep and C. C. Biddle called A Treatise on Political Economy, or, The Production, Distribution, and Consumption of Wealth (Wells and Lilly, Boston, 1821).

The relevant part of text is as follows (with yellow highlighting of important passages):

Chapter XV
Of the Vent or Demand for Products

It is common to hear adventurers in the different channels of industry assert, that their difficulty lies not in the production, but in the disposal of commodities; that products would always be abundant, if there were but a ready demand, or market for them. When the demand for their commodities is slow, difficult, and productive of little advantage, they pronounce money to be scarce; the grand object of their desire is, a consumption brisk enough to quicken sales and keep up prices. But ask them what peculiar causes and circumstances facilitate the demand for their products, and you will soon perceive that most of them have extremely vague notions of these matters; that their observation of facts is imperfect, and their explanation still more so; that they treat doubtful points as matter of certainty, often pray for what is directly opposite to their interests, and importunately solicit from authority a protection of the most mischievous tendency.

To enable us to form clear and correct practical notions in regard to markets for the products of industry, we must carefully analyse the best established and most certain facts, and apply to them the inferences we have already deduced from a similar way of proceeding; and thus perhaps we may arrive at new and important truths, that may serve to enlighten the views of the agents of industry, and to give confidence to the measures of governments anxious to afford them encouragement.

A man who applies his labour to the investing of objects with value by the creation of utility of some sort, can not expect such a value to be appreciated and paid for, unless where other men have the means of purchasing it. Now, of what do these means consist? Of other values of other products, likewise the fruits of industry, capital, and land. Which leads us to a conclusion that may at first sight appear paradoxical, namely, that it is production which opens a demand for products.

Should a tradesman say, “I do not want other products for my woollens, I want money,” there could be little difficulty in convincing him that his customers could not pay him in money, without having first procured it by the sale of some other commodities of their own. “Yonder farmer,” he may be told, “will buy your woollens, if his crops be good, and will buy more or less according to their abundance or scantiness; he can buy none at all, if his crops fail altogether. Neither can you buy his wool nor his corn yourself, unless you contrive to get woollens or some other article to buy withal. You say, you only want money; I say, you want other commodities, and not money. For what, in point of fact, do you want the money? Is it not for the purchase of raw materials or stock for your trade, or victuals for your support? Wherefore, it is products that you want, and not money. The silver coin you will have received on the sale of your own products, and given in the purchase of those of other people, will the next moment execute the same office between other contracting parties, and so from one to another to infinity; just as a public vehicle successively transports objects one after another. If you can not find a ready sale for your commodity, will you say, it is merely for want of a vehicle to transport it? For, after all, money is but the agent of the transfer of values. Its whole utility has consisted in conveying to your hands the value of the commodities, which your customer has sold, for the purpose of buying again from you; and the very next purchase you make, it will again convey to a third person the value of the products you may have sold to others. So that you will have bought, and every body must buy, the objects of want or desire, each with the value of his respective products transformed into money for the moment only. Otherwise, how could it be possible that there should now be bought and sold in France five or six times as many commodities, as in the miserable reign of Charles VI? Is it not obvious, that five or six times as many commodities must have been produced, and that they must have served to purchase one or the other?”

Thus, to say that sales are dull, owing to the scarcity of money, is to mistake the means for the cause; an error that proceeds from the circumstance, that almost all produce is in the first instance exchanged for money, before it is ultimately converted into other produce: and the commodity, which recurs so repeatedly in use, appears to vulgar apprehensions the most important of commodities, and the end and object of all transactions, whereas it is only the medium. Sales cannot be said to be dull because money is scarce, but because other products are so. There is always money enough to conduct the circulation and mutual interchange of other values, when those values really exist. Should the increase of traffic require more money to facilitate it, the want is easily supplied, and is a strong indication of prosperity a proof that a great abundance of values has been created, which it is wished to exchange for other values. In such cases, merchants know well enough how to find substitutes for the product serving as the medium of exchange or money*; and money itself soon pours in, for this reason, that all produce naturally gravitates to that place where it is most in demand. It is a good sign when the business is too great for the money; just in the same way as it is a good sign when the goods are too plentiful for the warehouses.

* By bills at sight or after date, bank-notes, running credits, write-offs, &c. as at London and Amsterdam.

When a superabundant article can find no vent, the scarcity of money has so little to do with the obstruction of its sale, that the sellers would gladly receive its value in goods for their own consumption at the current price of the day: they would not ask for money, or have any occasion for that product, since the only use they could make of it would be to convert it forthwith into articles of their own consumption.

This observation is applicable to all cases, where there is a supply of commodities or of services in the market. They will universally find the most extensive demand in those places, where the most of values are produced; because in no other places are the sole means of purchase created, that is, values. 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.

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.

For this reason, a good harvest is favourable, not only to the agriculturist, but likewise to the dealers in all commodities generally. The greater the crop, the larger are the purchases of the growers. A bad harvest, on the contrary, hurts the sale of commodities at large. And so it is also with the products of manufacture and commerce. The success of one branch of commerce supplies more ample means of purchase, and consequently opens a market for the products of all the other branches; on the other hand, the stagnation of one channel of manufacture, or of commerce, is felt in all the rest.

But it may be asked, if this be so, how does it happen, that there is at times so great a glut of commodities in the market, and so much difficulty in finding a vent for them? Why cannot one of these superabundant commodities be exchanged for another? I answer that the glut of a particular commodity arises from its having outrun the total demand for it in one or two ways; either because it has been produced in excessive abundance, or because the production of other commodities has fallen short.

It is because the production of some commodities has declined, that other commodities are superabundant. To use a more hackneyed phrase, people have bought less, because they have made less profit; and they have made less profit for one or two causes; either they have found difficulties in the employment of their productive means, or these means have themselves been deficient.

It is observable, moreover, that precisely at the same time that one commodity makes a loss, another commodity is making excessive profit. And, since such profits must operate as a powerful stimulus to the cultivation of that particular kind of products, there must needs be some violent means, or some extraordinary cause, a political or natural convulsion, or the avarice or ignorance of authority, to perpetuate this scarcity on the one hand, and consequent glut on the other. No sooner is the cause of this political disease removed, than the means of production feel a natural impulse towards the vacant channels, the replenishment of which restores activity to all the others. One kind of production would seldom outstrip every other, and its products be disproportionately cheapened, were production left entirely free.

Should a producer imagine, that many other classes, yielding no material products, are his customers and consumers equally with the classes that raise themselves a product of their own; as, for example, public functionaries, physicians, lawyers, churchmen, &c., and thence infer, that there is a class of demand other than that of the actual producers, he would but expose the shallowness and superficiality of his ideas. A priest goes to a shop to buy a gown or a surplice; he takes the value, that is to make the purchase, in the form of money. Whence had he that money? From some tax-gatherer who has taken it from a tax-payer. But whence did this latter derive it? From the value he has himself produced. This value, first produced by the tax-payer, and afterwards turned into money, and given to the priest for his salary, has enabled him to make the purchase. The priest stands in the place of the producer, who might himself have laid the value of his product on his own account, in the purchase, perhaps, not of a gown or surplice, but of some other more serviceable product. The consumption of the particular product, the gown or surplice, has but supplanted that of some other product. It is quite impossible that the purchase of one product can be affected, otherwise than by the value of another.

From this important truth may be deduced the following important conclusions: —

1. That, in every community the more numerous are the producers, and the more various their productions, the more prompt, numerous, and extensive are the markets for those productions; and, by a natural consequence, the more profitable are they to the producers; for price rises with the demand. But this advantage is to be derived from real production alone, and not from a forced circulation of products; for a value once created is not augmented in its passage from one hand to another, nor by being seized and expended by the government, instead of by an individual. The man, that lives upon the productions of other people, originates no demand for those productions; he merely puts himself in the place of the producer, to the great injury of production, as we shall presently see.

2. That each individual is interested in the general prosperity of all, and that the success of one branch of industry promotes that of all the others. In fact, whatever profession or line of business a man may devote himself to, he is the better paid and the more readily finds employment, in proportion as he sees others thriving equally around him. A man of talent, that scarcely vegetates in a retrograde state of society, would find a thousand ways of turning his faculties to account in a thriving community that could afford to employ and reward his ability. A merchant established in a rich and populous town, sells to a much larger amount than one who sets up in a poor district, with a population sunk in indolence and apathy.

What could an active manufacturer, or an intelligent merchant, do in a small deserted and semi-barbarous town in a remote corner of Poland or Westphalia? Though in no fear of a competitor, he could sell but little, because little was produced; whilst at Paris, Amsterdam, or London, in spite of the competition of a hundred dealers in his own line, he might do business on the largest scale. The reason is obvious: he is surrounded with people who produce largely in an infinity of ways, and who make purchases, each with his respective products, that is to say, with the money arising from the sale of what he may have produced.

This is the true source of the gains made by the towns’ people out of the country people, and again by the latter out of the former; both of them have wherewith to buy more largely, the more amply they themselves produce. A city, standing in the centre of a rich surrounding country, feels no want of rich and numerous customers’ and, on the other hand, the vicinity of an opulent city gives additional value to the produce of the country. The division of nations into agricultural, manufacturing, and commercial, is idle enough. For the success of a people in agriculture is a stimulus to its manufacturing and commercial prosperity; and the flourishing condition of its manufacture and commerce reflects a benefit upon its agriculture also.

The position of a nation, in respect of its neighbours, is analogous to the relation of one of its provinces to the others, or of the country to the town; it has an interest in their prosperity, being sure to profit by their opulence. The government of the United States, therefore, acted most wisely, in their attempt, about the year 1802, to civilize their savage neighbours, the Creek Indians. The design was to introduce habits of industry amongst them, and make them producers capable of carrying on a barter trade with the States of the Union; for there is nothing to be got by dealing with a people that have nothing to pay. It is useful and honourable to mankind, that one nation among so many should conduct itself uniformly upon liberal principles. The brilliant results of this enlightened policy will demonstrate, that the systems and theories really destructive and fallacious, are the exclusive and jealous maxims acted upon by the old European governments, and by them most impudently styled practical truths, for no other reason, as it would seem, than because they have the misfortune to put them in practice. The United States will have the honour of proving experimentally, that true policy goes hand in hand with moderation and humanity.

3. From this fruitful principle, we may draw this further conclusion, that it is no injury to the internal or national industry and production to buy and import commodities from abroad; for nothing can be bought from strangers, except with native products, which find a vent in this external traffic. Should it be objected, that this foreign produce may have been bought with specie, I answer, specie is not always a native product, but must have been bought itself with the products of native industry; so that, whether the foreign articles be paid for in specie or in home products, the vent for national industry is the same in both cases.

4. The same principle leads to the conclusion, that the encouragement of mere consumption is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire of consumption; and we have seen that production alone, furnishes those means. Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption.

For the same reason that the creation of a new product is the opening of a new market for other products, the consumption or destruction of a product is the stoppage of a vent for them. This is no evil where the end of the product has been answered, by its destruction, which end is the satisfying of some human want, or the creation of some new product designed for such a satisfaction. Indeed, if the nation be in a thriving condition, the gross national re-production exceeds the gross consumption. The consumed products have fulfilled their office, as it is natural and fitting they should; the consumption, however, has opened no new market, but just the reverse.

Having once arrived at the clear conviction, that the general demand for products is brisk in proportion to the activity of production, we need not trouble ourselves much to inquire towards what channel of industry production may be most advantageously directed. The products created give rise to various degrees of demand, according to the wants, the manners, the comparative capital, industry, and natural resources of each country; the article most in request, owing to the competition of buyers, yields the best interest of money to the capitalist, the largest profits to the adventurer, and the best wages to the labourer; and the agency of their respective services is naturally attracted by these advantages towards those particular channels.

In a community, city, province, or nation, that produces abundantly, and adds every moment to the sum of its products, almost all the branches of commerce, manufacture, and generally of industry, yield handsome profits, because the demand is great, and because there is always a large quantity of products in the market, ready to bid for new productive services. And, vice versa, wherever, by reason of the blunders of the nation or its government, production is stationary, or does not keep pace with consumption, the demand gradually declines, the value of the product is less than the charges of its production; no productive exertion is properly rewarded; profits and wages decrease; the employment of capital becomes less advantageous and more hazardous; it is consumed piecemeal, not through extravagance, but through necessity, and because the sources of profit are dried up. The labouring classes experience a want of work; families before in tolerable circumstances, are more cramped and confined; and those before in difficulties are left altogether destitute. Depopulation, misery, and returning barbarism, occupy the place of abundance and happiness. Such are the concomitants of declining production, which are only to be remedied by frugality, intelligence, activity, and freedom. (Say 1821: 107–119).

We could sum up the fundamental principles of this chapter as follows:

(1) that the “origin of the means” of purchasing products is the value of other products: “production ... opens a demand for products.” The means to attain the money for purchasing products comes from “having first procured it by the sale of some other commodities.”

(2) that producers do not really want money, but other goods. Therefore Say analyses a capitalist economy in terms of barter transactions, by which the money is merely a “veil.”

(3) money is merely used to purchase more commodities:

“The silver coin you will have received on the sale of your own products, and given in the purchase of those of other people, will the next moment execute the same office between other contracting parties, and so from one to another to infinity.”

(4) that the production and sale of a product creates demand for other products:

“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.”

It is particularly important to note the last sentence:

“Thus, the mere circumstance of the creation of one product immediately opens a vent for other products.”

By “vent” we can understand “demand”: so Say here is expressing the idea that the mere production of a commodity opens demand for other products.

Thus the sentence “supply creates its own demand” appears to be a legitimate way of expressing this idea.

For Baumol (1977: 158–159), this passage also demonstrates that Say had formulated and expressed a version of “Say’s Equality,” one of the two versions of Say’s law. According to Baumol, Say’s equality:

“admits the possibility of (brief) periods of disequilibrium during which the total demand for goods may fall short of the total supply, but maintains that there exist reliable equilibrating forces that must soon bring the two together.” (Baumol 1977: 146).

So what is wrong with the ideas described above?

It is easy to see why and how Say was in error:

(1) Say’s analysis ignores the role of endogenous money and the way in which capitalist banking systems and businesses create new money by debt instruments: whether bills of exchange, promissory notes, cheques, or fractional reserve bank notes.

The origin of the “means of purchasing” many commodities is not production, but debt, or new money created by the credit/debt operations of fractional reserve banks, and even things as simple as negotiable bills of exchange and other negotiable debt instruments.

(2) There is a flaw in Say’s analysis: the diversion of money into purchasing of financial assets and real assets on secondary markets, for speculative purposes. That becomes a major kind of spending for those of extreme wealth.

The money used to buy such assets can then flow to other speculators, who buy new financial assets or hold money idle in the process of using it in further speculation on assets. Thus there is a “speculative demand” for money that can rise or fall.

Money can be (1) held idle, (2) used to buy commodities or (3) used to buy assets (whether real or financial) on secondary markets.

(3) Say subscribed to the view that money cannot provide direct utility:

“For, after all, money is but the agent of the transfer of values. Its whole utility has consisted in conveying to your hands the value of the commodities, which your customer has sold, for the purpose of buying again from you; and the very next purchase you make, it will again convey to a third person the value of the products you may have sold to others.”

This is made clear to us by Say’s statement: “[sc. the] whole utility [sc. of money] has consisted in conveying to your hands the value of the commodities.” This is a world where nobody holds money for significant periods of time because money can have no utility, except in what it can purchase in terms of commodities.

But that is not the world we live in. We live in a world of uncertainty. In the face of uncertainty, money can yield direct utility (Graziani 2003: 11):

“In an uncertain world, the possession of money and other nonproducible liquid assets provides utility by protecting the holder from fear of being unable to meet future liabilities” (Davidson 2003: 236).

Possession of money gives direct satisfaction or utility in providing protection against uncertainty, and gives us the satisfaction or feeling of assurance that we will be able to discharge expected and unexpected future liabilities or obligations.

Appendix: The Law of Markets in Say’s Catechism of Political Economy

I reproduce below the relevant section of Say’s Catechism of Political Economy (1816) where he discusses the law of markets:

CHAPTER XX.
On Markets.

What do you mean by markets?

Before answering this question, I beg you to remark, that those who engage in production are seldom occupied with more than one product, or at most a small number of products. A tanner produces nothing but leather; a clothier, cloth; one merchant deals in wine, another imports foreign goods; one cultivator raises the vine, another corn, a third cattle.

What consequences do you draw from that?

That none of them can enjoy the greatest part of the various articles for which he has occasion, except by means of exchanging the greater part of his own productions for those which he desires to consume: so that the greater part of the consumptions of society take place only in consequence of an exchange.

But when we are able easily to exchange our own productions for those which we want, we are said to have found ready markets for our products.

On what does the ready sale of any particular article depend?

On the vivacity of the demand for it.

On what does the vivacity of the demand depend?

On two motives, which are—1st. The utility of the product, that is, the necessity the consumer has for it:—2d. The quantity of other products he is able to give in exchange.

I conceive the first motive. As to the second, it appears to me that it is the quantity of money that the buyer possesses, which induces him to buy or not.

That is also true: but the quantity of money which he has, depends on the quantity of product with which he has been able to buy this money.

Could he not obtain the money otherwise, than by having acquired it by products?

No.

If he had received the money from his tenants ... .?

His tenant had received it from the sale of part of the products to which the earth had contributed.

If he had received the interest of a capital lent — ?

The undertaker who employed that capital had received the money which he paid, on the sale of a part of the products to which his capital had concurred.

If the purchaser had obtained this money by gift or inheritance — ?

The giver, or he from whom the giver had obtained it, had it in exchange for some product.

In every case the money, with which any product is purchased, must have been produced by the sale of another product; and the purchase may be considered as an exchange in which the purchaser gives that which he has produced, (or that which another has produced for him), and in which he receives the thing bought.

What do you conclude from this?

That the more the purchasers produce, the more they have to purchase with, and that the productions of the one procure purchasers to the other.

It appears to me, that if the buyers only purchased by means of their products, they have generally more products than money to offer in payment.

Every producer asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product; for we do not consume money, and it is not sought after in ordinary cases to conceal it: thus, when a producer desires to exchange his product for money, he may be considered as already asking for the merchandise which he proposes to buy with this money. It is thus that the producers, though they have all of them the air of demanding money for their goods, do in reality demand merchandise for their merchandise.

Then the more merchandise there is produced, the more animated is the demand for merchandise?

Without doubt. It is for this reason that countries, which are but little civilized, present few markets, and those for products but little varied; while in populous, industrious, and productive districts, the sales are repeated and considerable.

It is not necessary then, in order that markets should he extended and multiplied, to look for them in foreign countries?

No; it is sufficient that other products should be multiplied in our own country.

What is it that multiplies foreign markets?

The riches of neighbouring nations, and the activity of their production.

What consequence do you draw from that?

That each of them is interested in the prosperity of his neighbour, and every nation in the prosperity of all others: for it is only those who produce much that can readily give you any thing in exchange for your products: or which comes to the same thing, that can give you the value of them in money.

What other consequence follows from this?

That riches are not exclusive: that, so far from that which another man, or another people gains, being a loss to you, their gains are favourable to you; that it is only necessary for you to produce, not that which they produce easier than you, but that which they cannot fail to demand from you by means of their products; and that wars, entered into for commerce, will appear so much the more senseless as we become better informed. (Say 1816: 102–106).

BIBLIOGRAPHY

Davidson, P. 2003. “Keynes’ General Theory,” in J. E. King (ed.), Elgar Companion to Post Keynesian Economics. Edward Elgar Publishing, Cheltenham, UK and Northampton, MA. 229–237.

Graziani, A. 2003. The Monetary Theory of Production. Cambridge University Press, Cambridge.

Say, Jean Baptiste. 1803. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (1st edn.). De Chapelet, Paris.

Say, Jean Baptiste. 1814. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (2nd edn.). Antoine-Augustin Renouard, Paris.

Say, Jean Baptiste. 1816. Catechism of Political Economy, or, Familiar Conversations on the Manner in which Wealth is Produced, Distributed, and Consumed in Society (trans. J. Richter). Sherwood, Neely, and Jones, London.

Say, Jean Baptiste. 1817. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (3rd edn.). Chez Deterville, Paris.

Say, Jean Baptiste. 1819. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (4th edn.). Deterville, Paris.

Say, Jean Baptiste. 1821. A Treatise on Political Economy, or, The Production, Distribution, and Consumption of Wealth (trans. from 4th edn by C.R. Prinsep with notes by the translator, with a translation of the introduction and additional notes by C. C. Biddle). Wells and Lilly, Boston.

Say, Jean Baptiste. 1826. Traité d’économie politique, ou, Simple exposition de la manière dont se forment, se distribuent et se consomment les richesses (5th edn.). Rapilly, Paris.

Sowell, T. 1994. Classical Economics Reconsidered. Princeton University Press, Princeton, N.J.

Say Repudiated Say’s Law

This is an interesting point that is rarely mentioned by the apologists for Say’s law. Say did in fact acknowledge that downturns in the business cycle could happen. Baumol has noted:

“Say and other writers recognized that the zero value of the sum of excess demands, or supply creates its own demand (“Say’s identity”), may not hold in the short run. Say’s passage in his Letters to Malthus … even suggests an explanation – a desire to hoard or, as we would now put it, a temporary excess demand for money. But they thought the market would fairly quickly and automatically restore equilibrium” (Baumol 1999: 201).

Thomas Sowell, who is usually regarded as the scholarly expert on Say’s law*, also states that Say “admitted to Malthus that Say’s Law was ‘subject to some restrictions’ and to Sismondi that the fifth edition of his Traite contained a ‘concession’ to the latter’s theory of equilibrium income” (Sowell 2006: 31).

We can see that eventually Say partly (though not fully) understood what Keynes himself believed: changes in liquidity preference can cause insufficient demand and involuntary unemployment. Both Say and J. S. Mill in some writings even appear to have allowed that failures in aggregate demand can cause recession (Hollander 2005: 383-284).

While Say’s recantation is of historical interest, it actually does not provide good grounds in itself for dismissing Say’s law. Why? The reason is that it is possible in principle for Say’s law to be true, even if the original inventor of it later rejected it. E.g., suppose Copernicus rejected the heliocentric theory of the solar system in later life: such a hypothetic repudiation in itself does not in fact provide good evidence for rejection of the heliocentric theory. What matter are arguments and evidence. The evidence for the heliocentric theory is overwhelming. The evidence against Say’s law is also overwhelming:

“The Myth of Say’s Law,” October 7, 2010.

This is why it should be rejected.

NOTE
* N.B. I am not telling readers to believe this just because Sowell says so. So, to the various libertarian readers of my blog: don’t waste my time invoking the argument from authority fallacy; it’s irrelevant. Moreover, not all arguments from authority are necessarily fallacious at all.

BIBLIOGRAPHY
Baumol, W. J. 1999. “Retrospectives: Say’s Law,” Journal of Economic Perspectives 13.1: 195–204.

Hollander, S. 2005. “Review of Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle,” History of Political Economy 37.2: 382–385.

Sowell, T. 2006. On Classical Economics. Yale University Press, New Haven, Conn.

Say’s Law Presupposes Aggregate Demand as a Meaningful Concept

It never ceases to amaze me to see certain Austrians and pro-free market libertarians making statements like this:

“When Krugman uses ‘demand,’ he means ‘aggregate demand,’ which economically speaking is a nonsensical term. There is no such thing as ‘aggregate demand’ …”

In fact, the concept of aggregate demand is presupposed by Say’s law, and if aggregate demand is a “nonsensical term,” “not meaningful” or if “there is no such thing,” then Say’s law utterly collapses with it.

In modern formulations of Say’s law, there are two main variants:

(1) Say’s Identity
According to Baumol (1977: 146), this

“is the assertion that no one ever wants to hold money for any significant amount of time, so that, as a result, every offer (supply) of a quantity of goods automatically constitutes a demand for a bundle of some other items of equal market value.”

(2) Say’s Equality
Again, according to Baumol (1977: 146), Say’s Equality

“admits the possibility of (brief) periods of disequilibrium during which the total demand for goods may fall short of the total supply, but maintains that there exist reliable equilibrating forces that must soon bring the two together.”

Say’s equality asserts that, in a given time period (say a year), total factor payments from production (= aggregate supply) will be spent on consumption or capital goods/business investment in new commodity output (= aggregate demand), and this either will be equal or tend to be equal to the value of aggregate supply in the short run. How can anyone seriously deny that the total demand for final goods and services in an economy is not a fundamental and meaningful concept here?

If we turn to Thomas Sowell (1994: 39–41), one of the supposed experts on Say’s law, we can see his summary of what the Classical economists meant by the expression:

“(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill].

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

(3) Investment is only an internal transfer, not a net reduction, of aggregate demand. The same amount that could have been spent by the thrifty consumer will be spent by the capitalists and/or the workers in the investment goods sector [John Stuart Mill].

(4) In real terms, supply equals demand ex ante [= “before the event”], since each individual produces only because of, and to the extent of, his demand for other goods. (Sometimes this doctrine was supported by demonstrating that supply equals demand ex post.) [James Mill.]

(5) A higher rate of savings will cause a higher rate of subsequent growth in aggregate output [James Mill and Adam Smith].

(6) Disequilibrium in the economy can exist only because the internal proportions of output differ from consumer’s preferred mix—not because output is excessive in the aggregate” [Say, Ricardo, Torrens, James Mill] (Sowell 1994: 39–41).

As we can see, propositions 3 and 4 above require aggregate demand as a fundamental concept. If there is no such thing as aggregate demand, how could these propositions even be true?

BIBLIOGRAPHY

Baumol, W. J. 1977. “Say’s (at Least) Eight Laws, or What Say and James Mill May Really Have Meant,” Economica n.s. 44.174: 145–161.

Sowell, T. 1994. Classical Economics Reconsidered, Princeton University Press, Princeton, N.J.

The Myth of Say’s Law

Jean Baptiste Say (1767–1832) is credited with Say’s law or Say’s law of markets (“loi des débouchés”, in French), of which Walras’ law appears to be a modern neoclassical restatement. Although Say did not use the expression “law” to describe his views, his writings on this subject are to be found in A Treatise on Political Economy (or the Traité d’économie politique in French), Book 1, Chapter 15 (Say 1832: 132–140; the first edition of which was published in 1803) and in the Catechism of Political Economy (Say 1816: 103–105).

In modern formulations of Say’s law, there are two main variants of it:

(1) Say’s Identity
According to Baumol (1977: 146), this

“is the assertion that no one ever wants to hold money for any significant amount of time, so that, as a result, every offer (supply) of a quantity of goods automatically constitutes a demand for a bundle of some other items of equal market value.”

(2) Say’s Equality
Again, according to Baumol (1977: 146), Say’s Equality

“admits the possibility of (brief) periods of disequilibrium during which the total demand for goods may fall short of the total supply, but maintains that there exist reliable equilibrating forces that must soon bring the two together.”

The issue of what J. B. Say himself thought is complicated by the fact that there was more than one edition of his Treatise on Political Economy. The second edition was published in 1814 and has a revised version of Say’s law (Baumol 1977: 147), while in the first edition the law of markets is not so complete. It was only in the second edition of the Treatise on Political Economy (1814) that Say’s discussion is identifiable as a “form of a type of Say’s equality, i.e., supply and demand are always equated by a rapid and powerful equilibration mechanism” (Baumol 1977: 159).

A reading of the modern interpreters of the law of markets make it clear that by Say’s equality, Say did not mean that downturns in the business cycle cannot occur. Say was attempting to show that there could not be a general glut or general overproduction of all commodities, and that there could never be an overall shortfall in aggregate demand. Say’s view was compatible with the possibility of downturns caused by individual commodities being overproduced. That is, there could be specific but limited types of commodities where overproduction occurred relative to demand for those commodities. Say’s law of markets appears to be compatible with short-term gluts of specific commodities. As Steve Keen has argued:

“[sc. before Keynes] mainstream economics did not believe there were any intractable macroeconomic problems. Individual markets might be out of equilibrium at any one time – and this could include the market for labour or the market for money – but the overall economy, the sum of all those individual markets, was bound to be balanced” (Keen 2001: 189).

On the neoclassical and classical view, there could not be a downturn caused by an overall deficiency in aggregate demand: slumps were caused by sectoral imbalances/sectoral disequilibrium or by external shocks. Aggregate supply could never exceed aggregate demand (Kates 1998: 4–5).

John Maynard Keynes in the General Theory had this to say about Say’s law:

“From the time of Say and Ricardo the classical economists have taught that supply creates its own demand;—meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product …. As a corollary of the same doctrine, it has been supposed that any individual act of abstaining from consumption necessarily leads to, and amounts to the same thing as, causing the labour and commodities thus released from supplying consumption to be invested in the production of capital wealth” (Keynes 1936: 18–19).

Keynes’ remark about the classical economists is correct (Baumol 1999: 200). For example, Adam Smith held these ideas:

“In all countries where there is tolerable security, every man of common understanding will endeavour to employ whatever stock he can command, in procuring either present enjoyment or future profit. If it is employed in procuring present enjoyment, it is a stock reserved for immediate consumption. If it is employed in procuring future profit, it must procure this profit, either by staying with him, or by going from him. In the one case it is a fixed, in the other it is a circulating capital. A man must be perfectly crazy who, where there is tolerable security, does not employ all the stock which he commands, whether it be his own, or borrowed of other people, in some one or other of those three ways.” (Smith 1811: 198).

“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 re-produce with a profit the value of their annual consumption. His revenue, we shall suppose, is paid him in money. Had he spent the whole, the food, clothing, and lodging, which the whole could have purchased, would have been distributed among the former set of people. By saving a part of it, as that part is for the sake of the profit immediately employed as a capital either by himself or by some other person, the food, clothing, and lodging, which may be purchased with it, are necessarily reserved for the latter. The consumption is the same, but the consumers are different” (Smith 1811: 240).

These passages are essentially an assertion of Say’s Identity (Baumol 1977: 158). Keynes also states:

“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” (Keynes 1936: 26).

This was perhaps a mischaracterization of Say’s actual ideas (Kates 1998; Keen 2001: 189–190). In this passage, Keynes was refuting the reformulation of Say’s law by John Stuart Mill and Alfred Marshall. Say did in fact acknowledge that downturns in the business cycle could happen. Baumol has even argued that

“Say and other writers recognized that the zero value of the sum of excess demands, or supply creates its own demand (“Say’s identity”), may not hold in the short run. Say’s passage in his Letters to Malthus … even suggests an explanation – a desire to hoard or, as we would now put it, a temporary excess demand for money. But they thought the market would fairly quickly and automatically restore equilibrium” (Baumol 1999: 201).

In other words, it appears that Say eventually partly though not fully understood what Keynes himself believed: changes in liquidity preference can cause insufficient demand and involuntary unemployment. Both Say and J. S. Mill in some writings even appear to have allowed that failures in aggregate demand can cause recession (Hollander 2005: 383-284).

However, the general view of Say and the 19th century classical economists seemed to be that recessions and involuntary unemployment could occur, but mainly by sectoral imbalances (though Hollander maintains that Say and Mill glimpsed that failures of aggregate demand might be involved), and that Say’s law of markets was the mechanism by which equilibrium was rapidly restored in a free market economy (Kates 1998: 14).

So what does all this prove? That Say’s law of markets is true? Hardly.

In fact, Keynes still refuted the version of Say’s law in J. S. Mill and Marshall, even if they did not understand Say properly.

And a careful examination of Say’s writings on demand and production shows that his reasoning is deeply flawed. A good starting point is this passage in Say’s Catechism of Political Economy (1816: 103–105):

On what does the vivacity of the demand depend?

On two motives which are—1st. The utility of the product, that is, the necessity the consumer has for it:—2nd. The quantity of other products he is able to give in exchange.

I conceive the first motive. As to the second it appears to me that it is the quantity of money that the buyer possesses which induces him to buy or not.

That is also true: but the quantity of money which he has, depends on the quantity of product with which he has been able to buy this money.

Could he not obtain the money otherwise than by having acquired it by products?

No.

If he had received the money from his tenants?

His tenant had received it from the sale of part of the products to which the earth had contributed.

If he had received the interest of a capital lent?

The undertaker who employed that capital had received the money which he paid, on the sale of a part of the products to which his capital had concurred.

If the purchaser had obtained this money by gift or inheritance—?

The giver, or he from whom the giver had obtained it, had it in exchange for some product. In every case the money, with which any product is purchased, must have been produced by the sale of another product; and the purchase may be considered as an exchange in which the purchaser gives that which he has produced, (or that which another has produced for him), and in which he receives the thing bought.

What do you conclude from this?

That the more the purchasers produce, the more they have to purchase with, and that the productions of the one procure purchasers to the other.

It appears to me, that if the buyers only purchased by means of their products, they have generally more products than money to offer in payment.

Every producer asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product; for we do not consume money, and it is not sought after in ordinary cases to conceal it: thus, when a producer desires to exchange his product for money, he may be considered as already asking for the merchandise which he proposes to buy with this money. It is thus that the producers, though they have all of them the air of demanding money for their goods, do in reality demand merchandise for their merchandise (Say 1816: 103–105).

Say believed that any short-term glut in particular commodities would be quickly eliminated.

First, Say holds that buyers of commodities cannot obtain money except by having acquired it from the sale of other commodities. This is also expressed in A Treatise on Political Economy, Book 1, Chapter 15:

“A man who applies his labour to the investing of objects with value by the creation of utility of some sort, can not expect such a value to be appreciated and paid for, unless where other men have the means of purchasing it. Now of what do these means consist? Of other values of other products, likewise the fruits of industry, capital and land. Which leads us to a conclusion that may at first sight appear paradoxical, namely, that it is production which opens a demand for products” (Say 1832: 133).

Here Say is clear that only production of other commodities provides the money to pay for “products” (a related question is what he means by “capital”: if this means investment money then it is obvious that Say naturally thinks of money as a commodity too). A form of this idea is sometimes encountered on libertarian blogs. For example, one will find Austrians asking questions such as “how could people have money if they hadn’t produced something to exchange for money?”

The answer is that without production people would have no commodities (= wealth) for consumption. They might still have money. The premise of such a question is that without prior production there is no money to purchase commodities. This commits Austrians to the view that money is a “produced” commodity. But today we live in a fiat money world. Money is no longer “commodity” money. It is not “produced” in the way that gold and silver are dug out of the ground. Today fractional reserve banking creates money through debt, and open market operations create new money in the form of bank reserves. This is the real world in which we live, and even in Say’s own time fractional reserve banking was creating fiduciary media without prior creation of commodities.

Say’s law appears to require a world where money is produced like any other commodity, and this is one condition for the law of markets to work. But the condition does not exist today: Say’s law is irrelevant to modern fiat money using economies, where money also has a store of value role.

The second fatal and ridiculous flaw in Say’s argument is the belief that “every producer asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product.”

In fact, it simply isn’t the case that producers of commodities (whether individuals or businesses) or the recipients of the money profits of the firm like workers or owners will always use the money they earn from the sale of commodities “only for the purpose of employing that money again immediately in the purchase of another product.” Money can be saved and it can become idle. Capitalism also has markets for real and financial assets. Money can flow into the purchasing of financial assets. If there are financial assets or real assets whose prices are rising, modern capitalists, producers and even workers might decide to start speculating on asset prices. This would take money away from the purchasing of commodities and instead tie it up in exchanges on asset markets, as money alternates between being (1) held idle before buying assets and (2) purchasing assets, and then being held idle again by the new owner of the money in preparation for further speculation.

Another fatal flaw in Say’s reasoning is that money has no utility and cannot be used as a store of value:

“for we do not consume money, and it is not sought after in ordinary cases to conceal it” (Say 1816: 104).

“For, after all, money is but the agent of the transfer of values. Its whole utility has consisted in conveying to your hands the value of the commodities, which your customer has sold, for the purpose of buying again from you; and the very next purchase you make, it will again convey to a third person the value of the products you may have sold to others” (Say 1832: 133).

“Money performs but a momentary function in … double exchange; and when the transaction is finally closed, it will always be found, that one kind of commodity has been exchanged for another” (Say 1832: 134).

“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” (Say 1832: 134–135).

It is clear that Say believes in neutral money, and he is deeply mistaken in thinking of money only as a neutral “veil” with no store of value function (for the concept of neutral money, see Visser 2002). Say’s analysis also ignores the role of financial markets in affecting demand for money.

It should be noted of course that Say’s ideas were later developed by the Classical economists, so Say’s law in that historical sense is not the same as the ideas found in Say’s own writings.

So what was Say’s law in its developed form and as held by modern defenders of it?

Thomas Sowell (1994: 39–41) argues that in Classical economics Say’s law can be expressed by these propositions:

“(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill].

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

(3) Investment is only an internal transfer, not a net reduction, of aggregate demand. The same amount that could have been spent by the thrifty consumer will be spent by the capitalists and/or the workers in the investment goods sector [John Stuart Mill].

(4) In real terms, supply equals demand ex ante [= “before the event”], since each individual produces only because of, and to the extent of, his demand for other goods. (Sometimes this doctrine was supported by demonstrating that supply equals demand ex post.) [James Mill.]

(5) A higher rate of savings will cause a higher rate of subsequent growth in aggregate output [James Mill and Adam Smith].

(6) Disequilibrium in the economy can exist only because the internal proportions of output differ from consumer’s preferred mix—not because output is excessive in the aggregate” [Say, Ricardo, Torrens, James Mill] (Sowell 1994: 39–41).

So this is Say’s law, according to the Classical economists.

First, it is perfectly possible that supply equals demand ex ante, which is asserted in proposition (1) and in the first statement in (4) (if one ignores the qualification “since each individual produces only because of, and to the extent of, his demand for other goods,” which does not follow at all), but to assert that it will always hold ex post is a non sequitur, without demonstrating the truth of propositions (2), (3), (5), and (6).

Unfortunately, these propositions cannot be held to be true.

Let’s start with proposition (2). Under conditions of uncertainty, money has utility (see my previous post “The Utility of Money in Post Keynesianism”, which I will use in what follows). It is deeply flawed to regard money only as a “neutral veil” that overcomes the inconveniences of direct barter. Such an idea is associated with the “neutral money axiom” (Davidson 2002: 19). In reality, people really do choose to hold money in and of itself as (1) a store of value and (2) a way of dealing with future uncertainty. Thus there is a precautionary motive for holding money, in addition to the transactions motive. Say’s law of markets requires neutral money or the idea that money only has a medium of exchange role. As Paul Davidson has argued,

“[in] an uncertain world, the possession of money and other nonproducible liquid assets provides utility by protecting the holder from fear of being unable to meet future liabilities” (Davidson 2003: 236).

The neoclassicals thought that only producible goods and services can provide utility. But money can have utility on its own account. So can liquid financial assets. The neoclassical view was that money has no utility, but only exchange value. The Austrian view also seems to be that money has no utility except for what can be obtained in exchange for it. The idea that money has no utility in itself is part of the three fundamental neoclassical axioms that Keynes rejected. The following three fundamental axioms are the basis of neoclassical economics and of Say’s law:

(1) the neutral money axiom (i.e., holding money by itself provides no utility),
(2) the gross substitution axiom, and
(3) the ergodic axiom.

If one assumes these false axioms, then one will believe that the “aggregate demand function is the same as the aggregate supply function” (Davidson 2002: 43). Post Keynesian economics requires the rejection of these axioms. In a fundamentally uncertain world, you have the problem of facing a possible lack of liquidity in the future (i.e., lack of money). This is why many people like to hold onto money, and precisely why money has utility – and in fact often has a great deal of utility.

Moreover, Keynes in the General Theory made the fundamental point that fiat money and even commodity money have special properties:

“… money has, both in the long and the short period, a zero, or at any rate a very small, elasticity of production, so far as the power of private enterprise is concerned, as distinct from the monetary authority;—elasticity of production meaning, in this context, the response of the quantity of labour applied to producing it to a rise in the quantity of labour which a unit of it will command. Money, that is to say, cannot be readily produced;—labour cannot be turned on at will by entrepreneurs to produce money in increasing quantities as its price rises in terms of the wage-unit. In the case of an inconvertible managed currency this condition is strictly satisfied. But in the case of a gold-standard currency it is also approximately so, in the sense that the maximum proportional addition to the quantity of labour which can be thus employed is very small, except indeed in a country of which gold-mining is the major industry.
Now, in the case of assets having an elasticity of production, the reason why we assumed their own-rate of interest to decline was because we assumed the stock of them to increase as the result of a higher rate of output. In the case of money, however—postponing, for the moment, our consideration of the effects of reducing the wage-unit or of a deliberate increase in its supply by the monetary authority—the supply is fixed. Thus the characteristic that money cannot be readily produced by labour gives at once some prima facie presumption for the view that its own-rate of interest will be relatively reluctant to fall; whereas if money could be grown like a crop or manufactured like a motor-car, depressions would be avoided or mitigated because, if the price of other assets was tending to fall in terms of money, more labour would be diverted into the production of money;—as we see to be the case in gold-mining countries, though for the world as a whole the maximum diversion in this way is almost negligible” (Keynes 1936: 230–231).

Money has a zero or very small elasticity of production. This means that a rise in demand for money and a rising “price” for money (i.e., an increase in its purchasing power) will not lead to businesses “producing” money by hiring workers.

The property of zero or very small elasticity of production also applies to liquid financial assets. If consumers decide to buy less producible commodities and increase their holding of money or ownership of financial assets, unemployment will result in some sectors as demand for commodities declines. The price of financial assets will rise and it is possible that the price of money could also rise. But private businesses cannot hire the unemployed to “produce” or “manufacture” more money or financial assets to exploit profit opportunities in the high-price liquid assets (Davidson 2010: 255–256).

In classical and neoclassical economics, however, money is held to be a commodity (e.g., gold, silver or some other type of commodity). If the demand for commodity money rises, neoclassical theory says it can be “produced” like any other commodity by hiring unemployed workers. But this idea is utterly false in a world where the commodity money consists of rare metals like gold or silver, and certainly false in the modern world of fiat money.

The second special property of money and liquid financial assets is that they have zero or near zero elasticity of substitution:

“The second differentia of money is that it has an elasticity of substitution equal, or nearly equal, to zero which means that as the exchange value of money rises there is no tendency to substitute some other factor for it;—except, perhaps, to some trifling extent, where the money-commodity is also used in manufacture or the arts. This follows from the peculiarity of money that its utility is solely derived from its exchange-value, so that the two rise and fall pari passu, with the result that as the exchange value of money rises there is no motive or tendency, as in the case of rent-factors, to substitute some other factor for it.
Thus, not only is it impossible to turn more labour on to producing money when its labour-price rises, but money is a bottomless sink for purchasing power, when the demand for it increases, since there is no value for it at which demand is diverted—as in the case of other rent-factors—so as to slop over into a demand for other things” (Keynes 1936: 231).

“money has (or may have) zero (or negligible) elasticities both of production and of substitution” (Keynes 1936: 234).

Financial assets are not gross substitutes for commodities. The neoclassical gross substitution axiom is wrong. In both a commodity money and fiat money world, savings are held in the form of money and non-producible financial assets. An increase in demand for money and non-producible financial assets and rising prices of such liquid assets will not spill over into a demand for relatively cheaper commodities, because the elasticity of substitution of money and liquid assets is zero or near zero (Davidson 2010: 256–257; Davidson 2002: 44–45; see also Hahn 1977: 31). Even if wages and prices were perfectly flexible, there could still be “leakages” in aggregate supply in the form of speculation on financial asset markets which would be “non-employment inducing demand” (Davidson 2010: 257; Hahn 1977: 37).

Thus a shortfall in aggregate demand is possible.

Moreover, there are other obvious leakages from the aggregate income arising from production that result in insufficient aggregate demand. There is no necessary reason why all the income will be spent on commodities in a particular time period, or even at all. Savings and changes in the rate of saving may happen.

Sowell’s proposition (3) above is also unacceptable. Classical advocates of Say’s law argued that saving would result in reasonably quick consumption or investment, but that simply does not follow. Money savings can become idle balances (“hoards,” in the terminology of Keynes). But even idle balances of money are not the only cause of a shortfall in demand. We can list the various “leakages” from aggregate income as described above, as well as some other ones, as follows:

(1) People desire to hold money as a hedge against future uncertainty (the “precautionary motive,” in Keynes’ theory), and since expectations are subjective such holdings can vary. In depressions or recessions, people may choose to hold more of their money as cash. In underdeveloped and pre-modern economies, hoarding can take the form of holding money physically outside of banks as cash or coin (Gootzeit 2003: 182). In the Great Depression, the rise in the hoarding of money was a significant factor, as it probably was in pre-1914 downturns in the business cycle (Wicker 1996: 144).

(2) As we have seen, even when people hold money either as individuals or as savings in financial institutions, not all the money will be invested in production of producible commodities (= goods and services). Money can be used to speculate on asset prices. New savings or a rise in savings can be diverted to purchasing of financial assets (or real assets) with the money used to buy such assets then flowing to other speculators, who buy new financial assets or hold money idle in the process of using it in further speculation on assets. Thus there is a “speculative demand” for money that can rise or fall.

(3) In modern economies where savings are held in demand deposits and saving accounts in banks, money is invested by banks themselves. But even here investment by banks will be subject to subjective expectations under uncertainty. In recessions or depressions when expectations are low, banks may simply choose to keep their depositors’ money as excess reserves or use it to buy financial assets on secondary markets. Thus even modern banks can “hoard” by reducing investment and leaving money in idle balances (at central banks or held in reserve for speculation on financial assets).

(4) Money income can be spent on imports causing a trade deficit, which in pre-fiat money days could result in a contraction of the money supply and deflationary pressures.

(5) A government might levy taxes and a run budget surplus without re-injecting that money back into the economy (and effectively destroying it).

Once propositions (2) and (3) of Say’s law above are shown to be false, propositions (4) and (5) collapse completely, and the idea that supply equals demand ex post cannot be possible.

For all these reasons, aggregate demand failures can cause recessions, whenever aggregate demand falls short of supply. Equilibrium will not result and is not necessarily a condition of free markets. Say’s law is a myth.


APPENDIX 1: SAY ADVOCATED PUBLIC WORKS

In his discussion of the introduction of labour saving machines, Say recognised that this would create short term unemployment, and in a footnote actually advocated public works spending by government:

“Without having recourse to local or temporary restrictions on the use of new methods or machinery which are invasions of the property of the inventors or fabricators a benevolent administration ran make prevision for the employment of supplanted or inactive labour in the construction of works of public utility at the public expense as of canals, roads, churches or the like …” (Say 1832: 87).

This must come as an embarrassing shock to Austrians who so frequently cite Say’s work with approval.

APPENDIX 2: RESERVATION DEMAND DOES NOT RESCUE SAY’S LAW

Reservation demand is defined as a type of demand in which producers or sellers of commodities hold their commodities off the market and refuse to sell them, because they expect higher prices in the future.

Reservation demand was never invoked by J. B. Say or other classical economists in defence of Say’s law, but one modern libertarian defence of Say’s law appears to use this concept.

As J. T. Salerno notes,

“Rothbard (1993, pp. 350–56, 662–67) was the first to analyze the demand for money in terms of its exchange demand and reservation demand components. In 1913, Herbert J. Davenport … also clearly identified these two partial demands for money but ultimately failed to integrate them into an overall theory of the demand for money” (Salerno 2006: 40, n, 4).

Rothbard sets out the types of reservation demand in relation to commodities:

“The sources of a reservation demand by the seller are two: (a) anticipation of later sale at a higher price; this is the speculative factor analyzed above; and (b) direct use of the good by the seller. This second factor is not often applicable to producers’ goods, since the seller produced the producers’ good for sale and is usually not immediately prepared to use it directly in further production. In some cases, however, this alternative of direct use for further production does exist. For example, a producer of crude oil may sell it or, if the money price falls below a certain minimum, may use it in his own plant to produce gasoline. In the case of consumers’ goods, which we are treating here, direct use may also be feasible, particularly in the case of a sale of an old consumers’ good previously used directly by the seller—such as an old house, painting, etc. However, with the great development of specialization in the money economy, these cases become infrequent” (Rothbard 2004 [1962]: 253).

Rothbard (2004 [1962]: 755ff.) treats money as a commodity and analyses the supply and demand for it “in terms of the total demand-stock analysis” he had used in Chapter 2 of Man, Economy, and State, and this obviously has relevance to Say’s law, and is indeed applied to it in Hoppe, Hulsmann, and Block (1998: 40).

To see how the concept of reservation demand is applied to money we can turn to Rothbard’s Man, Economy, and State: A Treatise on Economic Principles (1962):

“When a seller keeps his stock instead of selling it, what is the source of his reservation demand for the good? We have seen that the quantity of a good reserved at any point is the quantity of stock that the seller refuses to sell at the given price. The sources of a reservation demand by the seller are two: (a) anticipation of later sale at a higher price; this is the speculative factor analyzed above; and (b) direct use of the good by the seller. This second factor is not often applicable to producers’ goods, since the seller produced the producers’ good for sale and is usually not immediately prepared to use it directly in further production” (Rothbard 2004: 253).

So, in relation to commodities, Rothbard’s definition is in line with the generally accepted definition. But there is absolutely no necessary reason at all why (1) the value of commodities not sold due to reservation demand would equal (2) the total value of unsold commodities in a given period. Many commodities will remain on the shelves simply because they were not sold.

Moreover, Rothbard treats money as a commodity since he is an advocate of the gold standard. When we come to money, Rothbard also uses the concept of reservation demand:

“The total demand for money on the market consists of two parts: the exchange demand for money (by sellers of all other goods that wish to purchase money) and the reservation demand for money (the demand for money to hold by those who already hold it)” (Rothbard 2004: 759).

“More important, because more volatile, in the total demand for money on the market is the reservation demand to hold money. This is everyone’s post-income demand. After everyone has acquired his income, he must decide, as we have seen, between the allocation of his money assets in three directions: consumption spending, investment spending, and addition to his cash balance (‘net hoarding’). Furthermore, he has the additional choice of subtraction from his cash balance (‘net dishoarding’). How much he decides to retain in his cash balance is uniquely determined by the marginal utility of money in his cash balance on his value scale. … We have now to look at the remaining good: money in the cash balance, its utility and demand. Before discussing the sources of the demand for a cash balance, however, we may determine the shape of the reservation (or ‘cash balance’) demand curve for money” (Rothbard 2004: 759).

Rothbard’s reference to everyone acquiring “his income” can presumably refer to total factor payments from production (aggregate supply). Rothbard now defines “reservation demand” for money as the money flowing into cash balances (net hoarding).

It is here that libertarians might jump on Rothbard’s analysis to argue that Say’s law can be saved from collapse by applying the concept of reservation demand to money.

But what can the expression “reservation demand” mean when applied to money? When applied to commodities, it means that commodities are held off the market by sellers in expectation of higher prices in the future. Logically, then, reservation demand for money would be holding money in expectation of a higher price for money in the future in terms of its purchasing power. That is, a higher price for money can only mean a rise in money’s purchasing power, whether through general price deflation or falls in the prices of a commodity or commodities one wishes to purchase. Rothbard’s other comments support this:

“an expectation of a rise in the … [purchasing power of money] in the near future will tend to raise the demand-for-money schedule as people decide to “hoard” (add money to their cash balance) in expectation of a future rise in the exchange-value of a unit of their money. The result will be a present rise in the [purchasing power of money]” (Rothbard 2004: 768).

But Rothbard’s definition of “reservation demand” as all net money added to and held in cash balances (“net hoarding”) includes forms of idle money that cannot legitimately be called “reservation demand.” Rothbard has changed the meaning of “reservation demand” in a sleight of hand.

At most, “reservation demand” for money can only describe one subcategory of Keynes’ speculative demand for money: that category that involves holding money in expectation of general price deflation or price falls in one or other commodities.

Speculative demand for money includes many other categories, including holding money to buy assets expected to rise in price in the future.

And even if one chooses to make “reservation demand” for money in its only proper sense equal to its value as inserted into aggregate supply, this still leaves other idle money balances not spent on consumption or investment in capital goods.

A revised version of Say’s law according to the libertarian defence can be given here:

Aggregate supply (AS) = total factor payments + value of money held in reservation demand
equals Aggregate demand (AD) = consumption + investment on capital goods + value of commodities and money in reserve demand.

This still does not save Say’s law. Although the value of all commodities held by “reservation demand” equals the value of such commodities included in total factor payments, there will still be the value of commodities not purchased by consumption or investment on capital goods in AD left over.

As for AD, the value of total factor payments will be divided into these three categories when spent in aggregate demand:

(1) consumption payments;
(2) investment on capital goods;
(3) money held by reservation demand (a speculative demand for money);

But money from total factor payments can also be diverted into

(4) money held idle by precautionary motive (money held because of uncertain future);
(5) money held for other speculative demands;
(6) money held idle in financial market transactions.

Although money held in (3) will by definition equal money held in reservation demand in aggregate supply, there is still the likelihood that money will be held idle by the precautionary motive (4), other speculative demands (5), and in financial market transactions (6).

Rothbard’s sleight of hand is to lump (3), (4), (5), and (6) into one category he called reservation or ‘cash balance’ demand.

This can be used to then argue that Say’s law holds because the category “cash balance demand” is by definition equal to that value in aggregate supply when it is inserted into AS.

But this trick will not save Say’s law. In (3), (4), (5), and (6), money will be idle and not spent on aggregate supply. Without total factor payments going to purchase commodities or to capital goods investment, aggregate demand failures can occur.

I also note that Hoppe, Hulsmann, Block, in response to Selgin and White (1996), have also used the concept of reservation demand in discussing Say’s law and in arguing against the existence of fiduciary media:

“[Selgin and White] have overlooked Say’s law: all goods (property) are bought with other goods, no one can demand anything without supplying something else, and no one can demand or supply more of anything unless he demands or supplies less of something else. But this is here not the case whenever a fiduciary note is supplied and demanded. The increased demand for money is satisfied without the demander demanding, and without the supplier supplying, less of anything else. Through the issue and sale of fiduciary media, wishes are accommodated, not effective demand. Property is appropriated (effectively demanded) without supplying other property in exchange. Hence, this is not a market exchange which is governed by Say’s law – but an act of undue appropriation” (Hoppe, Hulsmann, Block 1998: 40).

One obvious consequence of such a view is that Say’s law can only hold in a world without fiduciary media, fractional reserve banking and fiat money! For Say’s law to work in the way postulated here there must only be commodity money and no fractional reserve banking or fiduciary media. We don’t live in such a world, so Say’s law does not hold.


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