Say’s Law and François Hollande

Following the discussion on L’offre crée même la demande, which are the words the French President used last week to indicate that economic policy will now follow more classical directions, and in particular adopt Say’s Law as the guide to policy, I have pulled this posting out of storage which was put up in December 2012. Having just watched the video again, I am even more astonished than I was then how accurate this is as a representation of the underlying ideas. But central to understanding Say’s Law is to understand that it is a macro concept related to how an economy works, rather than being a micro concept about individuals. In spite of everything you might have learned in a conventional economics course, Say’s Law was the foundation for understanding the classical theory of the cycle. If you want to know what causes recessions and then how to deal with them, you must understand Say’s Law.

My book, Say’s Law and the Keynesian Revolution, has been turned into a movie! John Papola, the genius behind the Keynes-Hayek Rap, has now done a movie on Say’s Law, the fundamental principle of the pre-Keynesian theory of the business cycle. Before Keynes, they knew you could have recessions but they also knew that the one thing that could never be the cause of recessions was a deficiency of demand. Too little demand relative to potential supply was a symptom, not a cause. Today all macroeconomics proclaims demand deficiency as the problem itself that must be cured. Therefore we have had one stimulus after another followed by one economic catastrophe after another. In Australia there’s the mining industry and nothing else to drive the economy forward.

To help you understand the video, here are a few bits of background to catch the full flavour of just how beautifully done this is.

John Maynard Keynes introduced the notion of aggregate demand into economic theory. Before he published his General Theory of Employment, Interest and Money in 1936, demand deficiency as a cause of recession was literally and with no exaggeration seen as a fallacy. Today, of course, his macroeconomics is the mainstream and when recessions occur the first thought in everyone’s mind is to restore demand.

Keynes took the idea of demand deficiency from Thomas Robert Malthus, a nineteenth economist who published his Principles of Political Economy in 1821. Keynes was reading Malthus’s letters to Ricardo in October 1932 which was the specific reason that he would eventually write a book on demand deficiency as the cause of recession. The entire economics fraternity refuses to accept this obvious bit of inspiration since it would make Keynes’s claims to originality not quite as honest as the great man would have liked us all to believe. But since there is general consensus that Keynes formed the idea of demand deficiency in late 1932 and there is no question whatsoever that Keynes was reading Malthus in late 1932, there is equally no doubt that the standard story as peddled by Keynes is utterly untrue.

Say’s Law, which does not get mentioned by name in the video, was called the Law of Markets during classical times. The principle was given the name Say’s Law in the 1920s but it was Jean-Baptiste Say in France and James Mill in England who together are responsible for the initial crafting of this bedrock proposition. But as a very good first approximation to its meaning, there is only a rolling momentary credit to the best short statement which was given by David Ricardo in a letter to Malthus in 1821. There he wrote:

Men err in their productions, there is no deficiency of demand.

Ricardo was trying to explain to Malthus that the recessions that followed the ending of the Napoleonic Wars in 1815 were not due to there being too much saving and therefore too little spending. It was not even spending that mattered. What had gone wrong, the same thing that is the cause of all recessions, is that the goods and services produced did not match the specific demands that people with incomes had. There were therefore unsold goods and services, but not because there was too little spending and too much saving, but because businesses had produced one set of goods (housing in the US to take the most recent example of recession) that could not be sold at prices which covered their costs. The structure of production was wrong which would inevitably, as it always does, affect credit markets as defaults became legion.

The notion that recessions were caused by not enough spending, either in 1821 or in 2012, is ridiculous. There is never a deficiency of demand, only a deficiency of purchasing power. And this is the last element you need to understand the plot of the video. What gives someone purchasing power – what makes individuals within an economy able to buy more – is more production. Producing saleable products – rising productivity – is the only means by which economies can grow and therefore, beneath it all, as Friedrich Hayek explains, there must be more investment in capital (actual productive assets not money) and more innovation which improves the technology embodied in the capital. An economy is driven by supply, never demand.

That is the message of the video. It is a piece of genius that so much can be so cleverly condensed into just over four minutes. But if you wish to understand the point, these are the things you need to know. And if you wish to know even more, there is my book as well.

This has now been posted at Quadrant Online.

This entry was posted in Classical Economics, Economics and economy. Bookmark the permalink.

40 Responses to Say’s Law and François Hollande

  1. brc

    is never a deficiency of demand, only a deficiency of purchasing power

    Isn’t half the problem people conflating ‘demand’ with ‘want’.

    I mean, I want a new M5, but I have been insufficiently productive to translate that want into actual demand for the BMW factory.

  2. Gab

    Excellent post, Steve. Thank you!

  3. Pedro

    “What had gone wrong, the same thing that is the cause of all recessions, is that the goods and services produced did not match the specific demands that people with incomes had.”

    “The notion that recessions were caused by not enough spending, either in 1821 or in 2012, is ridiculous. There is never a deficiency of demand, only a deficiency of purchasing power.”

    See the problem?

    “What gives someone purchasing power – what makes individuals within an economy able to buy more – is more production. Producing saleable products – rising productivity – is the only means by which economies can grow and therefore, beneath it all, as Friedrich Hayek explains, there must be more investment in capital (actual productive assets not money) and more innovation which improves the technology embodied in the capital. An economy is driven by supply, never demand.”

    That’s true in the long run, but it’s wrong to say that an economy cannot be affected by short run nominal shocks and frankly, I don’t think you believe otherwise. I also don’t think any of the serious keynsianism believe in magic puddings, but they do believe that there are various circumstances in which nominal shocks affect demand and the nominal problem needs to be overcome for the economy to get back on path.

    Here’s a chart of housing starts in the US
    http://www.macrotrends.net/1314/housing-starts-historical-chart
    And the chart here shows a big lag between the housing peak and the recession
    http://www.themoneyillusion.com/?p=25938

  4. The Pugilist

    That’s true in the long run, but it’s wrong to say that an economy cannot be affected by short run nominal shocks and frankly, I don’t think you believe otherwise. I also don’t think any of the serious keynsianism believe in magic puddings, but they do believe that there are various circumstances in which nominal shocks affect demand and the nominal problem needs to be overcome for the economy to get back on path.

    Pedro, here’s Schumpeter on the interdependence of AS and AD (I posted this under my old pseudonym Skuter in 2011):

    …demand, supply and equilibrium are concepts with which to describe quantitative relations within the universe of commodities and services. They do not carry meaning with respect to this universe itself. Strictly speaking, there is no more sense in speaking of an economic system’s total or aggregate demand and supply and, incidentally, of overproduction than there is in speaking of the exchange value of all vendible things taken together or of the weight of the solar system taken as a whole. But if we do insist on applying the terms demand and supply to social totals, we must be careful to bear in mind that they then mean something that is entirely different from what they mean in their usual acceptance. In particular, this aggregate demand and aggregate supply are not independent of each other…This is the proposition which (like Lerner) I call Say’s Law and which I believe renders Say’s fundamental meaning. As stated, Say’s law is obviously true. Nevertheless, it is neither trivial nor unimportant. in order to convince ourselves of this, we need only notice the errors that arise to this day from the mistaken application to social aggregates of propositions derived by means of the demand-supply apparatus….the law, at least by implication, amounts to a recognition of the general interdependence of economic quantities…

    JA Schumpeter, History of Economic Analysis, pp.617-618.
    We’ve been through this many times before. Demand shocks ARE supply shocks. If you want to see why nominal spending has collapsed, look to the supply side for your answers…recessions are structural. Plain and simple.

  5. Pedro

    Pug, why the name change? Any way, rubbish
    “Friedman and Schwartz identified four main policy mistakes made by the Federal Reserve that led to a sharp and undesirable decline in the money supply:[2]
    In the spring of 1928, the Federal Reserve began to tighten its monetary policy (resulting in rising interest rates) and continued that same policy until the stock market crash of October 1929. This caused the economy to enter a recession in mid-1929 and triggered the stock market crash a few months later.
    In the fall of 1931, it raised interest rates to defend the dollar in response to speculative attacks, ignoring the difficulties this caused to domestic commercial banks.
    After lowering interest rates early in 1932 with positive results, it raised interest rates again in late 1932, causing a further collapse in the U.S. economy.
    The Federal Reserve was also to be blamed for a pattern of ongoing neglect of problems in the U.S. banking sector throughout the early 1930s. It failed to create a stable domestic banking environment by supporting the domestic banks and acting as lender of last resort to domestic banks during banking panics.”

  6. Pedro

    “If you want to see why nominal spending has collapsed, look to the supply side for your answers…recessions are structural. ”

    Further, the other discussion that is going on about inflation and deflation shows that this just cannot be true. It must be the case that changes in the money supply affect demand without there being a preceding and causative change in supply. If money is needed to convert a given supply into the demand for other things then a lack of demand could be caused by a lack of money that is unrelated to a change in supply.

  7. The Pugilist

    Pedro, either inflationary or deflationary monetary disequilibrium alter the production structure setting in motion a chain of events that lead to people trying to reduce or increase their holdings of money balances.
    Put another way, monetary disequilibrium can occur due to movements in the money supply that are not accompanied (or in response to) a change in money demand. Likewise, a change in money demand not matched by a change in the supply of money will also lead to monetary disequilibrium. So that is the nominal shock…it can occur due to central bank error or a sudden change in the desire to hold money for whatever reason but the disequilibrium in the money market sets in motion a series of changes in all other markets simply because money has no market of its own, but touches all other markets.

    Aggregate demand and aggregate supply are inextricably linked. Thinking that one moves independently of the other is fallacious.

    As for the name change, I took up boxing as a hobby so morphing into The Pugilist seemed a natural thing to do…

  8. Pedro

    “but the disequilibrium in the money market sets in motion a series of changes in all other markets simply because money has no market of its own, but touches all other markets.” Agree

    “Aggregate demand and aggregate supply are inextricably linked. Thinking that one moves independently of the other is fallacious. ”
    Umm, that’s a function of the definitions, the interesting point is the cause of the movements. Earlier you said all recessions are structural and now you seem to say otherwise (and correctly).

    The Kates post says that recessions occur because people are making things that are not desired by the market (your structural problem). Thus my selection of these sentences:

    “What had gone wrong, the same thing that is the cause of all recessions, is that the goods and services produced did not match the specific demands that people with incomes had.”

    “The notion that recessions were caused by not enough spending, either in 1821 or in 2012, is ridiculous. There is never a deficiency of demand, only a deficiency of purchasing power.”

    A deficiency of purchasing power is a deficiency of demands and the deficiency could be caused by a reduction in available money that is not caused by a failure of desired supply.

  9. The Pugilist

    But Pedro, what causes the monetary policy error? It’s not as if central banks wake up one day and decide to cut the money supply in half. Likewise, it’s not as if individuals all wake up one day and decide to double their money holdings (and this is then ignored by the central bank). The reason is typically a structural issue that is propagated through the financial system.

  10. JC

    Fellas please, no squabbling over Says law.

  11. The Pugilist

    Warum nicht JC?

    It’s what I do…LOL

  12. Pedro

    “It’s not as if central banks wake up one day and decide to cut the money supply in half”
    Maybe not half
    http://www.reuters.com/article/2011/07/07/us-ecb-rates-text-idUSTRE7662WZ20110707

  13. Abu Chowdah

    A recent example of Say’s Law in action, Olympus creation of a market for a micro 4/3 interchangeable lens camera system:

    http://www.echenique.com/2012/08/05/olympus-om-d-e-m5-review/

    When Olympus and Panasonic first announced the Four-Thirds Alliance, I was intrigued as to why an established company like Olympus would want to venture out into left field like it did. Panasonic I could readily understand, not having any legacy in the SLR market. But Olympus, with it’s long and storied history, a sizeable user base, and a reputation for high quality imagery stood to lose a lot. Or did it?

    The DSLR market has been dominated by Canon and Nikon, with Sony making a strong show for third (some would argue second) place. Olympus’ desire to grow in this space was roadblocked by the stark reality that the top three could out-spend them at any turn, had a user base that was (and is) far larger than any they ever entertained, and were the darlings of pro and amateur photographer alike. Instead of playing their game, Olympus teamed up with photography upstart Panasonic and decided to play their own game.

    By introducing an entirely new sensor size specification, Olympus sought to free itself from trying to compete with the Big Three on their terms. Four-Thirds (and later Micro Four-Thirds) allowed Olympus and Panasonic to create a new paradigm for camera design and ultimately ushered in what Trey Ratcliff referred to as the “third generation of DSLRs.”

  14. Aristogeiton

    Abu Chowdah
    #1162682, posted on January 22, 2014 at 4:03 pm
    A recent example of Say’s Law in action [...]

    Sorry, I missed the thread. I was making pig iron in my backyard furnace.

  15. JC

    “It’s not as if central banks wake up one day and decide to cut the money supply in half”
    Maybe not half
    http://www.reuters.com/article/2011/07/07/us-ecb-rates-text-idUSTRE7662WZ20110707

    From Pedro’s link..

    (Reuters) – The European Central Bank raised interest rates for the second time this year on Thursday, tightening policy to address above-target inflation in the euro zone despite the intensifying debt crisis in Greece.

    Oh yea I vividly recall that. It was like…. “you did what? Are you people insane?”

  16. Abu Chowdah

    Sorry, I missed the thread. I was giving piggy-back rides in the nude in my backyard.

    WTF?

  17. Abu Chowdah

    Nobody knew there could be a demand for a m4/3 system until Olympus brought a product to market. Even then, and still now, there are nay-sayers in the DSLR pro and am world who are skeptical, while the units move off the shelf quicker than shit off a shovel and Olympus quietly builds a market base that Nikon and Canon swore didn’t exist, but may decide to service now that the scales are falling from their eyes.

    Say’s Law, bitches.

  18. Aristogeiton

    Abu Chowdah
    #1162772, posted on January 22, 2014 at 5:04 pm
    Sorry, I missed the thread. I was giving piggy-back rides in the nude in my backyard.

    WTF?

    http://en.wikipedia.org/wiki/Backyard_furnace

  19. Tel

    It’s not as if central banks wake up one day and decide to cut the money supply in half.

    Even if the central bank wanted to, it has no ability to do that. It cannot arbitrarily reduce the nominal value of bank accounts, nor can it snatch cash out of people’s hands. All it can do is raise interest rates. If you are neither a borrower, nor a lender the raising interest rates is neither here nor there to you. Even if you are in the business of borrowing of lending there are still limits on what the central bank can do… if they raise rates higher than what regular folks are willing to lend for then all the borrowers will just go for the lower rate. That is to say, the central bank can undercut the natural rate, but cannot go higher.

  20. Likewise, it’s not as if individuals all wake up one day and decide to double their money holdings

    They do when there’s a credit crunch. Were you paying attention at all during the GFC?

  21. Tel

    Pedro, in the article you posted they are wringing hands that the European money supply is not growing fast enough. At no time does anyone contemplate it actually shrinking.

    They still have inflation, just look at the energy prices, but some people think there needs to be more inflation. Central banks do not shrink money supply, simply does not happen.

  22. Tel

    desipis: most people are in debt, they don’t have money holdings, at all.

    In the USA many aren’t even staying afloat on their debt, where does this bullshit about cash hoarding even come from?

  23. Piett

    If you want to see why nominal spending has collapsed, look to the supply side for your answers…recessions are structural. Plain and simple.

    Pugilist/Skuter,

    The big problem with this is that employment collapsed in all sectors of the US economy following the GFC. A structural explanation, like that of the Austrians, implies above-normal unemployment only in those sectors where there has been mal-investment and markets are correcting.

    A general rise in unemployment implies a shock to AD. I cannot see any other explanation.

  24. Stateless, free and happy

    “And if you wish to know even more, there is my book as well. ”

    I hope there is demand for this supply.

  25. .

    Tel
    #1162982, posted on January 22, 2014 at 8:21 pm
    desipis: most people are in debt, they don’t have money holdings, at all.

    LOL

    So Desipis reckons they doubled down on borrowings in the credit crunch eh?

    Hint to forum readers: Do not engage in topics which you find yourself hopelessly out of your depth.

  26. Tel

    So Desipis reckons they doubled down on borrowings in the credit crunch eh?

    No he thinks they are stuffing wads of cash in pickle barrels because the animal spirit told them to.

  27. Tel

    The big problem with this is that employment collapsed in all sectors of the US economy following the GFC. A structural explanation, like that of the Austrians, implies above-normal unemployment only in those sectors where there has been mal-investment and markets are correcting.

    If you believe Paul Krugman… but who would be stupid enough to do that?

    http://mises.org/daily/6055/Charting-Fun-with-Krugman

    People in a hurry should scroll down to “The Structural Signature” near the bottom.

  28. desipis: most people are in debt, they don’t have money holdings, at all.

    Reducing debt would require the same net reducing in spending as increasing money holdings. That reduction in spending is seen in falling aggregate demand.

    So Desipis reckons they doubled down on borrowings in the credit crunch eh?

    No, I’m suggesting that individuals reducing their debt in a coordinated fashion during a credit crunch would result in a decrease in aggregate demand unrelated to any supply issues in the real economy.

  29. JC

    Even if the central bank wanted to, it has no ability to do that.

    Sure it can if a CB wanted to. All it has to do is sell bonds and take in money for those bonds.

    The money supply was sawn in half from 1930 to 1932…. or around 40% to be exact.

  30. The Pugilist

    The big problem with this is that employment collapsed in all sectors of the US economy following the GFC. A structural explanation, like that of the Austrians, implies above-normal unemployment only in those sectors where there has been mal-investment and markets are correcting.

    A general rise in unemployment implies a shock to AD. I cannot see any other explanation.

    It started in the investment banking sector in Europe and the US. It could have been quarantined but central banks didn’t recognise what was happening. Because it wasn’t dealt with early and effectively through recapitalization and orderly bankruptcy, it spread through the retail banking sector in the US and the flaws in the real estate sector were revealed in a catastrophic fashion. This destroyed wealth and confidence. Read up on ‘secondary depression’.

  31. JC

    I checked the stats.
    M2 fell 30% between 1929 to 1933. M1 fell 25%. Deposits fell 35%.

  32. Pedro

    “If you believe Paul Krugman… but who would be stupid enough to do that?”

    It would be stupid to believe Krugman without thinking, but it would be even more stupid to automatically dismiss him. He’s clearly a brilliant guy and, for example, has been completely correct about the impending non-hyperinflation.

  33. Pedro

    Pug you seem to flit between being sensible and being a hard-core austrian.

  34. Chris M

    Thanks Steve, interesting post – enjoyed the clip too, it’s very well done.

  35. The Pugilist

    Pedro, I’ll take that as a compliment. As long as you don’t call me a Rothbardian, we’re sweet…I can understand why you think that…I think the Misean-Hayekian story is useful to describe a lot of booms and the upper turning point of the cycle. I feel the market monetarists are better at explaining how to start a recovery. I find a lot of Austrians forget about deflationary monetary disequilibrium.

  36. .

    Pedro if you slur the Austrian school you slur yourself. All economics past 1870 is in part set on Austrian foundations.

    No, I’m suggesting that individuals reducing their debt in a coordinated fashion during a credit crunch would result in a decrease in aggregate demand unrelated to any supply issues in the real economy.

    1. Aggregate demand in the US fell before the credit crunch. It caused it to begin in the first quarter of the 2007 calendar year. Labour productivity growth was falling in the OECD since 2003.
    2. The supply of loanable funds fell. People, banks and other firms were denied credit before savings increased.
    3. You then believe the credit crunch caused demand to fall, but the inability to raise short term working capital for importers, retailers or crop farmers did not affect supply. In short you don’t believe in any interdependence between AS and AD. Or you are skipping this phase before everyone started saving again.

    Utter nonsense.

  37. The Pugilist

    1. Aggregate demand in the US fell before the credit crunch. It caused it to begin in the first quarter of the 2007 calendar year.

    Dot,
    I take slight issue with your use of the term “aggregate demand” above. Nominal spending fell as a result of the contraction of malinvested sectors. People stopped taking out new, bigger loans, and the rate of defaults started increasing due to some peculiar features of the US real estate and banking sectors. This caused the ponzi scheme that the investment banks were playing to fall over. But demand for everything did not fall initially. Just for housing and consumer durable goods. The fall in nominal spending was the commencement of a sectoral rebalancing…

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