Say’s Law on the GO

It is so rare for anyone to get Say’s Law exactly right that you must forgive me if I quote at length, specially since he quotes me. This is from an article by Steve H. Hanke, Professor of Applied Economics at the Johns Hopkins University in Baltimore, and titled, “GO: J.M. Keynes versus J.-B. Say”. It is found in the publication, Global Asia:

The French economist J.-B. Say (1767-1832) was a highly regarded member of the Classical School. To this day, he is best known for Say’s Law of markets. In the popular lexicon – courtesy of John Maynard Keynes – this law simply states that “supply creates its own demand.” But, according to Steven Kates, one of the world’s leading experts on Say, Keynes’ rendition of Say’s Law distorts its true meaning and leaves its main message on the cutting room floor.

Say’s message was clear: a demand failure could not cause an economic slump. This message was accepted by virtually every major economist, prior to the publication of Keynes’ General Theory in 1936. So, before the General Theory, even though most economists thought business cycles were in the cards, demand failure was not listed as one of the causes of an economic downturn.

All this was overturned by Keynes. Kates argues convincingly that Keynes had to set Say up as a sort of straw man so that he could remove Say’s ideas from the economists’ discourse and the public’s thinking. Keynes had to do this because his entire theory was based on the analysis of demand failure, and his prescription for putting life back into aggregate demand – namely, a fiscal stimulus (read: lower taxes and/or higher government spending).

The rest of the article deals with the new statistic that has just been released by the Bureau of Economic Analysis in the United States to be referred to as Gross Output, GO. The work was largely been undertaken at the instigation of the great Austrian economist, Mark Skousen. The notion that consumption drives an economy is so nonsensical since consumer demand is the end of all forms of production, from mining coal to generating electricity and so to focus on consumer demand is focusing on nothing at all other than the end of the production process. But if we are looking at value added, as we ought to be, only about 5% of economic activity is directed at selling directly to consumers. The new supply side statistic that has been developed, which at long last gets this balance right, will make a great difference in how the economy is perceived, which should also make a difference in how it is managed, or at least it is to be hoped. Let me finish with one further quote from Professor Hanke:

Even though the always clever Keynes temporarily buried J.-B. Say, the great Say is back. With that, the relative importance of consumption and government expenditures withers away. And, yes, the alleged importance of fiscal policy withers away, too.

If you really want to stimulate the economy, it is business at every stage of production you have to go through and not the consumer. How different that kind of economic policy would need to be, but at least it will have the merit of actually producing positive results.

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87 Responses to Say’s Law on the GO

  1. Anonandon

    So Ken Henry was full of s#$t!

  2. Joe Goodacre

    Say’s Law (as I understand it) seems contrary to my experience in business…

    When we are looking at how much to supply, this is entirely driven by demand now and expectations as to future demand.

    It seems an odd distortion of reality to suggest otherwise – what am I missing?

  3. My understanding of it is that it states that your capacity to demand is driven by your ability to supply, as are your customers.

    The other (and it isn’t insignificant) source of demand is force; generosity may also need to be considered.

  4. Joe Goodacre

    That makes sense – we won’t influence overall demand if people think we can’t pay for what we demand.

    I’m not sure I follow the extension of the argument that it is not possible to have a demand failure or follow what the policy implications from this are.

  5. Token

    I agree with the logic of what you say, it is so obvious and the examples from history should produce the substance to push along the argument…

    … but they don’t in the face of emotive arguments and race baiting.

    What are good examples of governments which successfully leave the economy to be driven by the marketplace while effectively managing the perception they are heartless in the face of suffering and poverty?

  6. Tel

    Joe, explain how to eat something that does not exist. This is not a riddle, it is simply a reminder without production there can be no consumption.

  7. Token

    Say’s Law (as I understand it) seems contrary to my experience in business…

    When we are looking at how much to supply, this is entirely driven by demand now and expectations as to future demand.

    Your time scale is too short.

    If Apple did not create the Ipod, Iphone & Ipad (which met latent but unstated demand in the marketplace), would the huge demand be discovered by the other players in the market?

  8. Diogenes

    @token there is also the great quote attributed to Henry ford. ” if I asked my customers what they wanted I would be building faster horses” :-)

  9. Joe Goodacre

    without production there can be no consumption.

    Agreed – did Keynes contest this?

  10. Joe Goodacre

    If Apple did not create the Ipod, Iphone & Ipad (which met latent but unstated demand in the marketplace), would the huge demand be discovered by the other players in the market?

    Possibly – what’s the significance of this?

  11. brc

    Say’s Law (as I understand it) seems contrary to my experience in business…

    When we are looking at how much to supply, this is entirely driven by demand now and expectations as to future demand.

    It seems an odd distortion of reality to suggest otherwise – what am I missing?

    It’s very simple.

    If you want something someone else has got, first you need to produce something, so then you have something to exchange for it.

    You can’t create demand for someone else’s goods until you’ve produced something yourself to trade.

    Production has to come before consumption.

    Just erase Keynes distortion ‘supply creates it’s own demand’ and start again from first principles. Keynes built a construct where paying people to dig holes and fill them back in again was good for the economy, because it put money in their hands, which would then have a multiplier effect. This may be true in the very short term, but those people need to be producing something they can exchange for the economy to grow. Keynes brushed this very large hole in his theory off with ‘in the long run we are all dead’.

    Your business can only buy things because it produces something to exchange. That’s all you need to remember.

    In the long run, the only thing that matters is an increase in production, which these days is generally achieved by an increase in productivity. This is so patently true – if you want everyone to be richer, they have to have more stuff, so someone has to produce it. Everything else is just noise intended to confuse the listener into believing in free lunches.

  12. brc

    If Apple did not create the Ipod, Iphone & Ipad (which met latent but unstated demand in the marketplace), would the huge demand be discovered by the other players in the market?

    Possibly – what’s the significance of this?

    While it’s true, it’s several levels above what you need to grasp to get into Says law properly.

    It helps not to bring organisations into it, and just think of the individual producer in a very basic economy.

    If a farmer wants to buy a woollen jumper, he first needs to produce some food so he can exchange the food for the jumper. He has to produce before he can consume. Of course the government can give him some money to buy the jumper – demand for jumpers will blip up. But self evidently, the economy based on food and jumpers has not grown, because the farmer didn’t produce the food as he should have.

  13. Joe Goodacre

    If a farmer wants to buy a woollen jumper, he first needs to produce some food so he can exchange the food for the jumper. He has to produce before he can consume.

    How does people consuming before they produce (credit) influence this dynamic?

  14. Token

    Possibly – what’s the significance of this?

    Keep working at what is being communicated here. It is more fundemental than a mere transaction at a point in time.

  15. Token

    While it’s true, it’s several levels above what you need to grasp to get into Says law properly.

    Please keep working at getting a good example to explain the concept.

    I was paraphrasing Rothbardt’s example of the creation of TV but am sure I didn’t explain it as clear has he does.

  16. Joe Goodacre

    Saying that Apple’s supply of the Ipod created demand.

    Presumably it’s possible that people who now bought Ipods, have now bought less of something else – demand shifted.

    The Ipod is a good manufactured offshore, with offshore intellectual property. If the demand it replaced was Australian produced goods and services, then those producers no longer have demand for their goods, there is a demand failure and people lose jobs as supply shifts to alternative options.

  17. Alfonso

    Alas, “in the long run we are all dead” and therefore I want maximum transfer of other people’s wealth to me via govt cheques while I can…..is a good description of how Kylie and Shane function. When a large number of the small business, self employed Tradies I associate with have this as their economic bottom line you know we’re in deep doo doo.

  18. Token

    Joe, Apple supplied a good which (e.g. Ipod) which did not have a tangible demand, but met a latent but undefined demand. When the supply of the good was brought to the market, the demand was “created”.

    The demand does not exist any longer as first the Iphone and now all Smartphones have integrated the features which met the demand.

    The Ipod is a good manufactured offshore, with offshore intellectual property.

    The need the Ipod & Smartphones meet are universal. “Offshore” is relevant in this case as it is to Chinese who buy our coal, iron ore, LPG and dairy products.

  19. Joe Goodacre

    the demand was “created”.

    In a narrow sense the demand was created for Ipods.

    In a wider sense is there are creation? It would appear to be a re-distribution of demand from one form of entertainment to another. Instead of using vinyl records, people bought walkmans. Instead of using walkmans, people use Ipods. It would appear that this is creative destuction, not creation of a new demand.

    “Offshore” is relevant in this case as it is to Chinese who buy our coal, iron ore, LPG and dairy products.

    Except that we’re in a trade deficit – so more Ipods than coal/iron ore equivalents are being bought.

    In the world economy there’s balance – new jobs have been created in China to manufacture Apple’s Ipods, but jobs have been lost here in Aussie entertainment services.

    Is it impossible for a recession to be generated in Australia because the demand we were supplying, has shifted to a demand produced offshore – particularly in a country in a trade deficit.

  20. Joe Goodacre

    Furthermore coal/iron ore are more capital intensive industries than Australian produced entertainment.

    If demand switches from locally produced entertainment which is labour intensive, to offshore produced entertainment and jobs are created in capital intensive export industries, presumably this would result in unemployment because people can’t immediately upskill in economies that have high specialisation?

  21. Token

    In a wider sense is there are creation? It would appear to be a re-distribution of demand from one form of entertainment to another.

    I’m sure I won’t get this 100% correct, but I believe that you are correct if you agree with demand being driven by marginal utility.

    Except that we’re in a trade deficit – so more Ipods than coal/iron ore equivalents are being bought.

    It doesn’t matter if our country is in deficit by one measure or another, it is whether the way people use the products create value or use it to offset costs. This is driven by the marginal utility of the products.

  22. Token

    …presumably this would result in unemployment because people can’t immediately upskill in economies that have high specialisation?

    Yes, the continual change due to technology, taste & the increase in global affluence forces this destruction and renewal process to keep occuring.

    No government can stop it. They can impede it & thereby make its citizens poorer.

  23. Joe Goodacre

    I’m not sure if it’s related to marginal utility – I thought that meant that people won’t demand an infinite amount of a good because you enjoy additional item less and less the more you have.

    The question is a simpler one – are our demands limited by human nature (shelter, food, security, love and entertainment). Creative destruction means that these demands are better met by other products, but the demand itself has not been created – it has always existed in our nature.

    That would imply that a new demand, is being met with demand that has been removed from a previous product or service that met these demands.

  24. .

    There is some confusion here:

    There is a misunderstanding of what “entrepreneur” truly means. There is a presumption that demand and supply cannot shift simultaneously or contemporaneously, which is likely with a permament increase in income and industry adjustment. There is confusion between a shift in demand with a shift of demand along the supply curve.

    None of this can be truly settled without knowing the empirics of the market to conclude what the implications are form market dynamics.

    Say’s Law does not violate the production function. This is why we know it is an economic truism.

  25. .

    That would imply that a new demand, is being met with demand that has been removed from a previous product or service that met these demands.

    Not necessarily.

    That would imply that a new demand, is being can be met with demand that has been removed from a previous product or service that met these demands.

    Marginal utility does not limit the range of preferences people have.

  26. Joe Goodacre

    My question is, how relevant is Say’s Law when you have differences between countries, in particular their living standards, cultures and regulations.

    It would appear to me that a demand failure can be created because of a market distortion in another country – i.e. if China forces its citizens to save with a depressed currency, jobs may go to that region, but that deployment of labor to that region is a symptom of a market distortion – not ipods in particular satisfying the demand for entertainment most efficiently.

  27. Token

    I’m not sure if it’s related to marginal utility – I thought that meant that people won’t demand an infinite amount of a good because you enjoy additional item less and less the more you have.

    Marginal utility more than that, it is built around the idea of individual allocating resources based upon their individual needs. Once they value one good more than another, they will choose to allocate resources to it.

    These decisions are made on a personal level by every individual, but are agregated when we talk about them.

    The question is a simpler one – are our demands limited by human nature (shelter, food, security, love and entertainment). Creative destruction means that these demands are better met by other products, but the demand itself has not been created – it has always existed in our nature.

    That would imply that a new demand, is being met with demand that has been removed from a previous product or service that met these demands.

    You are raising good questions here which I agree point to underlying needs and desires being met by goods and services which only satify a portion of the underlying demand. As new products arise which better address the demand.

    I am enjoying the discussion and am happy for the people who really understand this topic to correct me.

  28. Token

    It would appear to me that a demand failure can be created because of a market distortion in another country – i.e. if China forces its citizens to save with a depressed currency

    Absolutely.

    The global economy has all sorts of pricing distortions due to government & cultural actions distorting value. Our real estate prices are inflated due to the Chinese people using it as a way to store wealth where the ChiComs can’t arbitarily take it from them.

    WTF is that market for ivory about?

  29. .

    You are asking so many questions without realising it.

    The short answer is read von Mises and trade economics, particularly the Linder/Product Cylce Theory/trade in technology/waves of development trade hypothesis and then how trade can be an engine of growth through the standard trade model or Heckscher Ohlin model.

    I recommend Appleyard and Cobb for trade economics and Alexander H Shand and Mises’ Human Action for a quick explanation on the relevant topics.

    Artificially high saving can be just as damaging as engineered inflation.

    Say’s Law isn’t irrelevant to your question generally, but you are asking specifically about a make work scheme, market distortions of labour, land, capital and credit markets.

    The very short answer is that such a scheme would causes persistent monetary disequilibrium. There would be malinvestments (this time, typically characterised as under-investment) and a business cycle is created, even if the impetus is deflationary and not the typical inflationary tale.

  30. Joe Goodacre

    There is some confusion here:

    There is a misunderstanding of what “entrepreneur” truly means.

    In simple terms I’m assuming it means someone that comes up with a new product that satisfies a demand more fully or efficiently.

    There is a presumption that demand and supply cannot shift simultaneously or contemporaneously, which is likely with a permament increase in income and industry adjustment.

    Is there an example to illustrate what you mean?

    There is confusion between a shift in demand with a shift of demand along the supply curve.

    Can you elaborate – I understand that the demand curve can shift because people’s preferences shift which is separate from demand changing because the price has changed.

    None of this can be truly settled without knowing the empirics of the market to conclude what the implications are form market dynamics.

    This is why we know it is an economic truism.

    I don’t follow that if it is an economics truism, why does Steve continually write about it being ignored?

  31. Token

    You are asking so many questions without realising it.

    That is what happens when someone opens their mind to new ideas.

    It is hard to keep all the concepts seperated, especially when one is taught by Keynsians. Thanks for the reading list Dot.

  32. Joe Goodacre

    I’ve made a meal of the italics – please see again below.

    There is a misunderstanding of what “entrepreneur” truly means.
    In simple terms I’m assuming it means someone that comes up with a new product that satisfies a demand more fully or efficiently.

    There is a presumption that demand and supply cannot shift simultaneously or contemporaneously, which is likely with a permament increase in income and industry adjustment.
    Is there an example to illustrate what you mean?

    There is confusion between a shift in demand with a shift of demand along the supply curve.
    Can you elaborate – I understand that the demand curve can shift because people’s preferences shift which is separate from demand changing because the price has changed.

    This is why we know it is an economic truism.
    I don’t follow that if it is an economics truism, why does Steve continually write about it being ignored?

  33. brc

    Is it impossible for a recession to be generated in Australia because the demand we were supplying, has shifted to a demand produced offshore – particularly in a country in a trade deficit.

    Says Law doesn’t attempt to explain recessions. Recessions are caused by the business cycle and would happen regardless. It doesn’t attempt to talk about international trade or national economies- it’s just a foundation for understanding how economies work and grow. Economies grow when more people produce more things – end of story. People layer all kinds of incomprehensible mumbo-jumbo on top of it, but this is the essential point. You can’t make an economy grow without getting people to produce more stuff.

    How does people consuming before they produce (credit) influence this dynamic?

    As long as the production is subsequently done to make good the credit (and make the exchange whole), then the dynamic isn’t necessarily influenced. What matters is that production is increased – all credit does is alter the exact timing of the exchange but not the nature of the exchange. Of course if the credit is not repaid, then the production never happened, and the economy never grew. This is central to understanding, because the ‘refutation’ of Says law by Keynes was designed to enable just that – inflationary borrowing and spending on non-production activities, in the expectation that the economy grew. This is underpinned by talking about the economy exclusively in terms of demand (GDP) rather than production (GO). You’ve got to understand that Keynes was a raging socialist in the socialist golden age, when misapplication of economic theory had caused a deep depression. At the time, the Fed was considered to have saved the US economy during the depression – not made it worse as is the general understanding now.

    In general Joe – you are conflating a layman’s understanding of demand (I want a Ferrari) with the economists definition of demand (I am willing to exchange this set amount of my production for a Ferrari).

    There was a recent catallaxy post on the use of the word demand. As already noted, there is a difference between an increase in demand, and a progression along the demand curve due to a different supply dynamic (i.e. prices dropped due to demand increases)

  34. .

    This partly answers the question on supply and demand coidentification: Even if you have empirical parameters it can still be difficult to see what is going on:

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

  35. Joe Goodacre

    The short answer is read von Mises and trade economics, particularly the Linder/Product Cylce Theory/trade in technology/waves of development trade hypothesis and then how trade can be an engine of growth through the standard trade model or Heckscher Ohlin model.

    Is there a simple summary of those points?

    I understand that:

    a) trade undertaken on voluntary terms is always beneficial to the individuals involved; and
    b) that trade results in greater specialisation, greater competency and efficiency.

    What I’m really at a loss over though is why Say’s law is so controversial from a policy perspective if it is an economics truism.

  36. brc

    I don’t follow that if it is an economics truism, why does Steve continually write about it being ignored?

    Because so many economists are ignorant.

    That’s what happens when you define your work in terms of ‘social justice’ instead of understanding human dynamics and behaviour.

  37. .

    Long run industry adjustment can be found in any standard microeconomics textbook. The basic reasons are competitive pressures.

    You have confused the reasons why demand shifts and demand shifts along the supply curve.

    You note an increase in income. This will shift demand outwards. You also imply there is a unmet, never changing set of preferences – these by definition can’t change demand.

    Truisms do get ignored. Chartalists (purveyors of MMT and growing in popularity) contend that governments can print money as long as they please to fund spending because they are sovereign.

    This not only ignores economics generally, it ignores history. The truism it rejects is there is no such thing as a free lunch.

  38. Joe Goodacre

    Economies grow when more people produce more things – end of story. People layer all kinds of incomprehensible mumbo-jumbo on top of it, but this is the essential point. You can’t make an economy grow without getting people to produce more stuff.

    This doesn’t seem controversial or even hard to understand – where is the controversy from a policy perspective?

  39. brc

    What I’m really at a loss over though is why Say’s law is so controversial from a policy perspective if it is an economics truism.

    Because if you accept it as a truism, you accept that using Keynesian policy doesn’t help economies, and in fact makes them worse. And that means you can’t use it to justify spending on pet projects and causes.

    Ask yourself how many projects you have heard that will ‘create jobs’ at the announcement. Ask yourself if it was widely understood that this was a meaningless statement, like saying building a specific boondoggle would make everyone in the country richer. Take away that particular crutch for big borrowing and spending, and where are the politicians and their enabling intellectuals at?

    Prior to the invention of Keynesian policies, asking the public to take their money and waste it because it would make the economy better would have been greeted with ridicule. Now it is routinely part of policy – Joe Hockey was scared to cut the budget too much because he feared a contraction in Aggregate Demand. All that resides on the foundation that you can create free lunches because demand is more important than production. All of that is undercut by a proper understanding of Says Law.

    Essentially you’re asking what’s the big deal if c02 doesn’t create warming?

    Well, if that’s true a trillion dollar business collapses tomorrow. So the mere contention that rising c02 isn’t actually a big deal can never be accepted as a truism. And that’s why Says Law is so threatening.

  40. .

    Mises contends that Say’s Law is correct. The last six decades of macroeconometrics contends that Keynes, who rejected Say’s Law, was wrong.

    The Austrian credit cycle takes time to read through but it is not impossible to understand.

    I guess all I can do is be lazy and direct you to the wikis short of giving you a kindle copy of the books.

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

    This is not really exhaustive as it does not mention overlapping demand to explain trade between countries of different incomes. Also please see the wiki article on PCT.

  41. entropy

    Joe, Apple didn’t create a smartphone to meet unsatisfied demand. Prior to that the closest thing was a blackberry, essentially really good at being a mobile email device. The iPhone is a much more than that.
    The supply of the iPhone product created the demand for touch based smartphones in the first place. This demand did not exist at the time, the supply of the product led to people realising they wanted one, and so demand was created. Before that people were demanding iPod, blackberry, laptops and and their miniature flip phone.

  42. Driftforge

    Production creates the ability to demand in exchange. Force creates the ability to demand in excess. Generosity creates the capacity to gift in response to request.

    Say’s Law is only one third of the story; giving primacy to the economy is the same error as teaching to the test.

  43. .

    This demand did not exist at the time, the supply of the product led to people realising they wanted one, and so demand was created.

    Correct.

    It may have changed their preferences, but to create a shift in demand (not just a possible pivot), it also created an increase in real incomes.

  44. Joe Goodacre

    The supply of the iPhone product created the demand for touch based smartphones in the first place. This demand did not exist at the time, the supply of the product led to people realising they wanted one, and so demand was created.

    For demand to have been created, isn’t additional supply from those consumers then also created – i.e. people decided to work longer in order to buy the I phone. If people worked the same amount, hasn’t demand simply shifted from one product to another (if I’m understanding the implications of Say’s Law correctly).

  45. Joe Goodacre

    Because if you accept it as a truism, you accept that using Keynesian policy doesn’t help economies, and in fact makes them worse. And that means you can’t use it to justify spending on pet projects and causes.

    In theory I agree with the broken window fallacy.

  46. Piett

    At the risk of causing more confusion to Joe and other non-economists, I have a few points …

    1) It is perfectly possible to be a pro-free-market economist while still accepting Keynesian-derived models as a starting-point.

    It’s been a while since I checked it, but I seem to recall that Milton Friedman’s undergrad textbook was based on GDP=C+I+G+X and IS-LM — the short-hand for the basic Keynesian models.

    Certainly my other Macro textbooks did. But they then went on to show how fiscal stimulus ‘leaks’ from an open economy, and how difficult it is to time a fiscal response to a recession. Both were very relevant to Labor’s response to the GFC, and should have made Labor think twice about stimulus — particularly since the RBA still had room to move on interest rates.

    2) I don’t believe it is an adequate response to Joe’s initial question to talk about Steve Jobs and Apple.

    It’s easy to say that Apple created demand for its innovative products. And it’s probably true. But most companies are not Apple, and most CEOs are not Jobs.

    The sugar industry, for example, is not coming out with wild, innovative new types of sugar every week. Ditto petrol and beer and clothing, and probably the vast majority of industries that employ people. And if consumption falls in one such industry, what happens to production? Will companies rush out to expand their production facilities? Hardly. They probably contract production, rather than have unsold goods pile up. And then what happens to employment?

    3) The Says Law and Austrian folk don’t seem to have a response to the question of what do you do if there is a prolonged shift from consumption to saving.

    Let’s say Joe’s business is doing great, production and consumption are matched in equilibrium, there is full employment, and everything is dandy.

    And then Joe starts to worry about the future, and decides that he will save the majority of the business profits rather than spending it. The other businesses in this small island economy come over to ask Joe why he’s not buying their stuff anymore. He explains why, they get nervous, and start saving too. Nobody’s buying anything anymore, apart from the minimum needed for survival. Hello depression!

    The “Paradox of Thrift”: in an economic downturn, or impending downturn, it is perfectly rational for individuals to minimise consumption and maximise saving, but if everyone does it, firms go bankrupt, employment nosedives, and the economy is wrecked.

    Of course, there’s now a big pool of savings available as potentially investible funds, but with confidence so low, which business will be the first to gamble and start investing? There needs to be some sort of circuit-breaker, and I don’t see that Says Law or Austrians provide any.

  47. Joe Goodacre

    You note an increase in income. This will shift demand outwards. You also imply there is a unmet, never changing set of preferences – these by definition can’t change demand.

    I’d agree that preferences can change (i.e. if entertainment is really cheap and housing is very expensive, people will consume housing the minimum necessary that satisfies this need relative to the enjoyment that they would have received from buying more entertainment.

    Is it correct to say that the point of Say’s Law is that if you get out of the way of people producing things, they will have greater capacity to demand the goods and services of others which will stimulate supply and demand in other areas – that supply creates its own demand.

  48. brc

    For demand to have been created, isn’t additional supply from those consumers then also created – i.e. people decided to work longer in order to buy the I phone. If people worked the same amount, hasn’t demand simply shifted from one product to another (if I’m understanding the implications of Say’s Law correctly).

    If people work longer days – they are presumably producing more stuff – then they are producing in order to consume the iPhone – this is good for the economy – more economic activity – more growth – higher living standards.

    If the government decides to create money out of thin air and give it to people to buy the iPhone – then this is not good. Whether the government just flat out gives it to them or makes them dig holes and fill it in again is immaterial. In order to have sustainable growth, then people need to be doing something productive to earn the money to get their iPhones.

    If people worked the same amount, hasn’t demand simply shifted from one product to another (if I’m understanding the implications of Say’s Law correctly).

    Sure, their preferences may have switched from a Nokia phone and a replacement desktop to purchase the iPhone. The key here is that people know what is best and presumably choose the more expensive iPhone because it provides them with greater value. Greater value from a product makes the consumer more wealthy = higher living standards.

    But as I said earlier – going to the level of iPhones can bring you unstuck as there are layers to it.

    It’s easier to me to envisage a dirt-poor village somewhere. The food is bad, the houses are bad. Yet the men are all sitting around under a tree doing nothing.

    In this case what these men should do is start producing. One guy puts in more hours to grow better food. The other man puts in more hours building better houses. They exchange their labour with each other. Production goes up. Demand (for food and houses goes up). But until at least two of them get off their rear and start producing, the wealth of the village is going to stay where it is. You can give them some food and you can build them a house, but that is not going to keep the economy going for even the next year. True gains over time are when production starts and compounding returns from increasing productivity work their magic.

    That is Says law vs Keynesian policy.

  49. brc

    Is it correct to say that the point of Say’s Law is that if you get out of the way of people producing things, they will have greater capacity to demand the goods and services of others which will stimulate supply and demand in other areas – that supply creates its own demand.

    Thats not a bad effort. I would not ‘that they will have greater capacity’ – I would change to ‘they have capacity’. If you don’t produce anything, then you can only demand something if someone else gives you a share of their production.

    Essentially – everyone has to get off their backside and work if they want to buy stuff. There’s no shortcut around this.

  50. Joe Goodacre

    Heckscher-Ohlin theory (H-O). H-O predicts that patterns of international trade will be determined by the relative factor-endowments of different nations. Those with relatively high levels of capital in relation to labor would be expected to produce capital-intensive goods while those with an abundance of labor relative to (immobile) capital would be expected to produce labor intensive goods.

    Makes sense.

  51. brc

    Joe – you might also pick up a copy of the book ‘Waffle Street’ – it is a good introduction by way of stories rather than dry economic text. The author lays out the case for understanding Says Law by working in a Waffle House in a poor area. It also contains clear explanations for understanding money velocity and credit and how all those processes intersect to determine the health of the economy.

  52. Token

    But until at least two of them get off their rear and start producing, the wealth of the village is going to stay where it is. You can give them some food and you can build them a house, but that is not going to keep the economy going for even the next year. True gains over time are when production starts and compounding returns from increasing productivity work their magic.

    That is Says law vs Keynesian policy

    A story familiar in remote indigenous communities.

  53. Piett

    Joe,

    BRC is slightly misleading you on when you apply Keynesian policy. It was always meant as an response to an emergency. It’s not meant to suggest that governments just hand out unlimited money all the time.

    In fact, governments should be tightening in boom periods (spending less and building up a surplus) to match the deficit spending in a depression.

    Also, governments should be very careful about when they try to apply stimulus, and not do it if there is any doubt that there is a real emergency. (As I mentioned above, this applies to Labor’s handling of the GFC.)

    The fact that some governments violate these principles does not invalidate the theory, in my opinion.

  54. brc

    3) The Says Law and Austrian folk don’t seem to have a response to the question of what do you do if there is a prolonged shift from consumption to saving.

    That’s because it doesn’t matter.

    If you have bought into the paradox of thrift as laid out by Keynes, you won’t make progress until you dump that notion.

    Even if Joe sequesters profits from his business, he will place them in a bank, which will lend them out to other people. Thus the funds are not removed from the economy.

    In the very short term, a switch from spending to saving will cause a contraction in the economy. This is self evident as changes in investment have longer lead times whereas changes in consumption can be instant. However, in the longer term the economy will be better off with more savings. The question of which company will be the first to invest is easily answered – the one with the healthiest pool of savings who would prefer to see them earning a higher return in their chosen field.

    Trying to prevent savings at all costs – which is the desire of Keynesian followers (who get hysterical about monetary deflation) has the long run effects of starving an economy of investment pools of savings to fund production. This is a far worse outcome than a short term contraction in the economy to establish savings. The savings hysterics can never answer the question of what is supposed to fund investment in production if there are no savings. They fret about firms going bankrupt – not realising that firms are just collections of resources – bankruptcy does tend to make a bad day for the owners, but it doesn’t destroy the productive capacity.

  55. Piett

    Essentially – everyone has to get off their backside and work if they want to buy stuff. There’s no shortcut around this.

    Yeah, except that in a severe downturn there’s an army of unemployed labour that no one wants to employ. There is that minor problem.

  56. .

    Good to see this blog has provided value to you Joe Goodacre.

    Maybe I’ve been a bit harsh on you.

    As to why you’re wrong on what we disagree on – that is for another day but I am sure I can convince with with a more cordial approach.

  57. .

    Piett
    #1359660, posted on June 25, 2014 at 1:00 pm
    Joe,

    BRC is slightly misleading you on when you apply Keynesian policy. It was always meant as an response to an emergency. It’s not meant to suggest that governments just hand out unlimited money all the time.

    In fact, governments should be tightening in boom periods (spending less and building up a surplus) to match the deficit spending in a depression.

    Yea, but they also deceive themselves. Furthermore, it doesn’t work in the real world and cannot work in theory.

  58. Joe Goodacre

    The “Paradox of Thrift”: in an economic downturn, or impending downturn, it is perfectly rational for individuals to minimise consumption and maximise saving, but if everyone does it, firms go bankrupt, employment nosedives, and the economy is wrecked.

    This makes sense too – demand and supply need each other.

    People stop supplying when their nervous and think demand will fall. They’ll also demand less themselves of discretionary items.

    That is largely what the ‘stimulus’ is meant to rectify – what would be the response that such an intervention is incorrect.

  59. brc

    BRC is slightly misleading you on when you apply Keynesian policy. It was always meant as an response to an emergency. It’s not meant to suggest that governments just hand out unlimited money all the time.

    In fact, governments should be tightening in boom periods (spending less and building up a surplus) to match the deficit spending in a depression.

    On the contrary, a theory which only leads to poor application is a failed theory. It is possible to make post-hoc declarations of bad application of Keynesian policy, but difficult to do so in advance. The problem with Keynesian theory is multiple – 1) it allows governments a fig-leaf to freely spend limited capital on pet projects (school halls) 2) it assumes that centrally-planned production responses are the best way to restart an economy and 3) it enshrines a central tenet that any spending is good spending, and any saving is bad.

    Governments should be fiscally responsible in holding certain amounts of funds in savings to cover an unexpected drop in tax receipts – but that is a separate issue to thinking they can restart an economy by wasteful spending, that somehow returns through a magic multiplier.

    In 80 years of the theory being around, there have been 0 successful applications of it to restart an economy with no ill effects. A theory that seeks to even out the boom-bust cycle by allowing central planners capital allocation responsibilities seeks to confirm socialists desire to control the economy for their outcomes, and never benefits the public at large.

    The building up of large surpluses assumes that a government can manage capital better than individuals can do. This is patently false in theory and practice (NBN, anyone?). Surpluses should be return to taxpayers for more efficient allocation. Governments should run responsible fiscal policy as part of their budgeting process, but not because they think they can run the economy better than individuals making capital allocation choices.

  60. brc

    Yeah, except that in a severe downturn there’s an army of unemployed labour that no one wants to employ. There is that minor problem.

    Only if you see people as robots only able to take direction and not able to find or make work on their own accord. Unemployment is a feature of a dynamic economy – a painful feature – but not one you can or should avoid at all costs. Inflexible labor markets also exacerbate unemployment problems, as do labor market distortions like minimum wages and people being told they will never experience unemployment, so do not prepare for it. We are all destined to be unemployed and unemployable at some point.

    The US did it’s best to avoid a short, sharp unemployment period by running up ruinous debts in the belief that a magic Keynesian multiplier would come to the rescue. It did destructive things like borrow money to pay people to destroy vehicles in exchange for a new one bought on credit. These measures did not help with unemployment, and they set the scene for further years of sluggish unemployment. A day or two in surgery is better than years of chronic pain.

    As always with socialist policy – the proponents of it insist that it is curing a problem that ‘the other side’ would just let happen. The trick is that they both don’t fix the problem in the short term, and make it worse in the long term, but claim a moral victory in both. They stand in front of the smashed window and brag about how many glaziers will eat tonight.

  61. Piett

    In the very short term, a switch from spending to saving will cause a contraction in the economy. This is self evident as changes in investment have longer lead times whereas changes in consumption can be instant.

    How long is the “very short term”? The Long Depression in the 19th century lasted, in the US, for over 5 years, and longer in some other countries. And this was, obviously, well before Keynesian policy. It was an era of very small government, low taxes and minimal regulation.

    Is 5 years the “very short term”?

    However, in the longer term the economy will be better off with more savings. The question of which company will be the first to invest is easily answered – the one with the healthiest pool of savings who would prefer to see them earning a higher return in their chosen field.

    Except that if risk appears high, it may be entirely sensible to sit on one’s savings, even at 0% interest, rather than take the gamble of investing them.

    Companies are not acting in the interest of the overall economy, they’re acting in their own self-interest. There’s nothing wrong with that, but why would a company gamble on the economy recovering in say 6 months or a year, when it could hold its cash, and wait and see.

    If you were a business advisor, would you be urging a cautious board of directors to ramp up production in the face of falling demand?

  62. .

    Dissent on the Long Depression

    http://wiki.mises.org/wiki/Long_Depression

    I do believe France suffered, after the Franco Prussian War.

  63. brc

    How long is the “very short term”? The Long Depression in the 19th century lasted, in the US, for over 5 years, and longer in some other countries. And this was, obviously, well before Keynesian policy. It was an era of very small government, low taxes and minimal regulation.

    The important consideration is : would Keynesian policy have made things better? The answer is no. We know that, because each time it has been tried since, it hasn’t generated the expected results.

  64. brc

    if you were a business advisor, would you be urging a cautious board of directors to ramp up production in the face of falling demand?

    Of course not.

    Would I be looking for some area of the economy where I could deploy capital to earn a positive NPV?

    Of course I would.

  65. Pedro

    “Keynes had to do this because his entire theory was based on the analysis of demand failure, and his prescription for putting life back into aggregate demand – namely, a fiscal stimulus (read: lower taxes and/or higher government spending).”

    I think we are all for the lower taxes part of the equasion.

    “A day or two in surgery is better than years of chronic pain.”

    Perhaps you’re not aware that Hayek recanted his liquidationist views.

  66. Piett

    The important consideration is : would Keynesian policy have made things better? The answer is no. We know that, because each time it has been tried since, it hasn’t generated the expected results.

    Much depends on what your criteria for success are. If Keynesian policy is meant to be a magic wand that instantly restores the economy to full health, then no, it hasn’t ever succeeded.

    But if it’s meant to ‘smooth out’ the business cycle, having shallow (but often longer) downturns rather than short and sharp ones, then perhaps it has succeeded. Look at a graph of US GDP from the 19th century onwards. Recessions in the second half of the 20th century were certainly shallower than earlier ones.

    A day or two in surgery is better than years of chronic pain.

    Hmm, I’m not so sure. The ‘short and sharp’ downturns caused great misery — far worse than the GFC and recent recession — and led to the rise of vicious extremist political movements like the Commies and Fascists. The “day in surgery” almost killed the patient! :)

    Anyway, I’m bowing out, it’s been an interesting discussion, and I’ll explore some of the links that people have provided.

  67. brc

    The ‘short and sharp’ downturns caused great misery — far worse than the GFC and recent recession — and led to the rise of vicious extremist political movements like the Commies and Fascists.

    I think the problem here is that we overlook the chronic un-and-under employment that is occurring right now, particularly amongst young people. It’s particularly bad when one class or section of society has to bear the pain, and I think this gives rise to extremism more than a short, sharp period of general unemployment. My preference would be for more flexible labor markets but that is a separate discussion.

    I don’t discount the horrors of liquidation and unemployment lightly – I merely want to point out that the prescriptions to avoid them don’t normally work and do normally lead on to other effects. There is a real worry that places like Spain and Greece are setting the scene for more extremism in the next decade as a result of unemployed and unemployable youth. High minimum wages and inflexible labor markets coupled with general downturns affect young people disproportionately, and that’s a major worry to me. All of the serious extremist movements have been primarily made up of young people.

  68. .

    Perhaps you’re not aware that Hayek recanted his liquidationist views.

    No I’m not, along with Mises and Rothbard, they wrote a book on ABCT.

    What matters is the NPV as mentioned earlier. The shorter the crisis, the less loss of opportunities under a time value of money framework.

    Friedman showed that the idea of a “short, sharp” readjustment was largely misplaced.

    See The Role of Monetary Policy. Milton Friedman. The American Economic Review, Vol. 58, No. 1. (Mar., 1968), pp. 1-17

  69. Joe Goodacre

    Would I be looking for some area of the economy where I could deploy capital to earn a positive NPV?

    Of course I would.

    In my experience business doesn’t quite work that way.

    Most people are careful about going outside their circle of competence.

    Just because miners are making a lot of money doesn’t mean that an automobile parts manufacturer is going to redeploy their capital there.

  70. Empire

    but why would a company gamble on the economy recovering in say 6 months or a year, when it could hold its cash, and wait and see.

    Their investors will ultimately flee to higher returns. They can’t sit on their hands forever.

    If you were a business advisor, would you be urging a cautious board of directors to ramp up production in the face of falling demand?

    Depends what they produce, but if their risk appetite is low…

    The questions you raise are fair, but in my experience, the low risk appetite you invoke is not indicative of the average entrepreneur or even professional director in this country. Capital is so mobile now that the herd collectively cannot afford to adopt such a low risk position.

    Food for thought. First mover is instinctual for some. If so, an investment strike would seem impossible where individuals are free to act. Someone, somewhere will attempt to crash through. When they do, someone will follow. Soon enough, the worm turns.

    and led to the rise of vicious extremist political movements like the Commies and Fascists.

    You’re drawing a long bow there. Sharp downturns might have played nicely for their respective narratives, but were not the cause of their (temporary) success.

  71. Token

    Yeah, except that in a severe downturn there’s an army of unemployed labour that no one wants to employ. There is that minor problem.

    People discussing the Austrian business cycle really need to communicate how people living through the shock can be assisted during the worst of the change.

    As has been noted in the last couple of US elections working class people of a conservative bent with fixed outgoings react in a predictable emotional defensive manner when confronted with the thought of the pain.

    We all know stopping the assistance package is the challenge (with the depression era programs still in place in the US), but at the same time it is important to communicate in a way that does not trigger people’s instinctive fears.

  72. .

    People discussing the Austrian business cycle really need to communicate how people living through the shock can be assisted during the worst of the change.

    You are less likely to lose your job in a free market system. Hours can adjust down, then can benefits, then wages.

    A 10% cut in hours is better than a 100% loss in income.

  73. ) The Says Law and Austrian folk don’t seem to have a response to the question of what do you do if there is a prolonged shift from consumption to saving.

    You celebrate. More savings, more capital, more growth.

  74. Peewhit

    Primary industry operates in an auction system. The price is adjusted to clear supply. Ideally the same should happen in all markets, but various cartels mean it is not so. The labour market from top to bottom is operating a cartel in the land of Oz, except for the self employed. J M Keynes idea was that the budget should be neutral over the cycle. This was before it was tried and governments found how addictive it is to offer “freebies” to the electors. See TANSTAAFL, as defined by Robert Heinlen. One last thought I have been turning over is that if it is a rescue of the economy for a government to have half the unemployed going around digging holes, and the other half of the unemployed a day behind them filling them in, then why have we not been saved by our modern equivalent. How is this different to welfare. Welfare payments are no different to paying for nothing achieved in the time spent making and filling holes.

  75. Tel

    Your business can only buy things because it produces something to exchange. That’s all you need to remember.

    Unless I happen to be in the money printing business and then I can buy things without producing anything.

    However, that doesn’t create more things, so whatever I buy with my freshly printed money and then consume, is something that someone else missed out on. Only more production can create more goods.

    You might buy and sell a million virtual things on paper, but you can only consume actual things that were actually produced.

  76. Tel

    The Says Law and Austrian folk don’t seem to have a response to the question of what do you do if there is a prolonged shift from consumption to saving.

    Of course they have a response. Interest rates on the open market (not interfered with by government, nor central banks) will go down and thus discourage further saving, bringing the system into equilibrium.

  77. Tel

    The “Paradox of Thrift”: in an economic downturn, or impending downturn, it is perfectly rational for individuals to minimise consumption and maximise saving, but if everyone does it, firms go bankrupt, employment nosedives, and the economy is wrecked.

    Name one economy that was ever wrecked by thrifty citizens.

  78. .

    The “Paradox of Thrift”: in an economic downturn, or impending downturn, it is perfectly rational for individuals to minimise consumption and maximise saving, but if everyone does it, firms go bankrupt, employment nosedives, and the economy is wrecked.

    No.

    Firms cut costs, the price of credit falls and prices fall enabling for the economy to clear without much loss of employment or incomes.

    With a non clearing labour market and FX market, this can’t happen though.

  79. brc

    In my experience business doesn’t quite work that way.

    Most people are careful about going outside their circle of competence.

    Just because miners are making a lot of money doesn’t mean that an automobile parts manufacturer is going to redeploy their capital there.

    Businesses that can’t find a profitable way of deploying capital go broke or get dissolved. If your market is not coming back to you, you need to find a new market. This happens all the time. In fact, in my experience, the thing I have been involved in the most is looking for new opportunities. It’s very difficult. But you have to do it or you are sunk eventually.

    This brings up another point – various people suggest that the government should be doing the ‘rainy day’ thing and running a surplus – which is bad because for one it allows irresponsible politicians the chance to crack open a pot of money (Rudd, Swan) and for two it removes that money from people who could deploy it better.

    Businesses and individuals should be mindful of the existence of downturns and should be continually planning for what happens if one hits. If every business has catered for a downturn and every family also has, then there is no need for the government to do the job. A private savings led recovery will be much stronger because it is more efficiently allocated, and avoids idiotic situations like the school halls or insulation debacles.

    Beleiving in a little bit of Keynes is like believing in a little bit of assistance for global warming. It’s ineffective, deploys capital badly, and ultimately makes things worse in the long run.

    But it has the right vibe and so that’s why the meddlers, moochers and pollies love it. Nothing on earth is happier than a dangerous pair of loons like Rudd and Swan throwing cash around like confetti, believing they are actually making things better.

  80. Yohan

    Says Law doesn’t attempt to explain recessions. Recessions are caused by the business cycle and would happen regardless. It doesn’t attempt to talk about international trade or national economies- it’s just a foundation for understanding how economies work and grow. Economies grow when more people produce more things – end of story. People layer all kinds of incomprehensible mumbo-jumbo on top of it, but this is the essential point. You can’t make an economy grow without getting people to produce more stuff.

    I like this. People try to apply simple economic concepts like Say’s Law to some overall analysis that should explain everything.

  81. Yohan

    People discussing the Austrian business cycle really need to communicate how people living through the shock can be assisted during the worst of the change.

    How people can be assisted best is by making the shock ‘short and sharp’, rather than long, shallow and drawn out.

  82. Joe Goodacre

    Businesses that can’t find a profitable way of deploying capital go broke or get dissolved. If your market is not coming back to you, you need to find a new market.

    Agreed – it seems to me that there are recessional consequences that come with this because not everyone is good at finding new opportunities or even recognising the signs of decline on the horizon.

    What I’m not sure about is the argument that there is no market intervention that is beneficial. I can see the possibility that factors can combine to create a downturn and a targeted intervention that restores confidence or undertakes an investment in infrastructure that has a strong business case (but may require government involvement to remove other government roadblocks) may end a recession faster.

  83. .

    How do you “restore confidence”?

    Why wasn’t the road built anyway?

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