Send us your blog post, blog address, address of other great sites or suggestions by email. centerforeconomicliberty@gmail.com

Wednesday, July 17, 2013

Say's law of markets

While J.B. Say has been almost totally ignored by mainstream economists and historians of economic thought, this is not true for one relatively minor facet of his thought that became known as ‘Say's law of markets’. The one point of his doctrine that the active and aggressive British Ricardians got out of Say was this law. James Mill, the ‘Lenin’ of the Ricardian movement (see below), appropriated the law in his Commerce Defended (1808), and Ricardo adopted it from his discoverer and mentor.13
Say's law is simple and almost truistic and self-evident, and it is hard to escape the conviction that it has stirred up a series of storms only because of its obvious political implications and consequences. Essentially Say's law is a stern and proper response to the various economic ignoramuses as well as self-seekers who, in every economic recession or crisis, begin to complain loudly about the terrible problem of general ‘overproduction’ or, in the common language of Say's day, a ‘general glut’ of goods on the market. ‘Overproduction’ means production in excess of consumption: that is, production is too great in general compared to consumption, and hence products cannot be sold in the market. If production is too large in relation to consumption, then obviously this is a problem of what is now called ‘market failure’, a failure which must be compensated by the intervention of government. Intervention would have to take one or both of the following forms: reduce production, or artificially stimulate consumption. The American New Deal in the 1930s did both, with no success in relieving the alleged problem. Production can be reduced, as in the case of the New Deal, by the government's organizing compulsory cartels of business to force a cut in their output.
Stimulating consumer demand has long been the particularly favoured programme of interventionists. Generally, this is done by the government and its central bank inflating the money supply and/or by the government incurring heavy deficits, its spending passing for a surrogate consumption. Indeed, government deficits would seem to be ideal for the overproduction/ underconsumptionists. For if the problem is too much production and/or too little consumer spending, then the solution is to stimulate a lot of unproductive consumption, and who is better at that than government, which by its very nature is unproductive and even counter productive?
Say understandably reacted in horror to this analysis and to the prescription.14 In the first place, he pointed out, the wants of man are unlimited, and will continue to be until we achieve genuine general superabundance – a world marked by the prices of all goods and services falling to zero. But at that point there would be no problem of finding consumer demand, or, indeed, any economic problem at all. There would be no need to produce, to work, or to worry about accumulating capital, and we would all be in the Garden of Eden.
Thus Say postulates a situation where all costs of production are at last reduced to zero: ‘in which case, it is evident there can no longer be rent for land, interest upon capital, or wages on labour, and consequently, no longer any revenue to the productive classes’. What will happen then?

What then, I say, these classes would no longer exist. Every object of human want would stand in the same predicament as the air or the water, which are consumed without the necessity of being either produced or purchased. In like manner as every one is rich enough to provide himself with air, so would he be to provide himself with every other imaginable product. This would be the very acme of wealth. Political economy would no longer be a science; we should have no occasion to learn the mode of acquiring wealth; for we should find it ready made to our hands.

Since, apart from the Garden of Eden, production always falls short of man's wants, this means that there is no need to worry about any lack of consumption. The problem that limits wealth and living standards is a deficiency of production. On the market, Say points out, producers exchange their products for money and they use the money to buy the products of others. That is the essence of the exchange, or market, economy. Therefore the supply of one good constitutes, at bottom, the demand for other goods. Consumption demand is simply the embodiment of the supply of other products, whose owners are seeking to purchase the products in question. Far better to have demand emerging from the supply of other products, as on the free market, than for the government to stimulate consumer demand without any corresponding production.
For the government to stimulate consumption by itself ‘is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire for consumption; and we have seen that production alone, furnishes the means’. Since genuine demand only comes from the supply of products, and since the government is not productive, it follows that government spending cannot truly increase demand:

a value once created is not augmented... 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...

But if there can be no general overproduction short of the Garden of Eden, then why do businessmen and observers so often complain about a general glut? In one sense, a surplus of one or more commodities simply means that too little has been produced of other commodities for which they might exchange. Looked at in another way, since we know that an increased supply of any product lowers its price, then if any unsold surplus of one or more goods exists, this price should fall, thereby stimulating demand so that the full amount will be purchased. There can never be any problem of ‘overproduction’ or ‘underconsumption’ on the free market because prices can always fall until the markets are cleared. While Say did not always put the matter in these precise terms, he saw it clearly enough, particularly in his Letters to Malthus, in his controversy with the Rev. Thomas Robert Malthus over Say's law. Those who complain about overproduction or underconsumption rarely talk in terms of price, yet these concepts are virtually meaningless if the price system is not always held in mind. The question should always be: production or sales at what price! Demand or consumption at what price! There is never any genuine unsold surplus, or ‘glut’, whether specific or general over the whole economy, if prices are free to fall to clear the market and eliminate the surplus.
Moreover, Say wrote in his Letters to Malthus, ‘if the quantity sent in the slightest degree exceeds the want, it is sufficient to alter the price considerably’. It is this notion of what we would now call ‘elasticity’, and resulting sharp changes in price, that for Say leads many people to mistake a ‘slight excess’ of supply ‘for an excessive abundance’.
The policy implications of attending to the price system are crucial. It means that to cure a glut, whether specific or pervasive, the remedy is not for the government to spend or create money; it is to allow prices to fall so that the market will be cleared.
In his Letters to Malthus, Say offers the following example. One hundred sacks of wheat are produced and exchanged for 100 pieces of cloth (or rather, each is exchanged for money and then for the other commodity). Suppose that productivity and output of each is doubled, and now 200 sacks of wheat are exchanged for 200 pieces of cloth. How is superabundance or overproduction going to affect either or both commodities? And if by producing 100 units of each product, the producer made 30 francs' profit, why couldn't the resulting increase of production and fall in the price of each product still reap 30 francs' profit for each seller? And how can general glut arise? Yet Malthus would have to maintain that part of the new production of cloth would find no buyers.
Say then notes that Malthus in a sense conceded the point about prices falling due to increased production, and then fell back on a second line of defence: that ‘productions will fall to too low a price to pay for the labour necessary to their production’. Here we come to the nub of the overproductionist/underconsumptionist complaints – if we can get past their foggy aggregative concepts and their real or seeming neglect of the fact that a lower price of any product can always clear the market.
In reply, Say noted that Malthus, having unfortunately adopted the labour theory of value, neglected to add the productive services of land and capital to labour in the costs of production. So that the assertion is that selling prices will fall below the costs of production.
But where do ‘costs’ come from? And why are they somehow fixed, exogenous to the market system itself? How are they determined? Although Ricardo joined with Say on the question of overproduction, it was easy for a British follower of Smith and Ricardo (such as Malthus) on cost theories of value to fall into this trap and to assume that costs are somehow fixed and invariant. Say, believing as we have seen that costs are determined by selling price rather than the other way round, was impelled to a far clearer and more correct picture of the entire matter. Returning to his example, Say points out that if the wheat and cloth producers double the quantity produced with the same productive services, this means not only that the prices of wheat and cloth will fall, but also that factor productivity has risen in both industries. A rise of factor productivity means a lowering of cost. But this means that an increase in output will not only lower selling price; it will also lower costs, so there is no reason to assume grievous losses or even a lessening of profit if prices fall.
Apparently, Say continued, Malthus is worried about the prices of productive services remaining high and therefore keeping costs too high as production increases. But here Say brings in a brilliantly perceptive point: prices of productive factors must be high for a reason; they are not preordained to be high. But this high wage or rent in itself precisely ‘denotes that what we seek for exists, that is to say, that there is a mode of employing them so as to make the produce sufficient to repay what they cost’. In short, factor prices being high means that they have been bid up to that height by alternative uses for them. If the costs of these factors seriously impinge upon or erase the profits of a firm or industry, this is because these factors are more productive elsewhere and have been bid up to reflect that vital fact. Say's reasoning is strikingly similar to the modern free trade reply to the ‘cheap labour’ argument for protective tariffs. The reason why labour is more expensive, say, in the United States or other industrialized country, is that other American industries have bid up these labour costs. These industries are therefore more efficient than the industry suffering from competition, and hence the latter should cut back or shut down and allow resources to shift to more efficient and productive fields.
In more peripheral but still relevant areas, J.B. Say engaged in some lovely and powerful examples of reductio ad absurdum argument. Thus, on the importance of demand vis-à-vis supply, and on the question of gluts, he asked what would have happened if a merchant shipped a current cargo to the site of New York City in the early seventeenth century. Clearly, he wouldn't have been able to sell his cargo. Why not? Why this glut? Because no one in the New York area was producing enough other goods to exchange for this cargo. And why would this merchant be sure to sell his cargo nowadays in New York City? Because there are now enough producers in the New York area to make and import products, ‘by the means of which they acquire that which is offered to them by others’.
It would have been absurd to state that the problem about the seventeenth century cargo was there was too many producers and not enough consumers. Say adds that ‘the only real consumers are those who produce on their part, because they alone can buy the produce of others, [while]... barren consumers can buy nothing except by the means of value created by producers’. He concludes eloquently that ‘it is the capability of production which makes the difference between a country and a desert’.
The other potent reductio, also in his Letters to Malthus, is part of his defence of innovation and machinery against charges of overproduction. Malthus, Say notes, concedes that machinery is beneficial when the production of the product is so increased that employment in that field increases also. But, Say adds, new machinery is advantageous even in the seeming worst case, when production of the particular good is not increased and labourers are discharged. For, first, in the latter case as well as the former, productivity increases, selling prices fall, and standards of living rise. Besides, writes Say, bringing in the reductio, tools are vital to mankind. To propose, as Malthus does, to limit and restrain the introduction of new machinery is to argue implicitly that ‘we ought (retrograding rather than advancing the career of civilization) successively to renounce all the discoveries we have already made, and to render our arts more imperfect in order to multiply our labour by diminishing our enjoyments’.
As to labourers disemployed by the introduction of new machinery, Say writes that they can and will move elsewhere. After all, he adds caustically, the employer who brings in new machinery ‘does not compel them [the labourers] to remain unemployed, but only to seek another occupation’. And many employment opportunities will open up for these labourers, since income in society has increased due to the new machinery and product.
Echoing Turgot, Say also counters the Malthus-Sismondi worry about the leaking out of savings from vital spendings, pointing out that savings do not remain unspent; they are simply spent on other productive (or reproductive) factors rather than consumption. Rather than injuring consumption, saving is invested and thereby increases future consumer spending. Historically, savings and consumption thereby grow together. And just as there is no necessary limit to production, so there is no limit to investment and the accumulation of capital. ‘A produce created was a vent opened for another produce, and this is true whether the value of it is spent’ on consumption or added to savings.
Conceding that sometimes the savings might be hoarded, Say was for once less than satisfactory. He pointed out correctly that eventually the hoard will be spent, either on consumption or investment, since after all that is what money is for. Yet he admitted that he too deplored hoarding. And yet, as Turgot had hinted, hoarded cash balances that reduce spending will have the same effect as ‘overproduction’ at too high a price: the lower demand will reduce prices all round, real cash balances will rise, and all markets will again be cleared. Unfortunately, Say did not grasp this point.15
Say, however, was again powerful and hard-hitting in his critique of Malthus's belief in the importance of maintaining unproductive consumption by government: income and consumption by government officials, soldiers, and state pensioners. Say argued that these people live off production, whereas productive consumers add to the supply of goods and services. Say continued sardonically: ‘I cannot think that those who pay taxes would be at a loss what to do with their money if the collector did not come to their assistance; either their wants would be more amply satisfied, or they would employ the same money in a reproductive manner’.
In contrast to his opponents, who wished the government to stimulate consumer demand, Say believed that problems of glut, as well as poverty in general, could be solved by increasing production. And so he inveighed in many passages against excessive taxation, which raised the costs and prices of goods, and crippled production and economic growth. In essence, J.B. Say countered the statist proposals of the underconsumptionists Malthus and Sismondi by an activist programme of his own: the libertarian one of slashing taxation.
Say combined his anti-tax insights with his critique of Malthus's fondness for government spending via a trenchant attack on Malthus and the public debt. Say noted that Malthus, ‘still convinced that there are classes who render service to society simply by consuming without producing, would consider it a misfortune if the whole or a great part of the English national debt were paid off’. On the contrary, rebutted Say, this would be a highly beneficial event for England. For the result would be

that the stock-holders [government bond-holders], being paid off, would obtain some income from their capital. That those who pay taxes would themselves spend the 40 millions sterling which they now pay to the creditors of the State. That the 40 millions of taxes being taken off, all productions would be cheaper, and the consumption would considerably increase; that it would give work to the labourer, in place of sabre cuts, which are now dealt out to them; and I confess that these consequences do not appear to me of a nature to terrify the friends of public welfare.

Austrian Perspective on the History of Economic Thought (2 volume set)

No comments:

Post a Comment