A Rehabilitation of Say’s Law

II DEFINITIONS (WITH SOME EXPLANATIONS)

Production. The creation of value (Say’s definition). More rigorously, (a) as a process, provision of the flow of productive services by men or assets (natural resources being included under “assets”); and (b) as a magnitude, the “real” value of that flow.

This aggregate “real” value of the production flow—aggregate output, or aggregate real income, or whatever we call it—is not simply a question of the physical magnitudes of all the different outputs. It is a special measurement of the “creation of value,” the measuring-rod being an abstractly conceived money unit of constant purchasing power, defined in an index number, the weighting of which is regarded as appropriate (although it cannot avoid being arbitrary).1

Consumption. The extermination of value (Say’s definition). It is therefore the extermination of power to demand. Both the creation and the extermination of value may occur passively.

Manna falling from heaven would have to be classed as “production” and the destruction of manna (say, by a flood) would have to be classed as “consumption”. Consumption may be unintentional, purposeless or wasteful. A rise in the aggregate value of outputs is “production” and a decline in that value is “consumption.”2

Supplies. Ignoring the case of barter, inputs or outputs (including accumulated outputs) offered at “money’s worth” (see below), i.e., at prices which induce their sale to potential purchasers. That is, the magnitude of supplies in each case will depend upon the price asked, which will be the “money’s worth.”

Outputs of physically completed goods of which (because the marketing services demanded by potential purchasers have not been fully provided) the full production process is incomplete are also “supplied” to the owner (and “demanded” by him). They are not yet sold (purchased), but they are invested in as they replenish inventories or accumulate in the form of inventories. Just as materials may be “supplied” at their “money’s worth” to replace or add to a potential purchaser’s inventories, so will they be “supplied” without being sold (purchased), if they enter their producer’s inventories (their imputed value being their “money’s worth”). Entrepreneurs will ceteris paribus try to fix such prices as are calculated to maximize the “creation of value,” that is the yield to investment in inventories.

“Production” is the source of “supplies”; but some portion of potential supplies may be “withheld” (by curtailment of production) for the advantage of potential suppliers. As the theory of monopoly demonstrates, a contrived scarcity of the flow of certain valuable things (i.e., the “withholding” of potential supplies) may be to the advantage of those who own the flow; but while the “money’s worth” of that particular flow may rise, the “money’s worth” of the aggregate flow of output might decline under “monetary flexibility.” (See p. 22.)

To supply. To offer inputs or outputs at prices or values which induce their sale, or investment in them, whether for replacement of consumption or the net accumulation of assets.

Demands. Offers for inputs or outputs which induce their providers to sell, or invest in them as prospectively profitable assets.

“Potential supplies” of and “potential demands” for things (at different values or prices) may be represented in supply schedules and demand schedules; but actual supplies and actual demands are identical magnitudes with identical values or prices at the point of intersection of those schedules.

Competing and non-competing inputs and outputs. Output A (say, margarine) is “competing” with output B (say, butter) if an increase in the flow of A, or a fall in its price, implies a fall in the market-clearing price of B, or a reduction in its supply. Similarly, output A is “non-competing” with output C (say, shoe polish) if an increased flow of A, or a fall in its price, has no discernible influence on the market-clearing price of C or tends either to raise that price or bring forth a greater supply. Of course, as Walras stressed, all outputs (whether of consumer’s goods or of producer’s goods) are competing for the demands of income receivers and owners of assets.

Competition. The substitution of a lower cost method of (a) producing and marketing any commodity or service or (b) of attaining any other objective (material or non-material, private or collective) which involves a cost (the sacrifice of any other commodity or valued objective), irrespective of the institutional framework needed to create, release and/or protect incentives for the substitution. Strictly speaking, the word “marketing” under (a) is redundant; for the various marketing processes are as important as all other ways of “creating value,” such as farming, fishing, mining, transportation, manufacturing, and others.

Saving. The process of (a) replacing, partially or fully, the real value of that part of the stock of assets and the flow of services which is exterminated by consumption, in whatever sector of the economy the extermination occurs, or (b) adding to the stock of assets.

Savings. The net accumulation of value, i.e., the magnitude of the excess of value created (production) during a period over value exterminated (consumption) over that period.

Savers. To simplify exposition the term “savers” is used to mean “net savers,” although “dissavers” (see below) who do not consume the whole value of their assets over a period, in replacing some part of the value they exterminate, are simultaneously performing the saving and dissaving processes. Savers so defined accumulate assets—capital—a prospective income-stream, by refraining from consuming a greater value than is created by their efforts and assets (their “production”).

Dissavers. Those whose efforts and assets create insufficient value to offset the value they exterminate.

Saving preference. The aggregate expression of subjective valuations (preferences) as between consumption in the relatively distant future in contrast to consumption in the relatively immediate future. As with all changes in preferences, the extent to which they evoke actual supply responses (at market-clearing prices) will depend upon the versatilities of men and assets, i.e., elasticities of supply under that condition. A positive response to a rise in saving preference is usually manifested as a growth in that proportion of value created (production) which is embodied into assets of long life, to value created by embodiment of services into assets of short life and/or the immediate extermination of value created when services are consumed as they are rendered.

Assets. “Stores of value” other than human beings who are not slaves. In a money economy, all things—tangible or intangible—which, through the prospective income-stream they provide, have “money’s worth” are assets.

Investment. The entrepreneurial process of choosing the prospectively most profitable forms in which services are embodied into assets for replacement or accumulation, “human capital” (the composition of the stock of muscles and skills) included. That is, in this essay, “investment” is not conceived of as a magnitude. The relevant magnitudes are (i) “savings,” or “net accumulation,” and (ii) “dissavings” or “decumulation”.

Money. All assets the value of which arises, or is enhanced, because they are demanded and held wholly or partially for the monetary services they render, i.e., for the express purpose of exchange for non-money goods or services in the future. This definition covers currency in circulation, demand deposits, and (here my usage differs from what is conventional3) the pure money equivalent of “near-money” or “money substitutes”—“hybrid” assets which are partly non-money but which provide monetary services and are therefore partly money also (“hybrid assets”).4

Income. The aggregate value of production—i.e., the flow of productive services rendered by men and assets. This flow includes those services (a very small proportion) which are finally consumed as they are rendered, and those embodied into assets (short-life inventories or long-life “fixed assets”) which replace (wholly or partially) the value of consumption or contribute to the net accumulation of assets. Income may be measured in actual money units, such as dollars or pounds (“money income”) or in abstractly conceived units of defined constant purchasing power (“real income”).

Income may be broken down into the yield to labor and the yield to the owners of assets. Either of these yields may be contractual or residual, according to whether owners or workers accept responsibility for the success of productive operations and hence bear the risk. When the yields are contractual, they are known as “wages” and “interest” respectively. In the present essay it will be assumed for simplicity (and not unrealistically) that the yield to labor is wholly contractual, the entrepreneurial function being undertaken solely on behalf of the owners of assets,5 with the yield being, therefore, residual—that is, interest plus profits or minus losses.

Money income. The aggregate value of the flow of productive services, measured in actual money units (e.g., dollars), whether directly consumed or embodied into assets. Money income contributes to aggregate “money-spending power” (as distinct from “purchasing power”). But assets are “stores of value” and hence also contribute to “money-spending power” at their “money’s worth.”

Money’s worth. That price at which any chosen quantity of a thing (be it services or assets) can be sold at any moment. Any chosen portion of the stock of “assets, or of the flow of inputs, or of the flow of outputs is always realizable immediately for money, without cost, at its “money’s worth,” even if, through entrepreneurial misjudgement, this worth is influenced (i) by the services or assets having been produced in unprofitable abundance or (ii) by decisions to liquidate inventories more rapidly than is destined to maximize the yield from investment in them. In the extreme case, the “money’s worth” of outputs could be nil, in which event consumption equal to the value of the inputs will have occurred. “Money’s worth” may be determined under social discipline, i.e., under “free” competitive market pressures, or in the private interest (as via governmental “controls,” or private coercion, or collusion)6

Market-clearing price. A particular case of “money’s worth”; namely, that price at which such portion of the flow of services or of the stock of assets as the provider or owner does not judge it profitable to invest in or judges it profitable to disinvest from, can be sold at any moment in the absence of any “withholding of capacity” on his part. In the case of inputs, market-clearing prices (“costs”) are those which induce investment in all inputs which lack more remunerative fields of utilization, because prospective yields to the entrepreneurial intermediary from all increments acquired exceed or do not fall short of the market rate of interest.

Withheld capacity. Labor and assets that are idle or idling through a defect in the pricing system, i.e., through a failure to price their services for “market clearance.” Such a defect can occur (i) because prices are fixed (by law, through private duress, or through collusion) in the private interests of the suppliers or demanders of the services priced; or (ii) (simply a special form of “exploitative” pricing) because men or assets have, through various devices and stratagems, including discernible private duress, been shut out from particular areas, occupations or firms.

The distinction between (a) the “withholding” of outputs through the charging of values or prices above market-clearing values, and (b) the productive accumulation of outputs in the form of inventories or additions to physical plant and equipment is to be dealt with in several contexts. My Theory of Idle Resources, 1939, tried to explain this issue through a distinction between “pseudo-idleness” and wasteful idleness (in assets and men). An entrepreneur may have to invest in materials at prices raised by cartel action and invest in labor at wage-rates forced up by strike-threat duress. Such materials and labor will have a “money’s worth” which exceeds “market-clearing” values. But the entrepreneur himself may possess no similar power to contrive scarcities, and the price he must ask to clear the outputs which he judges will maximize his yield (given labor and material prices above the “market-clearing” level) will then be “market-clearing” under our definition.7

Monetary services. The contribution of money to production and hence to income; in other words, the value created by money held either (i) in households [mainly case (a), below] or (ii) in the course of production for exchange or sale. Monetary services are either (a) consumed as they are rendered, in which case money must be envisaged as a form of consumer assets creating value in the form of immediately consumed “gratifications”—security, convenience, etc.; or (b) embodied, as inputs, into the stock of assets [of short or long life], in which case money must be envisaged as a form of producer assets.

The money supply. The aggregate value of money measured in actual money units, such as dollars, pounds, francs, yen, or marks. It is often called “the nominal quantity of money.” In my book Keynesianism I called it at times “the number of money units,” to stress the reality that each unit can be envisaged as a container of “purchasing power,” and that the magnitude of the contents of the containers can vary.

In the case of money and monetary services, “market-clearing values”8 are prices of non-money which induce persons or corporations (for reasons of relative prospective profitability of money and non-money) either (a) to supply money, by decisions not to replenish their investments in money inventories as they are depleted through purchases, or (b) to demand money by accumulating money received, thereby increasing their investment in it.

Monetary flexibility. A monetary policy in which the treasury and/or the central bank (or other monetary authority) is under an obligation so to adjust or control the issue and withdrawal of credit (mainly deposits, notes, token money, and the pure money equivalent of “hybrid money” (see pp. 18-19) that, as far as is practicable, “the money supply” shall vary in direct proportion to the aggregate real value of money (i.e., “the money supply” measured in abstractly conceived money units of constant purchasing power). In other words, a monetary policy is flexible when the “money supply” can expand or contract sensitively, so as to be neither inflationary nor deflationary; and that means, in practice, when (through budgetary deficits or surpluses, open market operations, rediscount action, reserve ratio discipline and control of the note issue) the market rate of interest is maintained at what is judged to be the non-inflationary, non-deflationary level.9 Under monetary flexibility, an appropriate price index will oscillate within a narrow amplitude about a constant trend of zero. The money unit can then be said to be “convertible in real terms.”

Monetary rigidity. A condition in which “the money supply” fails to respond sensitively in either direction when the demand for money varies. In other words, monetary policy is rigid when “the money supply” remains unchanged, or does not vary in direct proportion to changes in the demand for money, so that the real value of the money unit (the “purchasing power” in each “container”) may rise or fall.

Loss-avoidance, profit-seeking incentives. Incentives for responsible entrepreneurial action, that is, incentives to compete. Such incentives can be created, released or protected through institutions designed to prevent as far as practicable “the contrivance of scarcities” or “the contrivance of plenitudes,”10 i.e., to prevent monopolistic or monopsonistic abuse (including oligopolistic or oligopsonistic abuse).

Exploitation. Any action taken, whether or not through discernible private coercion (collusion) or governmental coercion, or whether through monopolistic or monopsonistic power, which, under a given availability of resources (including the stock of knowledge and skills), reduces the value of the property or income of another person or group of persons, or prevents that value from rising as rapidly as it otherwise would, unless this effect is brought about through (a) the dissolution of some monopolistic or monopsonistic privilege, or (b) the substitution of some cheaper method (labor-saving or capital-saving) of achieving any objective (including the production and marketing of any output); or (c) the expression of a change in consumers’ preference; or (d) through taxation authorized by explicit legislation accepted as legitimate in any context.

 

 

11In my judgment such an index ought ideally, as far as is technically practicable, to give equal importance to every segment of the aggregate flow of productive services. But for many reasons, values of the flow of end products—which include the surviving values of previous services embodied into end products—must form the chief data for the construction of such an index.

12A rise in the value of outputs brought about by monopolistic restraint implies a reduction in the value of non-competing outputs.

13In the quantity theory identity (MV ≡ PT) as I use it (purely for exposition purposes), M includes the pure money equivalent of “near money.” As other economists use the identity the effects of “near money” are represented (most misleadingly in my judgment) under V.

14On the notion of the “pure money equivalent” of such “hybrid” assets, see Hutt, Keynesianism, p. 92.

15This assumption is relaxed on p. 106, first footnote.

16The implication that “all goods are perfectly liquid” (Leijonhufvud’s phrase) at their “money’s worth” does not require the condition of “general competitive equilibrium”. Nor does it mean that “the full value of any good can be instantly realized”, as Leijonhufvud suggests (On Keynesian Economics, p. 79), if the term “full value” means “market-clearing value”. But if the ambiguous term means “money’s worth”, the implication of perfect liquidity (instant realization) does exist.

17This point is further considered in Chapter V.

18To talk of the “price of money” is a slovenly use of language. Price is the valuation of non-money in terms of money. Today’s tendency to refer to the rate of interest as the “price of money” is worse than slovenly. The metaphor indicates a serious confusion of thought.

19I.e., at the Wicksellian “natural level.”

20I have explained the meaning of these terms elsewhere. See W. H. Hutt, The Strike-Threat System, Chapter VII; “Natural and Contrived Scarcities,” South African Journal of Economics, 1935.

• 1*T. Sowell, Say’s Law, Oxford University Press, 1973.
• 2*R. Clower and A. Leijonhufvud, Say’s Principle, What It Means and What It Does Not Mean (Intermountain Economic Review, Vol. IV, No. 2, Fall, 1973).
• 3*Even so, Say’s early phrasings of the “law of markets,” some of which are quoted in Chapter III, are laudably clear and unequivocal: and his detractors during the earlier period can be not unfairly regarded as “amateurs” in economics, in comparison with those who, like Thornton, the Mills, Senior, Ricardo and McCulloch, were learned scholars in the subject. (Compare Sowell, Say’s Law, pp. 220,232).
• 4*James Mill referred to Say as “a late French writer” and quoted an anecdote of Say’s to illustrate the absurdity of regarding consumption as the source of demand.
• 5*This statement holds without qualification in the absence of saving or dissaving. When saving is occurring, assets are being demanded through the offer of services (capital by the offer of income). When dissaving is occurring, services for consumption are being demanded through the offer of assets, or assets are themselves being consumed.
• 6*I am here thinking of such things as the confusion of saving-preference with liquidity-preference, the confusion of spending with demanding, the confusion of spending with consumption, the fear of general overproduction, the notion that consumption is the source of demands.
• 7*I use the word “may” because I think that, apart from Turgot, Say’s main inspiration came from Hume, Adam Smith and (possibly) James Mill, in whose works the confusion to which I have referred is absent. Of these, only James Mill stated the principle in general terms (in Commerce Defended, 1808), and his statement was better than Say’s had been in the first edition of the latter’s Political Economy.
• 8*E.g., R. W. Clower thinks that “however beneficial” the Keynesian revolution “may have been in its practical effects on a nearly decadent science, it added nothing novel or worthwhile to the theoretical foundations of economic science.”
• 9*That section is one of the few parts of my 1939 book which I do not think I should amend today if I were thinking of republishing.
• 10*I have explained the meaning of these terms elsewhere. See W. H. Hutt, The Strike-Threat System, Chapter VII; “Natural and Contrived Scarcities,” South African Journal of Economics, 1935.
• 11Since this essay was submitted to the publisher, a major work on an important aspect of the same subject has appeared: Say’s Law by Tom Sowell.* This is a work of distinction. Its scholarly treatment of the controversies which Say’s ideas provoked during the first half of the nineteenth century is, I judge, an important contribution to the history of economic thought. But Sowell’s aim and mine are not quite the same. I shall be trying to rehabilitate the “law of markets” by showing “what Say really meant” or “what Say ought to have meant.”
• 12At the galley proof stage, I became aware of yet another relevant contribution, which may turn out to be of path-breaking importance. It is a recent article entitled “Say’s Principle”, by R. Clower and A. Leijonhufvud*. It is essential to draw attention to it. Previous works by these authors suggested that they were hesitant about the importance of Say’s law. I discuss their earlier views at some length. But their treatment of “Say’s principle” (which, as now explained, refers to a vital implication of Say’s law rather than to the law itself) seems to me to record a significant development. The position of these economists is now much nearer to mine than appeared from their previous writings. The student is urged to read their latest treatment as corrective or supplementary to the argument I submit. Holding that “there is hardly a single problem in macro theory (or for that matter, micro theory) that can be consistently analyzed without . . .” a recognition of “Say’s principle,” they maintain that “the extensive literature since Keynes . . . has got bogged down in a mire of conceptual and semantic confusion.” Their words here explain my incentive and why I devote the whole of Chapter II to definitions. I am trying to clear up the confusion.
• 13Controversy about the validity of this law (which occurred mainly in two periods—from 1803-1850 and from 1936 until today) was described by the great Joseph Schumpeter as “a discussion which reflects little credit on all parties concerned.” It has “dragged on to this day,” he said, “with people armed with superior technique still chewing on the same old cud. . . .” Well, more than two decades after the posthumous appearance of Schumpeter’s monumental History of Economic Analysis, from which this scathing comment is quoted, I have been moved to keep the cud-chewing going. This is in spite of my agreement with Schumpeter (a) that Say did not fully understand the “law” to which his name has become attached; and (b) that in his defence of the “law” against acute but economically illiterate critics, Say was sometimes very “woolly,” slipping, at times, into serious fallacy.*
• 14An occasional eccentricity of the erudite Schumpeter was reckless exaggeration. It was unjust of him to have written that Say “hardly understood his discovery himself.” Certainly Say did not fully understand “the law of markets” which, I think, he regarded as accepted doctrine and not as his discovery. That is, I suggest, why James Mill did not refer to Say’s chapter on markets in his Commerce Defended (a most impressive exposition of the “law”), while Say, in his second edition, did not mention James Mill’s contribution which had appeared in between.* Both were explaining what they believed to be unchallengeable. Both attempted to convey to the business world, to governments and to students what the economists had learned from the Physiocrats, Hume and Adam Smith.
• 15“The source of demand” means “the power to demand.” In other words, the power to demand any part of the flow of productive services springs from the flow of non-competing productive services.* Moreover, all producers of goods or services are always in a position to value or price their contribution so as to induce a demand from others for that portion of their inputs or outputs as they (the producers) do not demand (i.e., retain) for themselves, as investors or consumers (unless what they intended to be production turns out to be valueless and wasted—inadvertent consumption).
• 16The basic notion of Say’s law had been expressed several decades before Say’s effective enunciation of it. For instance, the Physiocrats generally, as J. J. Spengler has pointed out, had recognized that “commerce consists, not in buying and selling, but in the exchange of goods and services for goods and services,” and that is a very broad yet apt statement of “the law of markets.” Josiah Tucker came near to stating the principle when he wrote, “the work of one man gives employment to another.” And Mercier de la Rivière, although accepting other ideas inconsistent with it, came even closer when he wrote, “no one can buy except by reason of what he sells.” But prior to Say, in spite of this recognition that one purchases things with money’s worth (and not with money, unless one’s money holdings are being depleted), certain mercantilist, Keynes-like fallacies, largely contradictory with this insight, seem to have prevented any clear perception of the full implications.*
• 17Turgot, however, discerned the confusion due to supposing that “saving and hoarding are synonymous,” and insisted that although “savings” are made “in the form of money,” the savers have no use for money “than to convert it immediately into different kinds of effects. . . . ” Turgot’s statement is, of course, an exaggeration because it tacitly assumes that the prospective productivity of money is not changing in relation to that of non-money. But his tacit assumption is reasonable enough for most circumstances and his criticism of his contemporaries on the point had, I suggest, validity. It was because of the Physiocrats’ misconceptions on the very issue Turgot had in mind that, in developing his “theory of markets,” Say strongly criticized the school of economists from whom his inspiration may have originated.*
• 18Of more recent years Harry G. Johnson, R. W. Clower, Axel Leijonhufvud and Leland Yeager have continued the process of challenging the very foundations of the Keynesian system, in the process indirectly, if unintendedly, re-asserting Say’s law. Yet paradoxically these eminent theorists, and other economists of repute who accept their criticisms of, or changing attitudes towards, the Keynesian system, still seem to leave the impression that, after all, Say’s law does not work—at least not in the manner in which the old general equilibrium analysis suggested it did; and they suggest that in some way the world must feel grateful to Keynes, not so much for his contributions to economic method as for the beneficial policy consequences of his General Theory up to some unspecified turning-point some years ago.* There are healthy opinion differences among these economists; yet they all agree that there were basic defects in the economics that Keynes attacked, and their criticisms all imply dissatisfaction with Say’s law. Their objections to the notion that supplies constitute the source of demands are always traceable, directly or indirectly (as I suggested before) to the surviving notion that the use of money somehow frustrates the operation of the market-clearing process. Under theoretical barter, the implication (or explicit assertion) is, Say’s law would apply. In a money economy it does not.
• 19Although Say’s law is no truism (indeed, I regard it as the most fundamental law in all economic theory) it is not difficult to grasp provided we are not confusing ourselves through defective notions. In my first reading of The General Theory, I was left with the impression that the crucial weakness of that book lay in its conceptual inadequacy. I developed this assertion in the Theory of Idle Resources, 1939, and I made it clear that my main purpose was to establish conceptual clarity in respect of the notion of “unemployment” of men and assets. I devoted a special section to the general question of definitions in economics.* In the Preface of my Keynesianism, 1963, I referred to the feeling I acquired in verbal discussion with friends at the London School of Economics during 1949 and 1956, that I was “not talking the modern language.” I explained how I had perceived “that there are some kinds of language the habitual use of which hinders the perception of certain things as well as the saying of them”; and how I had come to see “that the weaknesses of the system which Keynes had built rest in its conceptual foundations”. And my quarrel today with the surviving Keynesian influences which inspire attempts to inhibit recognition of Say’s law is not with the manipulatory methods used but chiefly with the arbitrariness or sheer woolliness of the notions on which the critical models are constructed. In this essay therefore I shall at the outset carefully define certain very simple yet basic concepts as I shall be using them. This procedure alone may, I think, dissolve many predictable objections to my defense of the law of markets.
• 20Loss-avoidance, profit-seeking incentives. Incentives for responsible entrepreneurial action, that is, incentives to compete. Such incentives can be created, released or protected through institutions designed to prevent as far as practicable “the contrivance of scarcities” or “the contrivance of plenitudes,”* i.e., to prevent monopolistic or monopsonistic abuse (including oligopolistic or oligopsonistic abuse).