A Rehabilitation of Say’s Law

In a very interesting paper, published since the present book was submitted to the publisher, Leland B. Yeager suggests that basically my position does not differ from that of Leijonhufvud and Clower. Nevertheless, he thinks that the crux of their insights lies in their recognition of the fact that “money alone among all assets, has no price of its own and no market of its own”.1 I feel myself, however, that the expositions of all three economists mentioned are clouded by this conviction about the special nature of money. The fact that prices are values expressed in terms of money, so that the money unit cannot have “a price of its own,” does not prevent the money unit from having “a value of its own.” And the value of the money unit is market-determined,2 even when its value is defined in a monetary (“convertibility”) obligation. Under any monetary standard, it is the contractual duty3 of the monetary authority to control the “supply” of money units in order to maintain a stipulated market value for the “container” of purchasing power. (See pp. 21-22).

The demand for money arises from the positions which monetary services occupy on peoples’ scales of preference and/or their judgment of the productivity of those services. It is this demand which determines the aggregate real value of money; while the “money supply,” the number of money units—the number of “containers” in which, so to speak, that aggregate real value is divided—is determined by monetary policy.4 I do not understand why Yeager thinks that these factors, which determine the size of the measuring rod, induce income constraints in the form of the withholding of supplies and hence of demands, except in the sense that, in the presence of downward cost and price rigidities, deflation will aggravate the cumulative withholding process—just as unanticipated inflation will mitigate or reverse it.

It is no valid objection to this thesis to say that “demands” may originate, not in “supplies”, but in “newly created” or “newly activated” money. For inflations5 or deflations which do not (via price-cost reactions) affect the magnitudes of “supplies” do not affect the magnitude of the source of “demands”: they merely dilute or condense it: they do not cause aggregate purchasing power to expand or contract but merely cause aggregate money-spending power to expand or contract.6 Thus, in the course of an inflation each money unit contains a diminishing purchasing power,7 A forger does not contribute to the source of demands. He steals someone else’s supplies (whatever he buys with the forged money) because he has stolen their demands.

Some of Keynes’ critics have followed him in perpetuating the notion that “supplies” of non-money must be viewed, not as contributions to “aggregate demand,” but as contributions to the demand for money. It is true of course that any increase in “supplies” (a rise in the real GNP) implies ceteris paribus a proportional rise in demand for monetary services. But as I shall be stressing almost ad nauseam, the flows of productive services (“supplies”—non-monetary or monetary) are expressions of demands for non-competing “supplies” as a whole; and although these non-competing productive services demanded include monetary services as inputs (or, for consumers, as outputs), non-money services make up by far the greater proportion in the aggregate. The phenomenon of selling no more contributes to the demand for money than the phenomenon of buying supplies money. That is, “the money supply” being assumed constant, selling and buying do not bid down or bid up the value of the money unit unless, on balance, people plan to allow their money inventories to run down or plan to accumulate money inventories respectively. And then it is entirely a question of changing preferences or changing entrepreneurial judgment of relative productivity in respect of money and non-money. (Whether these preferences or judgments are influenced by “illusion” in some measure is irrelevant. In any case, all our preferences and judgments are so influenced!)

Leland Yeager, referring to my exposition of this topic in my Keynesianism, suggests that my theory “is incomplete” because I do not “show how an adequate money supply keeps non-monetary disturbances from causing cumulative deterioration.” He says that I do not put “the blame for such deterioration on money in particular”.8 It is indeed true that I do not “blame” money, or rather the failure to spend money, for the generation of depression; but I do recognize all the reactions that Yeager has in mind when he thinks of the money supply being raised to an “adequate” volume. Unanticipated inflation is a way, albeit a very crude way, of mitigating incipient depression. And when economists think and talk of “a money supply compatible with full employment,” or of “the optimal rate of inflation,” or (like Yeager) of “an adequate money supply,” they are really envisaging the process under which “supplies” (and hence “demands”) withheld through pricing can be restored by an unanticipated contraction of the measuring-rod of money.9

The “monetarists” think in terms of an “adequate” money supply which can at any rate assist in maintaining the continuity of the market-clearing process while pure “Keynesians” say that it is an “adequate” rate of spending that matters. But the crucial continuity is always dependent upon valuing and pricing, whether or not monetary policy is flexible, rigid, inflationary or deflationary—i.e., independently of the factors which determine the purchasing power of the money unit. Certainly some monetary policies facilitate the process—at a cost—while others make it more difficult.

It will help to clarify the issue if we consider the significance of spending. Given any “money supply,” it is the demand for money to hold (not to spend) which determines the value of the money unit; and given the demand for money to hold, it is monetary policy which, in determining the “money supply,” determines the value of the unit. Spending is incidental. If prices in general rise, then in such transactions as must be made through spending, an increased number of money units must be offered for any quantum of non-money. Each price established represents what must be spent if a good is to be sold and purchased. The increased spending is, then, a consequence not a cause. It is the valuing process, not the spending (which follows the valuing) that determines prices. The truth of this proposition is established by the fact that all present prices are influenced by expectations of future prices. Another proof is that the prices of goods often change in a market which is closed for a period during which no spending on the goods could have occurred!

10Edwin Cannan made this clear as early as 1921 in his Economic Journal article, “The Application of the Theoretical Apparatus of Supply and Demand to Units of Currency.”

11The contractual obligation is of course not only with those who hold money but with all who make their own plans and conclude their own contracts in money terms.

12The acceptance of a monetary standard, such as the gold standard, simply limits the discretionary element in monetary policy.

13Including those caused by “monetary rigidity”, i.e., as when monetary policy ignores a declining demand for money—i.e., ignores “new activation” of money.

14See pp. 18-19, 118-119.

15There are also real income transfers (a) from contractual claimants on the value of output to residual claimants, or (b) from those whose money incomes rise less than the average to those whose money incomes rise more than the average, or (c) from creditors to debtors, or (d) from the ruled to the rulers. How such income transfers influence the source of demands is not an issue in the present context. (But see pp. 121-123).

16Thus, a central bank, taking into account a careful judgment about the effectiveness with which the public can be misled concerning the speed and duration of any inflation planned, can cause prospective yields to rise (a reduction of input costs in relation to output prices occurring through the depreciation of the money unit).

17  L. B. Yeager, “The Keynesian Diversion,” Western Economic Journal, June, 1973, p. 151.

18  Ibid., p. 159.

• 1 W. H. Hutt, Economists and the Public (London, Jonathan Cape, 1936), p. 34.
• 2*T. Sowell, Say’s Law, Oxford University Press, 1973.
• 3*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).
• 4*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).
• 5*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.
• 6*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.
• 7*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.
• 8 M. Blaug, Economic Theory in Retrospect (Homewood, Ill., Irwin, 1968), p. 154 n.
• 9*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.
• 10Since 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.”
• 11At 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.
• 12Controversy 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.*
• 13An 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.
• 14“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).
• 15The 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.*
• 16Turgot, 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.*
• 17While Keynes was writing his famous work I was engaged on a book that appeared a month or two later than his. In my contribution I maintained that “every independent and serious economist . . . must, if his beliefs lie in the path of ‘orthodox’ or Classical tradition, be aware of a periodic recurrence of a sense of utter helplessness. . . . He recognizes that in spheres in which policy and action can be influenced, he is doomed to virtual dumbness today.”* Thus, where Johnson blames the prevailing orthodoxy of the 1930s, I blamed (in 1936) the ignoring of its basic teachings for the emergence and perpetuation of depression.
• 18I can think of no economist who has shown greater intellectual courage than has Harry Johnson in abandoning previously held positions. Where he now stands in respect of the “law of markets,” I do not know. But I believe that “the classical economists” who “from Smith to Pigou” (in Keynes’ view and Mark Blaug’s words) “. . . fell victims to Say’s law” were better economists because they were so victimized. I believe also that with all their shortcomings the non-Keynesians of the inter-war period had a deeper insight into the origins of chronic unemployment and depression than the overwhelming majority of today’s professional economists. I shall try to substantiate this thesis after a restatement of Say’s “law of markets” and an examination of typical criticisms of that law. At the end of my essay, in Chapters XIV to XVII, I shall briefly discuss the British situation in 1936 as well as “classical” teachings and government policies in Britain between the first world war and 1936. The environment of that period was one which somehow inspired the most influential book in the history of economic thought, the book which engendered the so-called “new economics” or the “Keynesian revolution” and, at a crucial period, destroyed the authority of the economists whom Johnson still disparages but towards whose position he seems (to me at any rate) to have been veering. I shall finally submit my own brief diagnosis of the grave sickness which was plaguing the British economy during the 1930s; and I shall suggest, (a) that exactly the same fundamental problem is baffling British politicians and opinion makers today that was baffling them in the 1920s and 1930s; and (b) that the solution is to be found through a perception of the light which Say’s law throws upon the nature of co-operation in a free economy.