A Rehabilitation of Say’s Law

Modern economists dealing with the topic we are discussing seem to find inspiration in Leon Walras’ Elements. That they still have doubts or reservations about Say’s law is puzzling to me because Walras’ famous work can be reasonably interpreted as a detailed, mathematical statement of the law of markets, although Walras himself seems not to have perceived it. His exposition demonstrates, through the medium of a series of simultaneous equations, the interdependence and mutual determination of all values (prices). It shows further the function of such values established in allocating men and other resources to supplying different products. He conceived of this occurring through entrepreneurial “groping”—the setting of prices, and the reacting to prices set, via what Adam Smith called “the higgling of the market.” In my own terminology, Walras showed that the amounts supplied (and hence demanded) of particular inputs and outputs were determined by the prices asked; while these prices were in turn influenced by the prices and hence the magnitudes of other inputs and outputs. Had he used the word “noncompeting” for “other,” he would have greatly clarified his message. But what he was demonstrating did not require the assumption of perfect price (and wage-rate) flexibility, as he seemed to think it did. The market-clearing prices for any particular kind of output (say cabbages) are influenced by the actual prices (whether rigid or flexible) of all the other things which contribute to the source of demands as a whole and hence influence (in the Walrasian conception, but expressed in my own terminology) demand for any particular thing—cabbages.

Walras explained inter alia that disequilibrium—a condition in which values in different parts of the economy are mutually inconsistent—sets in motion the “groping” efforts he envisaged at achieving consistency—a chain of price and contract revisions which mark the path to equilibrium. He described the process as “the mechanism of competition”1, 2; and his analysis means that, if competition prevails, i.e., if the “groping” process is not suppressed (so that prices are not prevented from being adjusted in the manner required), not only full utilization of capacity (of men and assets) will be achieved but, subject to the considerations I raise in Chap. XIII, pp. 103-108, optimal utilization.

I have referred already to Walras’ “identity.” He seems, however, to have been showing (a) that the aggregate money value of sales must be identically equal to the aggregate money value of purchases—a wholly truistical proposition—and (b) that, on the assumption that an individual is not (in my terminology) investing in or disinvesting from money, and not himself investing in the final commodities he produces, the money value of his production must equal the money value of his purchases, irrespective of any constraints on “the mechanism of free competition” No person will be able to purchase an additional $x worth of goods or services unless he has sold additional goods or services of this value, or unless he can borrow an equivalent money’s worth from some other producer. And in this form the proposition is much less of a truism. It is an important implication of the law of markets.

In Chapter IV, p. 33, I asserted that the root coordinative act which keeps the economy in activity is the action of would-be sellers in pricing their inputs or outputs so as to permit sale of all services and products which are not retained by their producers for their own consumption or for investment in their own inventories (or, alternatively, in accepting would-be buyers’ offers.) It is this last truth which some of those very critics of Keynes who have helped to expose the untenability of the unemployment equilibrium notion still seem hesitant to accept. I think particularly of Clower and Leijonhufvud, who appear to believe that certain at least of Keynes’ innovations remain valid and relevant provided we think of unemployment disequilibrium instead of unemployment equilibrium.3 The disequilibria which obviously exist in different parts of the economy, it is suggested, cannot be explained by traditional equilibrium analysis. Prior to Keynes, the implication is, economists could not fully account for the idleness of resources being regarded at times as more profitable than (or preferable to) their utilization. Still less could the “orthodoxy” of the 1920s account for cumulative contractions of activity.

Well, of course, every state of disequilibrium means that buying and/or selling take place with smaller inputs and outputs than would have been realized under equilibrium. This is a tenet of pure orthodoxy (See Chapter XI, p. 81), although Clower believes he is indicating something which the “orthodox” economists did not understand. He says: “. . . not every household can buy and sell just what it pleases if supply exceeds demand somewhere in the economy.”4 But the only objection the old “orthodox” economists would have had to this assertion, if it means “somewhere in the economy prices are falling, so that the disappointed producers will be able to dispose of a smaller income than they had expected, in acquiring non-competing things,” is that Clower’s assertion is equally possible under imaginary general equilibrium! The true principle is that no household can ever “buy and sell just what it pleases”; for it is constrained always either by free-market inputs, outputs, and prices (whether the prices resulting reflect equilibrium or some position during movement towards it) or constrained by inputs, outputs and prices influenced by deliberate restraints on the free market. For instance, it makes no difference whether the price of bricks is rising because an earthquake has increased the cost of getting the materials, or a cartel has limited supplies, or a strike threat has pushed up costs. The consequences are identical.5

Unemployment disequilibrium envisaged as an enduring condition of part of the potential labor force merely means that there are wage-rates determined by sheer inertia, legal enactment, official edict or private duress at levels above the market-clearing “equilibrium” for labor’s inputs—the intersection of the relevant demand and supply schedules, while the laid-off resources (men and complementary assets), cheapened for other uses, have not yet found sub-optimal employments, i.e., not yet been absorbed into the next best utilizations. But in all cases of lasting divergencies from the equilibrium (whether above or below), quantities actually transacted (supplies and hence demands) are caused to contract.6 That is, all disequilibria cause some resources (men and assets) to become idle or idling in the short run; and, if the disequilibria are enduring, they cause the diversion of resources into less productive utilization (sub-optimal employment) in the long run. (The reasons why, in practice, the short-run may become indefinitely extended and create the phenomenon of chronic idleness are discussed in Chap. XIII, pp. 103-8. The vital reality implied by Say’s law is that every relaxation of the constraints through which market pressures to equilibrium are resisted (e.g., as by costs and prices imposed by law, collusion or duress) renders larger outputs profitably producible and hence makes larger non-competing outputs profitable.

It is for this reason that I cannot accept Clower’s suggestion that “orthodox analysis does not provide a general theory of disequilibrium states.”7, 8 I shall here be maintaining, on the contrary, that unless Say’s law can still be shown to be defective, it provides a very clear, very simple and completely general theory to account for “unemployment disequilibrium.”

The failure of Keynesians and some of the critics of Keynesian economics to perceive the all-embracing significance of Say’s law is largely due, I think, to the inherently defective concept of “aggregate demand” (not a purely Keynesian notion), which dictates their approach. Say was dealing with demands in general—a complex of separate phenomena of preference which are incapable of any meaningful aggregation. The demand for a particular productive service or commodity is merely the value (which may be and usually is measured in money, and effected through the use of money) of whatever other services, or assets originating or existing somewhere else in the economy are happening to be offered and exchanged for it. Attempts to add together all demands (or all supplies) to form “demand in general” (or “supply in general”) are futile.

But the aggregate stock of assets and the number of people of working-age, with the corresponding services they provide, may be legitimately regarded as the source of demands (or of supplies). If the value of the flow of such services is what is meant by the term “aggregate demand,” and the meaning is obvious to all readers, my point is merely a semantic one. It concerns appropriateness, that is all. But then the meaning of “aggregate demand” will be identical with that of “aggregate supply,” and identical with “real income” as well. There can be no schedule of aggregate demand set against a schedule of aggregate supply when terms are used in this connotation; for each actual demand is an actual supply.

Much of the controversy could, I often think, be finally settled for all time if economists would only use terms as closely as possible in their ordinary, every-day connotations (which would seldom entail any sacrifice of rigor). Surely a demand is only “effective” when the demander gets what he wants in return for his offer to buy at a particular price or when he finds somewhere an offer to sell something he wants at a price which causes him to prefer it to the alternatives he has. And surely a supply is only “effective” when whoever offers something for sale at a particular price achieves a sale. If this commonsense principle is accepted, then obviously every “effective demand” is an “effective supply”.9

Recognition of the point I am making in no way hinders our understanding of Walras’ meticulous analysis of demand and supply in lessons 5 and 6 of his Elements, although (to distinguish mere “want”, “desire” or “need” from an ability to offer or command money’s worth in exchange) he used the term “effective” for offers to buy and offers to sell which might induce no transaction until (via the groping process) one party or the other, or both parties, changed the terms appropriately.10

We are now in a position to consider further the light which Say’s law can throw upon the dynamics of recovery from recession. The following chapter is devoted to this topic.

11Sometimes he spoke of “free” competition and at other times of “market” competition.

12Patinkin was the first to take this line. Yeager more or less accepts the Clower-Leijonhufvud position.

13Clower goes on to say that “the demand functions of orthodox theory do not provide relevant market signals.”14 That is, however, an important but quite different point, to which we shall have to return.

15See, pp. 28-29, 48-49, 81.

16Clower’s case is that orthodox economics “yields no direct information about the magnitude of realized as distinct from planned transactions under equilibrium conditions”.17 But realized data—prices and quantities—are not the only data from which decision-makers extrapolate; and every forecast is provisional, subject to continuous revision until the revised and the realized meet.

18But a better term for “effective” in this connotation is “actual,” as distinct from “potential” or “possible.”

19  Leon Walras, Elements of Pure Economics, A.E.A. translation, Irwin, 1954, p. 86.

20  R. W. Clower, Monetary Theory, p. 286.

21  Ibid., p. 287.

22  Ibid., p. 275.

23  Walras, op. cit., pp. 83-91.

• 1*T. Sowell, Say’s Law, Oxford University Press, 1973.
• 2 W. H. Hutt, Economists and the Public (London, Jonathan Cape, 1936), p. 34.
• 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 M. Blaug, Economic Theory in Retrospect (Homewood, Ill., Irwin, 1968), p. 154 n.
• 5*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).
• 6*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.
• 7 J. M. Keynes, The General Theory (See note above), p. 19.
• 8*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.
• 9*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.
• 10 J. A. Schumpeter, History of Economic Analysis (Oxford University Press, 1954), p. 625.
• 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.*
• 14 M. Blaug, Economic Theory in Retrospect (Homewood, Ill., Irwin, 1968), p. 154 n.
• 15An 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.
• 16“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).
• 17 T. Sowell, Say’s Law (Princeton University Press, 1973), pp. 3, 4 (twice), 12, 19, 201.
• 18The 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.*
• 19While 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.
• 20I 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.
• 21In defending the pre-Keynesian “classical economists,” and “Say’s law,” I shall insist that this law dominated the prevailing orthodoxy of the 1930s so naturally that it was seldom if ever stated explicitly and (prior to the “Keynesian revolution”) virtually never challenged. But it was ideas we associate with J. B. Say which constitute the vital insight of the “orthodoxy” that Keynes attacked. In one passage Keynes explicitly recognized that the teachings he was trying to refute involved reliance on Say’s law, although in that passage he referred not to Say himself but to J. S. Mill, from whom he quoted an excerpt out of a not very satisfactory exposition of the principle. (See p. 24).
• 22*I believe that Keynes (General Theory, p. 18) was the first to use this phrase. It has been repeated in these very words by virtually all other economists who have since referred to Say’s law. Even erudite and careful historians of economic thought repeat Keynes’ words, e.g., Schumpeter, Mark Blaug and Tom Sowell, the latter opening his essay with Keynes’ summary of the law and subsequently using the phrase several times. But I cannot trace its ever having been used before Keynes. Sowell refers to it as a “familiar assertion,” which he admits is not a “direct quotation” from Say or James Mill. Leijonhufvud uses it in quotation marks without attributing it to Keynes. (On Keynesian Economics and the Economics of Keynes, p. 280).
• 23Controversy 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.*