A Rehabilitation of Say’s Law

The cumulative decline in real income which is set up through any one contraction of supply not offset by another expansion of supply will, at each successive induced withholding of supplies (induced through rigidity of prices in non-competing activities) tend to have a smaller effect. An eventual “equilibrium” (or “stable disequilibrium”1) will be reached at lower real income, probably with much “idle” or “idling” productive capacity (i.e., much unemployment) but possibly with much “sub-optimal employment.” That reaction chain is, I suggest, the negative operation of what I shall call the true or real multiplier. The reasons in this case are unconnected with the Keynesian multiplier thesis, which depends upon “expenditures”—changes in the ownership of money. Indeed, this view of the emergence of a chronic depression situation is the direct opposite of the Keynesian view of “unemployment equilibrium”; for under the conditions I have imagined, any market-pressured price cut, i.e., any increased supply, will tend to initiate a positive “real multiplier” effect—a cumulative rise in activity and real income, whereas Keynes’ thesis is that price-cutting is self-frustrating, tending to aggravate the contraction of activities.

Yet the cumulative reaction which Say’s law implies is almost exactly what Leijonhufvud is now treating as the Keynesian multiplier. He says:

During the time that the individual searches for a new job, he is “unemployed” in the everyday sense of the word. Keynes’ multiplier is based on the assumption that the loss of receipts from current sales of labor services during this period will make him reduce his spending on consumer goods. This second-round reduction in effective demand will cause additional unemployment, a consequent third-round reduction in demand, etc. Each successive increment to unemployment and decrement in aggregate demand will be smaller than the last, so there will be a limit to the total decline in income consequent upon an initial reduction in expenditures of given magnitude. But the process entails an amplification of the initial deflationary disturbance.2

[The italics in the text are mine.] What should have been said in the words italicized is, I suggest: “. . . the loss of some workers’ inputs during this period will reduce those workers’ contribution to the source of demands for all non-competing inputs.”

Let us consider first the last sentence of Leijonhufvud’s quotation. The initiating “disturbance” need not have been deflationary in the sense of monetary deflation. That is solely a matter of monetary policy. Under monetary flexibility and price rigidity, any new withholding of capacity (the pricing of additional potential productive services above market-clearing levels—beyond the reach of current income—as judged by entrepreneurs) will tend to set going the consequences to which Leijonhufvud refers.

Hence it is certainly possible to imagine the state of affairs he describes, under which productive capacity (of men and assets) becomes chronically priced for under-utilization, with the flow of wages and income subject at first to a self-aggravating contraction and later to a relatively stable condition of sub-optimal utilization of men and assets. But the assumption then is that, through inertias, collusive action or otherwise, the pricing system—the market-clearing system—is restrained. There is “equilibrium” (or “stable disequilibrium”) only in the sense that market pressures to restore fuller or more productive activity are suppressed.

Such a situation is aggravated if income transfers are used to subsidize the idleness (e.g., as through “unemployment compensation” or “price supports”). The “unemployment” then becomes a collectively purchased product, similar in effect to private decisions in favor of greater leisure. There is indeed “unemployment equilibrium” in a special sense—chronic unemployment. Far from negating Say’s law, however, such a situation is explained by that law; for as I suggested above, if wage-rate cuts and price cuts could occur, they would be capable (in the circumstances imagined) of initiating a “multiplier” effect, restoring the wages-flow and the income-flow. It follows that an understanding of Say’s law is essential not only for any realistic insight into the nature and genesis of depression (depression being brought about by a succession of withdrawals of supplies, which is a succession of withdrawals of demands), but of chronic unemployment due to subsidization of the condition by income transfers, or of the “sub-optimal full employment” which must eventually result in the absence of subsidized idleness.

I must stress that the “sub-optimal full employment” condition3 differs fundamentally from that of chronic unemployment, in the ordinary connotation of that term. It seems to me that, if it were not for various ways in which idleness is subsidized, unemployment could not long persist. “Waste” would continue, and it could well be chronic waste, but productive resources would find other, less productive and less remunerative employments. The composition of the stock of assets would adapt itself, while displaced workers, and juveniles reaching working-age, would enter new or different occupations. When all resources (men and assets) were employed in that manner, there would be “full employment”—although “sub-optimal employment.” I shall return to this point, which I regard as vital.

In Leijonhufvud’s interpretation, it is the fact—explicitly asserted—that “goods are always exchanged for money and money for goods”4 which is diagnosed as the crucial explanation of the phenomenon that Keynes thought he had discerned. But why should the use of the monetary mechanism be conducive to the disco-ordination of the economy? Why should it precipitate a disorder which may be manifested in growing layoffs of labor, with productive capacity being thrown into cumulatively worsening idleness, following an initial stimulus? Why should the fact that market institutions are served by a measuring rod of value be held responsible, at times, for causing initially valuable (because initially demanded) productive resources (men and assets) to drift into unproductiveness, temporary idleness, and, with the assistance of income transfers, into chronic idleness? The following chapter will consider whether the use of money is in any way likely to disconnect one supplier and demander from other suppliers and demanders, thereby inaugurating or perpetuating depression.

5“Stable” in the sense of unlikely to be disturbed (a) by government action to protect incentives (loss-avoiding, profit-seeking) for the substitutions we call “competition” (see definition in Chap. II, p. 15), or (b) by successful competitive initiatives in spite of the absence of official action to dissolve duress-imposed costs or prices.

6Joan Robinson has described what I have called “sub-optimal full employment” as “disguised unemployment”. In my Theory of Idle Resources, I called it “diverted capacity” (as distinct from “withheld capacity”).

7  Leijonhufvud, Keynes and the Classics, (London, Institute of Economic Affairs, 1969), p. 32.

8  Ibid, p. 33.

• 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.
• 5Since 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.”
• 6At 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.
• 7While 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.
• 8I 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.