A Rehabilitation of Say’s Law

XII PRICING FOR MARKET CLEARANCE

As I explained (on pages 41-42 and pages 82-86), if there is much unemployed labor, the reduction of wage-rates in any particular occupation needed to make “full employment” in it profitable will, in general, be a greater reduction than will be necessary if unemployed workers in other occupations generally are also concurrently trying to price their labor for its profitable employment. But even so, ceteris paribus, every downward wage-rate adjustment will not only tend to increase the profitability of employment in the occupation immediately affected but will contribute to a rise in the real value of wage outlets profitably offer able in non-competing fields.

To illustrate a thesis which does not quite accord with this analysis, Leijonhufvud uses a device of Walras’. He conceives of all prices being set every day to clear the market by an imaginary and infallible auctioneer, with entrepreneurs simply determining profitable quantities in the light of the prices so determined. We are asked to imagine for a certain day a possible labor supply which exceeds the actual supply (i.e., a condition of “excess supply”) together with “excess demand for commodities” in the sense that, if the unemployed obtained employment, they would “devote their entire wage proceeds to consumption”.1 In such circumstances, Leijonhufvud says, the Walrasian auctioneer would have to raise the prices of consumers’ commodities and reduce wage-rate offers.

Now to the extent to which certain wage-rates are “too high” in the sense of higher than the equilibrium value, it may mean (and probably does mean) that the equilibrium levels of other wage-rates are lower than they would otherwise be. But let us simply assume that the downward adjustments made increase the employment of labor (i.e., increase the workers’ inputs supplied). In that case, they must enhance the flow of goods and services as a whole. Hence, the Walrasian auctioneer would have to raise the relative prices only of those goods of which the supplies did not increase by as much as the average, or for which demand increased by more than the average. Leijonhufvud imagines, however, the whole of the increased earnings being, as he puts it, “spent on consumption.” Strictly speaking one “spends on consumption” only when one buys services consumed as they are rendered. “Consumption” is, as I have insisted (pp. 13-14), the extermination of power to demand, and hence, in itself, a depressive factor. What is called “spending on consumption” usually refers to replacement (partial or full) of a value equal to what has been consumed (of services or assets) whether the inventories replenished are in households or in warehouses, shops and factories. Hence Leijonhufvud means by “spent on consumption,” I take it (in the terminology I myself prefer), “used for investment in replacement or to acquire services consumed as they are rendered.” The replacement will probably be mainly of inventories of consumers’ goods, i.e., goods of relatively short life. If so, it seems to me, his assumption implies that different portions of the stock of assets into which labor’s services flow will increase relatively in value in proportion to the expected shortness of their lives, with services consumed directly increasing most in value, while long-life assets will tend to lose most in relative value.

However, Leijonhufvud holds that Walras’ auctioneer would, as his first step in the “groping” process, reduce wage-rates as a means of restoring employment of labor and raise consumer goods prices in response to or in anticipation of the postulated increase in demand for such goods. But I do not see why Walras’ auctioneer should raise the price of consumer goods unless his infallible forecast tells him that, with no time lag, labor’s money income will be so increased by the reduction of wage-rates that, at unchanged consumer good prices, there would have to be some form of rationing.2

Here again, it seems that money is thought to be the root of all evil; for Leijonhufvud thinks that, under conceptual barter, through the “groping” process, there would be no difficulty and a co-ordinated economy would result. The Walrasian position is not simulated in a money economy, he says, because “there is no upward pressure on commodity prices” as fuller employment occurs and hence “no stimulus towards expanding production.”3 I do not understand this passage. For given Leijonhufvud’s assumption that the newly employed workers devote all the additional income they produce (i.e., the whole value of their new contribution to inputs) to what he calls “consumption,” the prices of services consumed or of short-life commodities replaced must be assumed to rise relatively to the prices of long-life commodities. In other words, if downward wage-rate adjustments are achieved, the consequence (under Leijonhufvud’s assumption) will certainly be a rise in the prices of consumer goods relative to the prices of producer goods. On the assumption that monetary policy is flexible, that will mean an absolute rise in the prices of consumer goods as soon as the wages-flow begins to grow (i.e., as downward wage-rate adjustments are brought about) parallel with an absolute fall in the prices of producer goods. Of course, as we have seen, if monetary policy is rigid,4 fuller employment must mean deflationary pressures because it means greater output, and vice versa. But I do not suggest that this is what Leijonhufvud has in mind.

In any case, it is not “upward pressures on commodity prices” in general which is the essential condition for expanding production. Prospective yields compatible with greater outputs may be established through those downward cost adjustments which enhance the wages and income flow. If the prices of a majority of inputs and outputs have been fixed too high for complete market clearance, whether through collusion, duress, or general entrepreneurial pricing errors, that is one way in which “supplies” (and hence “demands”) can be withheld. But in practice, for political reasons, what may be called “the normal withdrawal of supplies” occurs, not through entrepreneurial pricing errors, but through the forcing up of input prices relatively to output prices, output prices still being, on the whole, consistent with market clearance of the reduced outputs that remain prospectively profitable.5

Nevertheless, Leijonhufvud suggests that (for some reason connected with the use of money) business forecasters will not see things as they are presumed to be in general equilibrium analysis. He says: “Not perceiving that more output is called for, individual firms will” turn down unemployed labor which offers itself at reduced wage-rates, “even if no more than labor’s marginal product (evaluated at going prices) is being asked for.” In other words, “prospective employers” who do not perceive that “more output is called for” will not acquire the additional labor “even if no more than the money wage that the system would have in equilibrium is being asked for.”6 The assumption here is that entrepreneurs expect—but expect wrongly—that, in order to sell the additional output, they will have to reduce output prices by an amount which would reduce prospective yields to the point at which it would be unprofitable to employ the cheapened labor which is offered.

It seems to me that, in the passage just quoted, Leijonhufvud conceives of “labor’s marginal product” in a different way from what I have always conceived of it. I have always thought of marginal productivity in relation to prospective yields. It would be better expressed as “labor’s marginal prospective product.” But when Leijonhufvud maintains that pessimistic entrepreneurs will not give employment to workers who merely ask their marginal product, he appears to be thinking of what their marginal product would eventually turn out to be if workers generally were employed at market-clearing wage-rates. For at wage-rates equal to the “marginal prospective product,” all labor is immediately employable; its actual employment will set in operation the required “groping” process; this process will lead, in subsequent periods, to a rise in labor scarcity; and that scarcity will, in turn, result in entrepreneurs being forced to offer real wage-rates which correspond to labor’s rising realized marginal product. Leijonhufvud tacitly assumes that labor refuses to accept its present marginal prospective product.

I should have said that “the equilibrium wage-rate” at any moment is that which is established in the light of whatever prospective yields happen to be at that moment, and however much the prospects are destined to change in the future. Admittedly, in the circumstances Leijonhufvud imagines, it might happen that, because entrepreneurs as a whole do not perceive the truth that a general reduction of duress-imposed labor costs magnifies the source of demands as a whole, they delay longer than is for their (and society’s) advantage in accepting fallen wage-rate offers. But that only means that labor’s marginal prospective product is further reduced, not that the wheels cannot be set spinning again by wage-rate adjustments, which is the topic under debate.

I suggest, then, that what Leijonhufvud is actually envisaging here is a situation which Say’s law explains, namely, that the unemployed workers, although they have reduced their wage offer, have not reduced it sufficiently—in the light of unjustifiably pessimistic entrepreneurial expectations—to release their full potential contribution to supplies and hence to the source of demands. But when wage offers have been sufficiently adjusted for entrepreneurs generally to accept them, each output expansion is contributing to a state of affairs in which, through dynamic reactions set going, higher marginal prospective labor products will generally emerge and higher money wage-rates will be forced by the market. Entrepreneurs are indeed engaged in the Walrasian “groping” process; and if the workers did price their services initially in consistency with whatever entrepreneurial forecasts happened to be, entrepreneurs would soon find themselves confronted with the harsh realities of labor shortage.

Hence Leijonhufvud’s contention that “there is no stimulus towards expanding production”7 when unemployed workers offer their services (because the prices of end products do not rise) does not hold if “the offer” of the workers’ services means “the actual supply”—the actual sale of—those services. The employment of formerly unemployed workers is in itself an expansion of the source of demands; and if we find the concept of “stimulus” useful, we can say that every particular increase in employment of labor “stimulates” an expansion of non-competing outputs in the sense of tending to raise (a) the prospective values of such outputs and hence (b) the real wage-rates it is profitable to offer for labor to produce them.

But, says Leijonhufvud, “once the multiplier has done its dirty work, the system may remain in an unemployment state although the money wage is ‘right’ from the standpoint of over-all equilibrium.”8 If he had said “ultimate equilibrium” instead of “over-all equilibrium” here, I could have accepted it, although I should think of the cumulative decline in activity implied by Say’s law as “the multiplier.” As it is, the wage-rate Leijonhufvud envisages is “wrong” from the standpoint of present equilibrium. He maintains, however, that in “unemployment disequilibrium” producers will not be willing to absorb the excess “supply of labor . . . at a wage corresponding to the real wage that would satisfy the Walrasian problem”.9 But this problem is solved only when “ultimate equilibrium” has been reached, while he ignores the path to that equilibrium. As long as the workers generally hold out for the higher remuneration which the market would be destined eventually to force if they did not hold out, they will never move towards it.

Leijonhufvud (like Clower) regards the situation as a “communication failure.” He says: “The unemployed supply labor and demand bread. . . . But . . . the demand is an ‘ineffective’ demand that does not constitute a stimulus to increased (and labor-demanding) production of bread. The market signals presupposed in general equilibrium analysis are not transmitted.”10 But is it not rather the reverse—a case of market signals being ignored or misinterpreted? The workers are not demanding bread until they pay for it the price which is being asked; and they are not supplying labor until they accept wage-rates that appear profitable to entrepreneurs. And if a general failure to pay the price asked for bread is not a transmitted signal that present prices (not the ultimate prices) of grain, milling, baking and retailing are somehow wrong, I do not know what could be; while the layoff or unemployment of workers is surely equally a market signal that present wage-rates (not ultimate wage-rates) are “unduly high.”

At times, Leijonhufvud seems to be using the term “demand” to mean what I should call “desire” and the term “effective demand” to mean what I call “demand” as distinct from “desire.” When he says that unemployed workers “supply” labor and “demand” bread, but they do not demand bread “effectively,” he means that entrepreneurs are unjustifiably pessimistic and do not accept the offer of labor at its reserve price, which price means the withholding of its supply, so that although the workers would like to buy bread, they have nothing to offer for it and hence cannot demand it.

What is conceivable, however, is that earnings of formerly unemployed labor (other than bakers), and increased earnings of bakers could mutually justify one another if they came about spontaneously and simultaneously. That this may not happen because the true situation is not perceived is exactly the point that Cannan was making in 1933 (see pp. 57-59). Leijonhufvud is wrong, however, if he implies that pricing adjustments are incapable of bringing about the recovery sought. The exploratory initial wage-rate cuts I have envisaged are the required mechanism—the first step in Walrasian “groping.”11

The problem of rapid and accurate transmission of market signals is tied up with the separate problem of the inferences through the medium of which all decision-makers must extrapolate from past events. But if policy aimed throughout at the improvement of price flexibility, entrepreneurs would surely learn that any inadvertently caused slowing down of economic activity would be early reversed through market-selected cost and price adjustments.

These considerations are relevant to Leijonhufvud’s discussion of the response of the economy to “changes in saving behavior,” to which I have already referred. He brings in here, as I have said, what I regard as a wholly separate factor, liquidity-preference. (See Chapter X.) But he holds that “producers’ demand forecasts do not respond in an appropriate and reliable fashion” to such changes;12 and he explains later that if “entrepreneurial expectations were to approximate more closely to the demand that would actually be experienced . . . , they would become self-fulfilling. . . .”13 Admittedly, the net accumulation of assets which the achievement of savings implies14 should, if perceived, enhance profit prospects;15 while the optimism of one entrepreneur will justify the optimism of another (in a non-competing field). But this does not detract from the importance of the principle that the path to the creation of justified entrepreneurial expectations is wage-rates (and other prices constituting costs) which are sensitively adjusted to entrepreneurial forecasts, however unjustifiably pessimistic those forecasts may happen to be at the outset. On the next page, Leijonhufvud explains: “Entrepreneurial demand forecasts are attuned to a continuation of depression. The immediate objective is to change them while meddling as little as possible with interest rates that are already at (or below) the level they would have been in equilibrium. Direct government expenditure would do the trick.”16

Because ultimate equilibrium is destined to be achieved at higher wage-rates than appear profitable under entrepreneurial pessimism, it is theoretically possible that an increase in MV17 (“increased expenditure,” irrespective of whether it is directed to public works) would not mean any departure from a policy of “monetary flexibility,” i.e., it might not have any inflationary consequences. (The rate of interest would not have to fall below the “natural” level.) The wage-rates for which the workers were holding out would justify themselves (through Say’s law repercussions) by proving to be profitable after all, and the workers’ initiatives (to reduce labor costs) could be avoided. But if that is what is intended, it is a criticism of the monetary authority which, it is assumed, fails to recognize the very high elasticity of labor supply that is implied. Purposeless monetary stringency is tacitly alleged therefore—perhaps what Leijonhufvud envisages as “perverse” action by a central bank or treasury.

The passage I am discussing is, however, capable of a different interpretation, namely, that the officials who decide on “direct government expenditure” are tacitly assumed to be shrewder judges of prospective yields than business entrepreneurs. On that assumption, during depression the provision of such public works as taxpayers are predicted to demand as recovery occurs—not boondoggling—is justified. If the labor required is then recognized as temporarily cheap, the public incentive to invest in it (and so contribute to the source of demands) will be enhanced. But the question remains: Why should not shrewd businessmen perceive the profit to be won from temporarily cheap labor at least as wisely as government officials?

My own diagnosis of the origins of entrepreneurial forecasts “attuned to a continuation of depression” differs from Leijonhufvud’s. During this century at least, that pessimism has been, I judge, far more often justified than unjustified. Thus, in the situation to be described on pp. 135-7, entrepreneurs confronted with the depression were reacting realistically to a situation in which (i) the toleration of private duress or collusion to bring about “wage-push,” or to maintain certain prices, and (ii) so-called “unemployment insurance” and other government action tending to render certain wage-rates or prices rigid, were frustrating rapid co-ordinative adjustments and exterminating prospective yields to investments, especially in such improvements of, or additions to, fixed capital as were subject to prospective strike-threat pressures. As a whole, entrepreneurs may not have clearly perceived the causes of the situation. But their apparent timidity in so-called slump periods was always, I suggest, a consequence of the price mechanism having been prevented from fulfilling its co-ordinative role. With the onset of recession, sheer realism prompted a reluctant perception that, to avoid individual disaster, the distasteful step of laying-off labor and working fixed assets at below technical capacity was quite unavoidable; and in the depth of depression a similar well-founded interpretation of the situation obstructed recovery.

One reason for my judgment that entrepreneurial pessimism in the circumstances of this century’s depressions has been due to effective market signals correctly interpreted, rather than the reverse, is that forecasting acumen and risk-taking propensities cannot be assumed to be evenly shared within any industry. If labor costs are no longer unprofitably high, i.e., if the wage-rates for which the workers are holding out have been reduced (because bidding for the labor trained for, or attached to, an industry has been weak) those entrepreneurs who are more enterprising or better forecasters than the rest will be able to profit by getting in first. The shrewder or bolder will thereby steal a march on the others, in spite of the immediate demand for the product of the industry being well below what it is destined to be. They will profitably provide the additional outputs which the more timid or less perspicacious were wrongly afraid would lead to losses. The greater the extent to which unjustified pessimism causes some entrepreneurs to hold back, the greater will be the special yields to be won by those who do not; and the success of the latter will emit market signals to activate the others. Such considerations reinforce my judgment that in practice the entrepreneurial gloom which is typical of depression reflects wise insight, even when some concessions in respect of wage-rates have been made.

I conclude that Leijonhufvud has not, as he thinks, shown that “unemployment may persist even with the ‘right’ level” of money wage-rates, unless he means by “the right level” (in any employment) what I call “the wrong level” because it is not adjusted to current entrepreneurial assessments of profitability, right or wrong, and although the ultimate level may be destined to be much higher. In so far as any recession, having once begun, has become self-perpetuating or self-aggravating, that has not been due to successive cost and price reductions. It has been due to the opposite—(a) resistances to co-ordinative cost and price reductions and (b) entrepreneurial recognition of the unwillingness of governments to perform their “classical” task.

Everything I have said about the depressive effects on the economy of pricing labor’s inputs above their market-clearing values in any given state of prospective yields applies equally, of course, to the pricing of the services of complementary factors. Not only the contractual claimants, but the residual claimants on the value of outputs may be in a position to contrive scarcities, thereby reducing their contribution to the source of demands for non-competing inputs and outputs. No less than labor employing the strike-threat, the owners of industrial assets in any field may gain at the expense of the prosperity of the community as a whole. Thus far I have stressed the responsibility of “unduly-high” wage-rates (in relation to prospective yields) for the slowing down of economic activity, partly because Clower and Leijonhufvud seem to regard labor costs-as the crucial factor and partly because, on empirical grounds,18 I share that apparent judgment. Statistical enquiries into income distribution have established the fact that, in general, it is the owners of assets whose relative incomes contract most in depression. Moreover, students of business administration have noticed how, during the onset of depression, managements do everything in their power to avoid the necessity of layoffs; and, as the situation worsens and physical assets begin to operate at below full technical capacity, with consequential declining residues, they (the managers) become scared of their own displacement which, in the case of elderly executives or those of middle age could, in some instances, mean disaster for them. Typically, they are almost desperately anxious to get the wheels turning again.

I am not suggesting that collusion among managements trying “not to spoil the market,” as market-clearing prices tend to fall in any industry, may not exert a depressive influence on demands for the inputs and outputs of non-competing industries. Nor do I ignore the possibility that prices charged by natural monopolies may not be incompetently controlled, whether as a result of lobby pressures or otherwise. I certainly believe that anti-trust or its equivalent (if it could be rescued from vote-gathering influences and its purpose explicitly recognized and declared)19 would be a rational method of contributing to that objective and the full employment it implies. But recognition of this in no way weakens the significance of Say’s law. It is yet another possibility that illustrates the all-pervasiveness of that law.

I have mentioned that both Leijonhufvud and Clower place very great stress on the imperfections of the information or communication process as a cause of the hiatus. But the kind of communication or information required for the coordination of the economy takes the form of market pressures;20 and these pressures are exerted through loss-avoidance, profit-seeking incentives. Faced with such market signals as shrinking or accumulating inventories, entrepreneurs react by changing the rates of liquidation of different inventories via the price changes which they forecast will effect the desired results.

 

 

21Moreover, if we make different assumptions, namely, that the newly employed workers produce only consumer goods, the auctioneer would not raise consumer goods prices because there would be increased supplies of such goods to meet the increased demands for them.

22I.e., if the “money supply” remains constant as the aggregate real value of money changes.

23Market-freeing action (like United States anti-trust) intended to deter one set of manufacturers or merchants from attempting to exploit the others (as producers or consumers) is seldom paralleled by action to restrain different groups of workers from trying to exploit their fellows, either as workers or in their consumer role.

24Actually, a failure of communications, the absence of prompt signals to changing conditions or the absence of prompt response to such signals, or wrong interpretation of them is no explanation of the idleness of men or assets. It is an explanation of waste (that is, non-optimal use of men and assets) because it means tardy adjustments to change instead of expeditious adjustments, that is all. In other words, it does not explain non-use of valuable (i.e. potentially demanded) services. It explains wrong-use. (See pp. 104-109).

25Because (ceteris paribus) if the aggregate real value of assets increases, then irrespective of the composition of the stock, it means that the prospective income stream from them (which, discounted, represents their capital value) is also enhanced, as well as the yield to labor’s efforts which will increase absolutely and, ceteris paribus, relatively.

26I.e., an increase in “money supply” or an increase in its “activation.”

27For reasons discussed at length in my recently published The Strike-Threat System.28

29Its purpose being that of maximizing aggregate profits, i.e., the raising of prospective yields in general, so as to cause increased competition for labor and the maximization of the absolute wages-flow.

30It is important to recognize that other types of communication of information are technical in nature, irrelevant to the problems we are here discussing.

 

 

31.  Leijonhufvud, Keynes and the Classics, p. 34.

32.  Ibid., p. 35.

33.  Ibid., p. 35.

34.  Ibid., p. 35.

35.  Ibid., pp. 35-6.

36.  Leijonhufvud, On Keynes and Keynesian Economics, p. 90.

37.  Leijonhufvud, Keynes and the Classics, p. 36.

38.  Ibid., p. 38.

39.  Ibid., p. 40.

40.  See Hutt, Keynesianism, Ch. XI.

41.  Leijonhufvud, Keynes and the Classics, p. 41.

42.  W. H. Hutt, The Strike-Threat System, N.Y., Arlington House, 1973.

• 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 M. Blaug, Economic Theory in Retrospect (Homewood, Ill., Irwin, 1968), p. 154 n.
• 4*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).
• 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 J. M. Keynes, The General Theory (See note above), p. 19.
• 7 T. Sowell, Say’s Law (Princeton University Press, 1973), pp. 3, 4 (twice), 12, 19, 201.
• 8 J. A. Schumpeter, History of Economic Analysis (Oxford University Press, 1954), p. 625.
• 9 Ibid., p. 625.
• 10 James Mill, Commerce Defended (London, C. and R. Baldwin, 1808), p. 76.
• 11*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.
• 12 Schumpeter, op. cit., p. 617.
• 13 Ibid.,p. 618.
• 14 J. J. Spengler, “The Physiocrats and Say’s Law of Markets,” in J. J. Spengler and W. R. Allen, Essays in Economic Thought (Chicago, McNally, 1960), p. 170.
• 15*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.
• 16 Quoted in Ibid., p. 204.
• 17*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.
• 18*For reasons discussed at length in my recently published The Strike-Threat System.
• 19*Its purpose being that of maximizing aggregate profits, i.e., the raising of prospective yields in general, so as to cause increased competition for labor and the maximization of the absolute wages-flow.
• 20*It is important to recognize that other types of communication of information are technical in nature, irrelevant to the problems we are here discussing.
• 21Since 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.”
• 22At 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.
• 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.*
• 24An 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.
• 25“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).
• 26The 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.*
• 27Everything I have said about the depressive effects on the economy of pricing labor’s inputs above their market-clearing values in any given state of prospective yields applies equally, of course, to the pricing of the services of complementary factors. Not only the contractual claimants, but the residual claimants on the value of outputs may be in a position to contrive scarcities, thereby reducing their contribution to the source of demands for non-competing inputs and outputs. No less than labor employing the strike-threat, the owners of industrial assets in any field may gain at the expense of the prosperity of the community as a whole. Thus far I have stressed the responsibility of “unduly-high” wage-rates (in relation to prospective yields) for the slowing down of economic activity, partly because Clower and Leijonhufvud seem to regard labor costs-as the crucial factor and partly because, on empirical grounds,* I share that apparent judgment. Statistical enquiries into income distribution have established the fact that, in general, it is the owners of assets whose relative incomes contract most in depression. Moreover, students of business administration have noticed how, during the onset of depression, managements do everything in their power to avoid the necessity of layoffs; and, as the situation worsens and physical assets begin to operate at below full technical capacity, with consequential declining residues, they (the managers) become scared of their own displacement which, in the case of elderly executives or those of middle age could, in some instances, mean disaster for them. Typically, they are almost desperately anxious to get the wheels turning again.
• 28 Quoted in Ibid., p. 175.
• 29I am not suggesting that collusion among managements trying “not to spoil the market,” as market-clearing prices tend to fall in any industry, may not exert a depressive influence on demands for the inputs and outputs of non-competing industries. Nor do I ignore the possibility that prices charged by natural monopolies may not be incompetently controlled, whether as a result of lobby pressures or otherwise. I certainly believe that anti-trust or its equivalent (if it could be rescued from vote-gathering influences and its purpose explicitly recognized and declared)* would be a rational method of contributing to that objective and the full employment it implies. But recognition of this in no way weakens the significance of Say’s law. It is yet another possibility that illustrates the all-pervasiveness of that law.
• 30I have mentioned that both Leijonhufvud and Clower place very great stress on the imperfections of the information or communication process as a cause of the hiatus. But the kind of communication or information required for the coordination of the economy takes the form of market pressures;* and these pressures are exerted through loss-avoidance, profit-seeking incentives. Faced with such market signals as shrinking or accumulating inventories, entrepreneurs react by changing the rates of liquidation of different inventories via the price changes which they forecast will effect the desired results.
• 31While 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.
• 32I 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.
• 33In 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).
• 34*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).
• 35Controversy 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.*
• 36Controversy 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.*
• 37*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.
• 38Schumpeter was by no means anti-Say, in spite of the harshness with which he treated him. Properly formulated, he said, Say’s law is true, and “neither trivial nor unimportant.” But he thought that its main importance arose from its “negative” demonstration that general “restrictions of output” were no cure for crisis or depression. Such phenomena were “never to be causally explained solely by everybody’s having produced too much.” This is, of course, a significant implication of the “law.” But if the arguments I shall be developing in this book are valid, Schumpeter disclosed that, just like Say, he did not fully understand the “law of markets.”
• 39Schumpeter was by no means anti-Say, in spite of the harshness with which he treated him. Properly formulated, he said, Say’s law is true, and “neither trivial nor unimportant.” But he thought that its main importance arose from its “negative” demonstration that general “restrictions of output” were no cure for crisis or depression. Such phenomena were “never to be causally explained solely by everybody’s having produced too much.” This is, of course, a significant implication of the “law.” But if the arguments I shall be developing in this book are valid, Schumpeter disclosed that, just like Say, he did not fully understand the “law of markets.”
• 40The 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.*
• 41The 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.*
• 42The 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.*