A Rehabilitation of Say’s Law

XIII SUB-OPTIMAL EMPLOYMENT AND CHRONIC UNEMPLOYMENT

Only when inputs are widely priced incompatibly with current prospective yields, and output prices are widely fixed incompatibly with current money income and consumer price expectations do we find reasons for a general contraction in economic activity leading to chronic under-utilization or “sub-optimal utilization” of productive capacity. Cumulative, self-aggravating failures to maintain activity are due to pricing defects which first dam up the source of demands and then prevent the dam from being breached. In other words, the condition which Leijonhufvud and Clower seem to believe Keynes (to his credit) somehow perceived but failed to enunciate (while other economists had not even perceived it) emerges when (irrespective of rectifiable entrepreneurial error) “wage push” is allowed to occur or any other form of pricing which relies on the overruling of free market pressures. If our empirical studies tell us that “wage-push” is the initiating cause, the repercussions are firstly, initiatory layoffs of labor and wasteful idleness of assets (possibly including wastefully held inventories) in the firm or industry in which labor costs are raised; and secondly, induced layoffs and wasteful idleness in non-competing sectors, due to wage-rate rigidities, price rigidities, and sectionalist barriers generally in those sectors.1 Each such contraction tends, in turn, to induce similar contractions in yet other sectors.

But what could still be merely temporary idleness, merging into full but “sub-optimal” (wasteful, relatively unremunerative and unproductive) employment tends, as we have seen, to become chronic idleness through subsidies financed by income transfers. Subsidized non-use of valuable resources (through some forms of unemployment compensation, relief handouts, price supports, and so forth) prevents or discourages displaced men and assets from finding alternative, “sub-optimal” employments which could otherwise mitigate the extent to which the source of demands is repressed and recession aggravated, as well as preventing or discouraging such idle resources from returning to formerly profitable activities and supplying inputs at costs compatible with prospective yields to investment.

The difficulty economists trained in the Keynesian tradition have in recognizing the nature of the failure to clear the labor market, and the real causes of the phenomenon of chronic unemployment of labor, stands as a powerful hindrance to clarity of thought in their expositions. For instance, H. I. Grossman believes that Keynes accepted and enunciated “classical” theory in respect of the “unemployment” of labor.2 Certainly Keynes himself thought (in 1936) that he was accepting the then current theory. In the words of The General Theory, “the real wage earned by a unit of labor has a unique inverse correlation with the volume of employment”. Well, duress-raised labor costs do reduce the profitability of employment in any occupation. Yet Grossman objects (citing statistical enquiries of Kuh and Bodkin) that “despite repeated attempts, such a pattern of real wages has not been observed.”3 He is, however, thinking of the aggregate wages-flow, not of the price of labor in any industry or firm.

Now all these economists, including Keynes, confuse the pricing of some resources out of supply—the process of withholding some resources from their existing occupations—with something quite different, namely, the failure of the displaced resources to accept “sub-optimal employments”—the next best employments available. And this is a matter of (a) the alternative outlets (the versatility of men and assets laid off) and (b) the incentives to accept those alternatives. I mentioned before the most important disincentives, in referring to subsidized idleness—“unemployment compensation,” relief handouts, price supports, etc.,4 disincentives which equally operate to obstruct the labor-cost adjustments essential for recovery of the wages-flow. The truth is that, during the present century, employable people have been increasingly able in the western world, through income transfers (including private transfers—“charity”), to survive without contributing through work to the source of demands, and without an income from their own savings or inherited property. In the United States at present, persons in this class can live in what the overwhelming majority of mankind would regard as affluence. But even in the very low income countries there are a host of other factors which may cause large numbers of people of conventional working age to refuse such contractually remunerated employment as is available, and to survive (however miserably) without a contractual income from work.

Hence there are no reasons for expecting the arbitrary magnitudes which are termed “unemployment” in different countries to be closely correlated with the rate of layoffs. This reality appears to me almost to make nonsense of some statistical correlations between average wage-rates and “unemployment,” however the latter is defined.

Chronic “unemployment” of labor (such as existed in the 1930s) is certainly not due to any inability of the pricing mechanism, freed from the barriers of strike-threat duress and politically determined minima, to clear the labor market. The wages-flow can always be restored, when “unemployment” of any kind has developed, by pricing labor’s inputs compatibly with prospective yields, which means within reach of uninflated income and consistently with price expectations. And market-selected wage-rate and price adjustments can achieve this result not only by releasing for more productive, higher-paid work, those workers who have been forced into “sub-optimal employment,” but by restoring “employment” in the sense of absorbing workers who have been in subsidized idleness or actively prospecting for the most favorable employment outlets.5 This is the true “classical” understanding of the relation between the cost of labor’s inputs and the profitability of investing in those inputs;6 and no statistical studies have disclosed any facts that might in the least disturb it.

Leland Yeager is one of the few contemporary economists to refer explicitly to the relevance of what I have called (for men and assets) “sub-optimal employment”—in Yeager’s words, the fact that “misallocation wastes can persist without idleness waste.”7 But he believes, if I understand him correctly, that the inferior employments available to workers laid-off through duress-imposed costs, and for assets displaced thereby, are unimportant mitigations because demand will be “deficient” for the inputs in alternative employments.8 Certainly the cumulative effects of collusive or governmental cost-raising and price-raising operate to reduce still further the contractual remuneration at which the victims among the workers can alleviate the detriment imposed upon them, and also to reduce still further the residual yields of owners of displaced assets (which may have some versatility). This does not imply, however, that the condition is unimportant.

In my judgment, the mitigation can be substantial; although I certainly do not regard “sub-optimal full employment” as a tolerable condition. Chronic unemployment is conspicuous. Chronic misallocations are sometimes hardly recognizable and, in their most burdensome manifestations, often wholly unrecognizable. Yet the wastes implied under “sub-optimal employment” are, as I see things, normally the most virulent form which wastes can take, both in prolonged depression and in inflation-maintained “prosperity.” When duress-imposed costs are allowed to repress the source of demands for decades (as I judge has happened in Britain since World War II), the composition of the whole stock of assets becomes adversely affected, just as does the composition of “the stock of skills” acquired and the particular occupations to which workers “become attached.”

Grossman’s theory of unemployment differs from Keynes’ in that whereas the latter relied upon the reduction of real wage-rates for recovery, the former holds that the recovery of “aggregate demand” (the restoration of the source of demands) is possible (via inflation) “even with the real wage-rate unchanged,” so that, under deficient aggregate demand, “the level of employment is unaffected by changes in real wages.”9 Grossman’s presentation illustrates excellently how seriously astray some Keynesian-trained economists have been led and how poorly they have understood “classical economics.” Of course the restoration of employment is compatible “with the real wage-rate unchanged,” in the sense of the average wage-rate, provided unemployed workers are reckoned in the averages as having a wage-rate of nil. Indeed, recovery is not only compatible with a considerable rise in “the real wage-rate” in this sense but may be expected to bring it about. This applies whether the recovery is achieved by deceiving the community about the planned speed and duration of inflation or, much less unjustly and more potently, through the initial market-selected wage-rate and price adjustments needed for the gradual restoration of the wages-flow. Either policy can raise the average real wage-rate while, under the assumption of monetary flexibility, downward wage-rate adjustments will raise the average money wage-rate also. This result may be expected (i) because, through reducing costs in relation to prospective prices in activities where unprofitable cost-price ratios have previously ruled, workers whose wage earnings have for some time been zero (including some in subsidized idleness) will begin to receive positive wage incomes; (ii) because workers laid off into “sub-optimal” employments may be expected to return to more valuable work; and (iii) (most important) because, through the dynamic repercussions of Say’s law, demands for outputs and hence for labor, will be rising in real terms in all non-competing sectors.

It remains necessary to deal briefly with Keynes’ objection (a fallacy which has not yet been eradicated) that the workers cannot effectively cut their real wage-rates directly, so as to make larger outputs profitable, because that will in turn induce price cuts and thereby prevent any reduction of the average real wage-rate. There is no reason whatsoever why, in depression, widely adopted wage-rate cuts should bring about general cuts in the prices of output; for firstly, all labor absorbed will be augmenting the source of demands, and secondly, only under a deflationary monetary policy (perhaps due to monetary rigidity) will initial cuts in wage-rates fixed above full employment values cause a defensibly weighted price index to fall. Hence, under flexible monetary policy, the reduction of such wage-rates as have been forced above the level that clears the market for labor (which will occur in each case as a reduction of money wage-rates) must, ceteris paribus, raise the average money wage-rate also, just as rapidly as outputs in general recover.

The policy implications of the “classical” theory which Keynes attacked (in relation to recovery from depression) can be summarized as follows. The implicit aim was to achieve a higher wages-flow and hence a higher average real wage-rate together with an increased flow of real income generally. But that process does require initial adjustments that bring down the costs of inputs to values which are related to prospective yields to investment in those inputs in the existing state of depression. The acceptance of these values will always mitigate the harsh consequences of non-market impositions on the co-ordinating price mechanism; but as I have insisted, while these values may be well below those which are destined to rule as prospective yields recover, initial acquiescence in them may be inescapable for non-inflationary recovery from depression.

To recapitulate, it is through restraints on the coordinative process that the source of demands can come to be cumulatively constrained. This is the origin of the condition that macro-economists so inappropriately call “increasingly deficient aggregate effective demand.” Through such constraints, employment outlets remain available only at continuously falling real remuneration. The process can be reversed by unemployed (or sub-optimally employed) persons accepting jobs at labor costs which are related to current prospects of yields.

 

 

10Such as labor union “demarcations,” apprenticeship restraints, occupational licensing, minimum wage enactments, etc.

11The fact that such mitigations may seem to be patently just in a society that permits and encourages poverty creation and the aggravation of inequalities of opportunity and income (e.g., through tolerance of the strike-threat system; apprenticeship restraints; occupational licensing; minimum wage-rates; demoralization through relief; and restraints on the accumulation of wage-multiplying assets via taxation levied for vote-purchasing objectives) does not affect the reality that the subsidization of idleness exacerbates social injustices.

12This discussion of the “unemployment” condition is unduly simplified. My book The Theory of Idle Resources (1939) is entirely devoted to an analysis of the different reasons why valuable services of men and assets are, at times, not purchased. For instance, a laid-off worker may be refusing contractual employment offers because he is prospecting for better outlets, which he can sometimes do most efficiently if he is not contractually engaged. As with all prospecting, such (basically entrepreneurial) efforts are really remunerated employment, but with the remuneration being received later, through the superior employment that is the reward of a wise or lucky search for a job. The “prospecting” may be subsidized out of income transfers or financed out of the individual’s own capital (e.g., from actuarially sound unemployment insurance).

13I maintained, in The Theory of Idle Resources, that my contribution was “pure orthodoxy.” I regarded that work as original only in the sense that it tried to make more clear what pre-Keynesian (“classical”) economists really envisaged when they thought of “unemployment.”

 

 

14.  H.I. Grossman, “Was Keynes a Keynesian?”, Journal of Economic Literature, 1972.

15.  Ibid., p. 28.

16.  L. Yeager, “The Keynesian Diversion,” p. 155.

17.  Ibid., pp. 154-155.

18.  Grossman, op. cit., p. 29.

• 1*Such as labor union “demarcations,” apprenticeship restraints, occupational licensing, minimum wage enactments, etc.
• 2 W. H. Hutt, Economists and the Public (London, Jonathan Cape, 1936), p. 34.
• 3 M. Blaug, Economic Theory in Retrospect (Homewood, Ill., Irwin, 1968), p. 154 n.
• 4*The fact that such mitigations may seem to be patently just in a society that permits and encourages poverty creation and the aggravation of inequalities of opportunity and income (e.g., through tolerance of the strike-threat system; apprenticeship restraints; occupational licensing; minimum wage-rates; demoralization through relief; and restraints on the accumulation of wage-multiplying assets via taxation levied for vote-purchasing objectives) does not affect the reality that the subsidization of idleness exacerbates social injustices.
• 5*This discussion of the “unemployment” condition is unduly simplified. My book The Theory of Idle Resources (1939) is entirely devoted to an analysis of the different reasons why valuable services of men and assets are, at times, not purchased. For instance, a laid-off worker may be refusing contractual employment offers because he is prospecting for better outlets, which he can sometimes do most efficiently if he is not contractually engaged. As with all prospecting, such (basically entrepreneurial) efforts are really remunerated employment, but with the remuneration being received later, through the superior employment that is the reward of a wise or lucky search for a job. The “prospecting” may be subsidized out of income transfers or financed out of the individual’s own capital (e.g., from actuarially sound unemployment insurance).
• 6*I maintained, in The Theory of Idle Resources, that my contribution was “pure orthodoxy.” I regarded that work as original only in the sense that it tried to make more clear what pre-Keynesian (“classical”) economists really envisaged when they thought of “unemployment.”
• 7 J. M. Keynes, The General Theory (See note above), p. 19.
• 8 T. Sowell, Say’s Law (Princeton University Press, 1973), pp. 3, 4 (twice), 12, 19, 201.
• 9 J. A. Schumpeter, History of Economic Analysis (Oxford University Press, 1954), p. 625.
• 10Only when inputs are widely priced incompatibly with current prospective yields, and output prices are widely fixed incompatibly with current money income and consumer price expectations do we find reasons for a general contraction in economic activity leading to chronic under-utilization or “sub-optimal utilization” of productive capacity. Cumulative, self-aggravating failures to maintain activity are due to pricing defects which first dam up the source of demands and then prevent the dam from being breached. In other words, the condition which Leijonhufvud and Clower seem to believe Keynes (to his credit) somehow perceived but failed to enunciate (while other economists had not even perceived it) emerges when (irrespective of rectifiable entrepreneurial error) “wage push” is allowed to occur or any other form of pricing which relies on the overruling of free market pressures. If our empirical studies tell us that “wage-push” is the initiating cause, the repercussions are firstly, initiatory layoffs of labor and wasteful idleness of assets (possibly including wastefully held inventories) in the firm or industry in which labor costs are raised; and secondly, induced layoffs and wasteful idleness in non-competing sectors, due to wage-rate rigidities, price rigidities, and sectionalist barriers generally in those sectors.* Each such contraction tends, in turn, to induce similar contractions in yet other sectors.
• 11Now all these economists, including Keynes, confuse the pricing of some resources out of supply—the process of withholding some resources from their existing occupations—with something quite different, namely, the failure of the displaced resources to accept “sub-optimal employments”—the next best employments available. And this is a matter of (a) the alternative outlets (the versatility of men and assets laid off) and (b) the incentives to accept those alternatives. I mentioned before the most important disincentives, in referring to subsidized idleness—“unemployment compensation,” relief handouts, price supports, etc.,* disincentives which equally operate to obstruct the labor-cost adjustments essential for recovery of the wages-flow. The truth is that, during the present century, employable people have been increasingly able in the western world, through income transfers (including private transfers—“charity”), to survive without contributing through work to the source of demands, and without an income from their own savings or inherited property. In the United States at present, persons in this class can live in what the overwhelming majority of mankind would regard as affluence. But even in the very low income countries there are a host of other factors which may cause large numbers of people of conventional working age to refuse such contractually remunerated employment as is available, and to survive (however miserably) without a contractual income from work.
• 12Chronic “unemployment” of labor (such as existed in the 1930s) is certainly not due to any inability of the pricing mechanism, freed from the barriers of strike-threat duress and politically determined minima, to clear the labor market. The wages-flow can always be restored, when “unemployment” of any kind has developed, by pricing labor’s inputs compatibly with prospective yields, which means within reach of uninflated income and consistently with price expectations. And market-selected wage-rate and price adjustments can achieve this result not only by releasing for more productive, higher-paid work, those workers who have been forced into “sub-optimal employment,” but by restoring “employment” in the sense of absorbing workers who have been in subsidized idleness or actively prospecting for the most favorable employment outlets.* This is the true “classical” understanding of the relation between the cost of labor’s inputs and the profitability of investing in those inputs;* and no statistical studies have disclosed any facts that might in the least disturb it.
• 13Chronic “unemployment” of labor (such as existed in the 1930s) is certainly not due to any inability of the pricing mechanism, freed from the barriers of strike-threat duress and politically determined minima, to clear the labor market. The wages-flow can always be restored, when “unemployment” of any kind has developed, by pricing labor’s inputs compatibly with prospective yields, which means within reach of uninflated income and consistently with price expectations. And market-selected wage-rate and price adjustments can achieve this result not only by releasing for more productive, higher-paid work, those workers who have been forced into “sub-optimal employment,” but by restoring “employment” in the sense of absorbing workers who have been in subsidized idleness or actively prospecting for the most favorable employment outlets.* This is the true “classical” understanding of the relation between the cost of labor’s inputs and the profitability of investing in those inputs;* and no statistical studies have disclosed any facts that might in the least disturb it.
• 14While 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.
• 15I 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.
• 16In 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).
• 17*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).
• 18Controversy 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.*