Tuesday, 1 August 2017

Politicians–and everyone else—still don’t understand Say’s Law

[Editor's note: How do you do away with a “Law” that had been core to economists’ understanding of the market economy for 150 years? You misrepresent it.
    On Thursday US Energy Secretary Rick Perry on declared "you put the supply out there and the demand will follow." It appears that Perry was attempting to invoke Say's Law, and many professional economists and pundits quickly took to mocking both Perry and Say's Law for making assertions contrary to modern Keynesian orthodoxy.
    Below, economist Per Bylund explains in this Guest Post what Say's Law really says, how Keynes misrepsented it, and why understanding the Law is still a good thing.

179299134Few concepts are as misunderstood as the so-called Say’s Law. In part, this is the fault of John Maynard Keynes who, needing to do away with it to make room for interventionist policy, did much to make it mis-understandable. How do you do away with a “Law” that had been core to economists’ understanding of the market economy for 150 years? Simple: You misrepresent it. Strawmen are so much easier to knock over than the real thing.

Hence, the “Law” is presently known in the misbegotten terms Keynes gave it, that “supply creates its own demand,” something that is obviously untrue.

Originally, however, Say’s Law was different. It even had a different name. Economists prior to Keynes tended to refer to it simply as the Law of Markets, so-called because it describes in very simple terms the fundamentals of how a market functions. Jean Baptiste Say was simply the earliest to express the law, which may be why it has come to bear his name.

Say noted that

A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value.

This means that

As each of us can only purchase the productions of others with his own productions — as the value we can buy is equal to the value we can produce, the more men can produce, the more they will purchase.

In other words (and this still shocks postmodern economists), production necessarily precedes consumption; and (in the way Keynes’s mis-statement should be re-ordered) anyone’s demand is constituted by their supply.

The Law of Markets thus summarises the nature of market actions where production is specialised under the division of labour. Specifically, that we produce to sell, with the intention to then use the proceeds to buy what we really want. Market production is in other words indirect and not undertaken to directly satisfy one’s own wants. We produce instead to satisfy other people’s wants, and can thereby satisfy our own by purchasing what others produce.

The benefit is that there is a separation between what I want to consume and what I produce, which means we can each specialise in producing something we are comparatively good at instead of producing only what we want to consume. It also means we can specialise in producing only one thing instead of a multitude, thereby cutting switching costs, develop skills and expertise, increase knowledge, and consequently increase output.

But while universal specialisation under the division of labour means that overall output is significantly increased, it also means we become dependent on each other in trade. Not only do we need to sell what we produce to others in order to get the means necessary, but we need to also trade with those who produce what we want to satisfy our wants. We become interdependent – and voluntarily so. This is why Ludwig Von Mises stated that

Society is division of labour and combination of labour. In his capacity as an acting animal man becomes a social animal.

This “social animal” benefits from, engages in, and in fact arises out of market (inter)action. As we can only benefit ourselves by properly aligning our own productive efforts with what other people want, we must understand other people. By doing so, we can better anticipate what needs and wants they have and then busy ourselves with attempting to meet those needs. And because production takes time, production must precede demand.

Because demand is unknown, production is necessarily speculative and entrepreneurial. Actual demand will be discovered when the goods are presented to potential buyers. Entrepreneurs are therefore forecasters, project appraisers, and risk-takers; in an advanced economy they advance funds to owners of labour and capital, and only recoup this investment if they succeed in selling the product.

At the same time, the consumers can only buy if they have themselves engaged in production that satisfies other people’s needs — because otherwise they will only have the willingness but not the ability to buy (and that is not demand). This is not a circular argument but an integration at the “macro” level – and also an explanation for economic growth. The ability to sell goods in the market and thus engage in specialised production requires prior investment [i.e., a ‘wages fund’ – Ed.]. So to specialise one needed to first produce demanded goods in excess of one’s own wants. The same is true today: development of a new good requires investment, and that investment is speculative because actual demand cannot be known until it is too late.

The implication is that there can never be a general glut in the economy and therefore no “deficiency” in what Keynes called “aggregate demand.” It is however certainly possible for there to exist a surplus or shortage of any particular commodity, which happens regularly as entrepreneurs fail to precisely anticipate and therefore meet market demand, but only in the short term.

As all production is undertaken to sell the goods produced to then purchase goods that better satisfy the producer’s want, the inability to sell becomes an inability to demand. We cannot demand unless we first produce the means to demand. It is thus not a “demand deficiency” that someone is unable to sell what he or she produce, and consequently cannot demand goods in the market. Rather, it is a production failure that causes a reduction in effective demand — specifically, an entrepreneurial failure.

If government stimulates demand, then this only subsidises those goods that have been produced at too high cost. Consequently, the entrepreneurial errors are propped up and production therefore remains misaligned with demand.

So it is easy to see why proponents of interventionism would want to do away with the Law of Markets. If demand is not constituted by supply, then markets may not clear and government must save us from ourselves. Something every government today feels compelled to promise.

PerBylundPer Bylund is assistant professor of entrepreneurship & Records-Johnston Professor of Free Enterprise in the School of Entrepreneurship at Oklahoma State University. Website: PerBylund.com.
This post previously appeared at the
Mises Wire. It has been lightly edited.

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