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Sunday, February 19, 2017
The Antidote to Countless Economic Fallacies....Say's Law
Say's Law: The Antidote to Countless Economic Fallacies
To understand the principle that has been called Say’s Law, it is useful to start by thinking about what unhampered exchange is: the mutual offering of goods and services between people. Seeing exchange as a mutual offering shows demand-and-supply is not an unsolvable chicken-or-egg problem. People produce what in their best judgment they think others want, in the expectation that others are producing or will produce what they want. Production, in other words, is always speculative.
In small social settings, this speculation is usually not too difficult. Two people deserted on a tropical island, for example, can discuss beforehand what each one will make and offer to the other. In larger social settings this speculation is harder, so a money system develops to help people judge what others want using market prices as a signal of consumer preferences. But the essence does not change: people produce what they judge others want in expectation that others will provide what they want.
Say’s Law, then, can be described as follows: The value of goods and services anyone can purchase is equal to the market value of what they supply. Or in an aggregate, macroeconomic sense, the value of goods and services any group of people can purchase in aggregate is equal to the market value of what they supply in aggregate.
Economist Paul Cwik more helpfully explains that Say’s Law is simply the reality that “we produce in order to consume.”
Say’s Law is always true because it applies to the subjective conception of value. Supply into the marketplace always provides the means for the supplier to purchase other goods and services, but only to the extent of the subjective value placed by others on that supply at any given time. Even if supply failed to create any purchasing power at all for the supplier because it was considered utterly valueless in the marketplace — like say, creating holes in the middle of nowhere — this would not be a contravention of Say’s Law but merely another manifestation of it. It also distinguishes Say’s Law from the Marxists’ labor theory of value in recognizing the crucial fact that the act of production alone is insufficient to create purchasing power, but rather the act of producing something which is valued by someone else who has also produced something valued in the marketplace. In short, it’s not production that matters per se but what is produced and for whom.
We can now understand why David Ricardo said,
Men err in their productions, there is no deficiency of demand.1
Ricardo was commenting during the great "general glut" debate that had arisen in the nineteenth century between himself and Thomas Malthus on the cause and cure of economic downturns. Malthus espoused the view that became the essence of Keynesianism and the modern mainstream. Too much saving and too little spending, they argue, cause a general glut or general overproduction. Producers sit with unsold stock and declining revenues and have to lay off workers. A recession ensues. Malthus, and later, more emphatically, Keynes, advocated saving less and spending more to recover from the recession.
But the validity of Say’s Law renders the Malthusian-Keynesian view incorrect. Since demand itself is determined only by products and services that are valued in the marketplace, widespread business errors revealed in the recession must be the result of widespread errors in speculating what value the market would place on the goods and services supplied.
If men (and women) err in their productions, then recovery efforts must be focused on rearranging productive efforts to estimate and serve consumers’ needs better. This diagnosis is very different from the Keynesian one which emphasizes demand deficiency due to mysterious fluctuations in “animal spirits” to be rectified with state and household debt spending and money printing. In a Say’s-Law diagnosis, entrepreneurs need as few obstacles as possible to discovering what products and services the market wants. Since the price mechanism is the primary information signal to entrepreneurs, market price flexibility is essential to a proper recovery. Also, once resources have been misallocated and some capital wasted altogether, more not less saving is needed to tide workers and entrepreneurs over and accumulate sufficient funds to redeploy in new endeavors.2
If we concede the fallacy that virtuous individual action like saving more can lead to chaotic social outcomes without state intervention, then all manner of central planning can be justified as not only of public benefit but as fundamentally essential for civilization. But this is the very path to civilizational ruin, to which the ash heap of history attests.
Say’s Law stands as the gatekeeper of economic freedom, prosperity, and even civilization itself.
1.Credit to economist and classical scholar Steve Kates;for this insight. Steven Kates, "Why Keynesian Concepts Cannot Be Used to Explain Pre-Keynesian Economic Thought: A Reader’s Guide to Classical Economic Theory," Quarterly Journal of Austrian Economics 17, no. 3 (Fall 2014): 313–326.
2.Paul Cwik, “Austrian Business Cycle Theory: A Corporate Finance Point of View,” Quarterly Journal of Austrian Economics 11, no. 1 (2008): 60–68.