Say's Law of Markets

Only someone with professional training in economics has ever heard of the economic principle now known as Say’s Law of Markets. Indeed it was Keynes’s explicit aim in writing his General Theory – an aim in which he was wildly successful – to have Say’s Law removed from economic discourse.

For all that, if you wish to understand what causes recessions and how they are overcome, it is to Say’s Law you need to turn which, to put it as briefly as possible, argues that an economy cannot be made to grow from the demand side but only through higher productivity. You can therefore see how contrary to modern macroeconomic theory Say’s Law is.

Say’s Law was the bedrock principle of classical economics. I describe it as economic theory’s Law of Gravity. And why I think it is of such importance can be seen from this simple equation: 

CE – SL = MT

Where:

CE = classical economics (i.e. economic theory before Keynes)

SL  = Say’s Law

MT = Macroeconomic theory today

Macroeconomic theory is Keynesian. It is what everyone is taught and has been for seventy years.

If it should turn out that MT is finally recognised for being the useless amalgam of theoretical nonsense I think it is, there is an awful lot of capital that will be burned away. Many of our mis-educated economists will find that what they thought they knew may actually be incorrect, and many of those texts that pour out page after page of MT stuff will need to be junked for presenting the misleading nonsense they do.

It does not surprise me that those who trade on their knowledge of MT economics have a hostile reaction to those who point out that Say’s Law may have been right after all. The Global Financial Crisis (GFC) and the stimulus packages put in place to deal with it have been a crucially decisive test of Keynesian macroeconomic theory. That it has failed this test in every conceivable way – other than through the Krugman/Stiglitz ‘we should have had an even larger deficit’ criterion – is recognised by virtually everyone. Applying Keynesian policies makes things worse. An alternative to today’s MT is therefore needed.

What I argue is that Say’s Law of Markets must be reintroduced into economic theory as a core principle of what is taught. Unless it is, the blunders which have followed one after the other during the two years following the GFC – the same policies which led to the ‘lost decade’ in Japan and created the Great Stagflation of the 1970s – will be repeated time and again.

The problem is that the Law of Markets is difficult to understand, especially after having absorbed the MT theories taught today. But I can see no alternative. Either economic theory once again re-absorbs Say’s Law or the MT economics most economists are taught will remain a danger to any economy attempting to apply the policies it recommends in the real world.

Any programme in rehabilitating Say’s Law can start with the video of Professor Kates’s excellent Mises Institute defence, later published in The Quarterly Journal of Austrian Economics.
You know in the dynamic ridesharing space, we have exactly the same problem. It is called "probability of a ridematch" and is subscribed to, it seems, by almost every major Transport School. In short they state "Dynamic Realtime Ridesharing is only possible in a densely populated area and any attempt to do it anywhere else will fail". We got strangers to share rides in a little hick town of population 20,000 or so. Which, in a rational world, would provide the one proof (you only need one) to demolish the standard claptrap that so many transport people still believe. It could be why they failed to make dynamic, realtime ridesharing work all these years. It also shows that the "Macroeconomic / Planning approach to transport" does not work. There *is* more than a passing similarity between Keynesian theories of markets and the way in which transport professors have historically approached the rideshare problem. And the outcomes in both senses are remarkably similar. Big Fail.

According to Proposition 5 on p19 of your article in The Quarterly Journal of Austrian Economics:

"Recessions are due to structural problems of one kind or another. In particular, recessions occur where the structure of supply does not match the structure of demand. Recessions occur when the pattern of demand is different from the actual composition of output so that a significant proportion of the goods and services put up for sale remains unsold."

So how does this account for the 1929 crash when US output fell by over 30%? How could such a massive disequilibrium between the pattern of demand and the actual composition of output occur so quickly? Statistically this is highly improbable.

True, I can think of a few situations where Proposition 5 might hold true. For example, in a largely agricultural economy (such as in 18th and early 19th century Europe) a recession would surely follow any major failure in the annual harvest. It is also perhaps revealing that both the Napoleonic wars and WWI were followed by periods of recession. In both cases the country would need to readjust rapidly to a large decline in military spending and armament manufacture coupled with a large increase in the available manpower. And it could certainly account for the Thatcher recession of 1980 which was driven by a deliberate structural realignment of the economy by the Government. But where is the evidence that the balance of the economy, or the pattern of demand, is permanently altered after every recession, including the current one?

Say's Law is clearly predicated on the assumption that all money circulates continuously. Yet we know that in times of economic hardship banks recapitalise and people hoard their cash. That money is dead money. It is not spent. It is not invested. It is not lent to others. Nor does Say’s Law take into account the psychological impact of recessions in inducing a fear for the future in most consumers. That is where the fall in aggregate demand comes from. It is this general panic that leads to an amplification of deflationary factors and a downward spiral. So while Say's Law may explain some recessions, it certainly cannot explain all of them, and in particular modern recessions.

What Say’s Law represents is an affirmation of steady state theory in economics. It is a statement to the effect that if the relative proportions of production and consumption within an economy remain unchanged over time, or are continuously in balance over time, then recessions will be avoided. It is in effect the application of time-invariant symmetry to an economic system.

Thus the corollary to Say’s Law is that any factor that leads to a radical reallocation of resources over time, or which drives the economy away from its long term equilibrium position is also capable of causing a recession. One such factor is inequality, or a steady growth in inequality (as we saw in the late 1980s). If the rich get much richer each year, and the poor don’t, then with each successive iteration the problem will be magnified. Such a state of affairs cannot continue ad infinitum any more than a Ponzi scheme can. Sooner or later the poor will run out of money and the rich will run out of consumer objects of desire with which to indulge themselves. Then the rich put their money into inflated assets and the poor get even poorer paying the rising rents on those assets.

Consequently, if Say's Law of Markets has anything to teach us it is that inequality, or at least the continuous growth in inequality, is likely to be a major contributor to future recessions. Therefore, reducing inequality will also reduce the likelihood of a recession. So not only is reducing, or at least limiting, inequality the moral thing to do, it is the economically sensible, pragmatic and prudent thing to do as well. Unfortunately, while this indicates that Say’s Law may still have some relevance in explaining how we could avoid getting into recessions in the future, it has nothing practical to say about how we can get out of them in the present.

If one modifies Goodwin's Model in accordance with Q=MV/p, a useful result is obtained.Goodwin Simulation-US Economy 1913-2100 This model correctly shows how inflation consumes the wages share of GDP.

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