Thursday, July 15, 2010

Keynes on Say's Law

Just a quick post on what Keynes actually said, because people are getting hot and bothered over it. I've bolded the key passage that basically says what I'm saying - this isn't a strictly adhered to doctrine so much as a heuristic device for the subconscious stumbling block of classical economics. It's not all that harsh - certainly nothing for anyone to get upset and defensive about:

From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product.

In J. S. Mill’s Principles of Political Economy the doctrine is expressly set forth:

"What constitutes the means of payment for commodities is simply commodities. Each person’s means of paying for the productions of other people consist of those which he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. Could we suddenly double the productive powers of the country, we should double the supply of commodities in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply; everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange. [Principles of Political Economy, Book III, Chap. xiv. § 2.] "

As a corollary of the same doctrine, it has been supposed that any individual act of abstaining from consumption necessarily leads to, and amounts to the same thing as, causing the labour and commodities thus released from supplying consumption to be invested in the production of capital wealth. The following passage from Marshall’s Pure Theory of Domestic Values illustrates the traditional approach:

"The whole of a man’s income is expended in the purchase of services and of commodities. It is indeed commonly said that a man spends some portion of his income and saves another. But it is a familiar economic axiom that a man purchases labour and commodities with that portion of his income which he saves just as much as he does with that he is said to spend. He is said to spend when he seeks to obtain present enjoyment from the services and commodities which he purchases. He is said to save when he causes the labour and the commodities which he purchases to be devoted to the production of wealth from which he expects to derive the means of enjoyment in the future. "

It is true that it would not be easy to quote comparable passages from Marshall’s later work or from Edgeworth or Professor Pigou. The doctrine is never stated today in this crude form. Nevertheless it still underlies the whole classical theory, which would collapse without it. Contemporary economists, who might hesitate to agree with Mill, do not hesitate to accept conclusions which require Mill’s doctrine as their premise. The conviction, which runs, for example, through almost all Professor Pigou’s work, that money makes no real difference except frictionally and that the theory of production and employment can be worked out (like Mill’s) as being based on ‘real’ exchanges with money introduced perfunctorily in a later chapter, is the modern version of the classical tradition. Contemporary thought is still deeply steeped in the notion that if people do not spend their money in one way they will spend it in another. Post-war economists seldom, indeed, succeed in maintaining this standpoint consistently; for their thought today is too much permeated with the contrary tendency and with facts of experience too obviously inconsistent with their former view. But they have not drawn sufficiently far-reaching consequences; and have not revised their fundamental theory.

In the first instance, these conclusions may have been applied to the kind of economy in which we actually live by false analogy from some kind of non-exchange Robinson Crusoe economy, in which the income which individuals consume or retain as a result of their productive activity is, actually and exclusively, the output in specie of that activity. But, apart from this, the conclusion that the costs of output are always covered in the aggregate by the sale-proceeds resulting from demand, has great plausibility, because it is difficult to distinguish it from another, similar-looking proposition which is indubitable, namely that income derived in the aggregate by all the elements in the community concerned in a productive activity necessarily has a value exactly equal to the value of the output.

Similarly it is natural to suppose that the act of an individual, by which he enriches himself without apparently taking anything from anyone else, must also enrich the community as a whole; so that (as in the passage just quoted from Marshall) an act of individual saving inevitably leads to a parallel act of investment. For, once more, it is indubitable that the sum of the net increments of the wealth of individuals must be exactly equal to the aggregate net increment of the wealth of the community.

Those who think in this way are deceived, nevertheless, by an optical illusion, which makes two essentially different activities appear to be the same. They are fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption; whereas the motives which determine the latter are not linked in any simple way with the motives which determine the former.

It is, then, the assumption of equality between the demand price of output as a whole and its supply price which is to be regarded as the classical theory’s ‘axiom of parallels’. Granted this, all the rest follows — the social advantages of private and national thrift, the traditional attitude towards the rate of interest, the classical theory of unemployment, the quantity theory of money, the unqualified advantages of laissez-faire in respect of foreign trade and much else which we shall have to question."



This is Mises on Keynes and Say's Law, for those who are intereseted.

10 comments:

  1. Roger Garrison does the same thing.

    He lets the economy get bumped off the production possibilities frontier and then adjust back, but the assumption is always that there is something magic and magnetic about an output level that makes full and efficient use of resources. If they economy doesn't stay on it strictly it fluctuates closely around it.

    That's the only point - that's what's being called "Say's Law". That's what's being challenged.

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  2. Oh ya - and note Keynes only mentions say ONCE here.

    Later he refers to this doctrine with the short hand of "Say's Law", again ONCE.

    Some people have this view that Keynes really dumps on Jean-Baptiste Say. He really doesn't, if you actually take the time to read it.

    Actually, after rereading it, I'd agree with DeLong's approval of Say, but actually maybe criticize DeLong for being too harsh on Keynes!

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  3. What objections do you hold against Mises' analysis?

    Also, Hazlitt advances objections against Keynes as well. Chapter III, page 32 if you're interested. http://mises.org/books/failureofneweconomics.pdf

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  4. I only read the beginning - I don't hold any objections to Mises's analysis at this point. His description of Say's project seems reasonably sensible - I have to take his word for it. I didn't read too much farther than that.

    I'll try to take a look at Hazlitt.

    So you would be in the "Jean-Baptiste Say did think what Keynes said he thought, and Say was right" crowd - is that right? Not in the "Keynes misrepresented Say crowd".

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  5. I haven't read Say first hand so I can't speak absolutely about what he really did say, but I'll argue Say's contributions were recognizing that:

    1. Supply creates demand; as such, in an aggregate sense, there can never be disparities between the two.

    2. There is never a such thing as general overproduction (given 1); merely relative over-and-under production in certain industries (like Mises says).

    If these are what he really says, then Keynes' arguments are wrong. The two positions expressed above are true.

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  6. I'm reading what Keynes said of Hume ... and I will state this bluntly, he really didn't understand Hume at all.

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  7. Garrison usually assumes monetary equilibrium, I think, whereas Keynes does not. Money is Hayek's "loose joint" that can confound the naive application of Say's law.

    Keynes seemed to perceive a high propensity for market orders to generate monetary disequilibrium. I suspect Garrison believes this is, in fact, a consequence of government monopolisation and control of the monetary order.

    Following economists like Selgin and White, I am inclined to believe the "loose joint" would be much tighter in a free banking world. It seems to me that the powers government needs to correct monetary disequilibrium, are also partly responsible for destabilising money demand.

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  8. Lee Kelly -
    What do you think of something like a Hicksian economy, though, where there is monetary equilibrium. Money I think arguably serves the "loose joint" function there, but there is no disequilibrium per se.

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  9. Daniel,

    I don't know what a Hicksian economy is, though I cannot imagine how money could serve as a loose joint without disequilibrium. Perhaps we have something slightly different in mind when writing "loose joint."

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  10. "He lets the economy get bumped off the production possibilities frontier and then adjust back, but the assumption is always that there is something magic and magnetic about an output level that makes full and efficient use of resources. If they economy doesn't stay on it strictly it fluctuates closely around it."

    "That's the only point - that's what's being called "Say's Law". That's what's being challenged. "

    No, whether Say's Law is true or not has no bearing on whether an economy has a tendency towards full employment. Keynes believed that by disproving Say's Law he was attacking the notion that an economy has a tendency to move towards full employment, when this was not particularly relevant.

    I believe Say's Law to be true and quite straightforward (in its heavily qualified and intricate form), but Say's Law could not be true and a laissez faire economy would still tend towards full employment.

    Keynes' real sin IMO was believing the demand for employment to be a function of the demand for commodities, which he then links to what he believes is Say's Law, that aggregate demand and aggregate supply are necessarily equal (which is obviously absurd, and not what the classics believed).

    Although, to be fair, many modern day believers of Say's Law see it as critical to the belief that a laissez faire economy tends to full employment, when it is not the issue at stake.

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