The French economist Jean-Baptiste Say, in his A Treatise on Political Economy (1803), developed a theory of market activity that sited the source of the demand for products not on the quantity of money possessed by individuals but rather on the value of the quantity of products that those individuals supplied. People receive money for producing goods with the purpose of immediately purchasing goods of an equivalent value: “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” (Say 1971, p. 134). Money itself has no bearing on the relationship between the production of goods and the quantity of goods that they could fetch. It was in this sense that one might infer from Say’s analysis that “supply creates its own demand.” Changes in production by one individual thereby affect production in many markets: “The success of one branch of commerce supplies more ample means of purchase, and consequently opens a market for the products of all the other branches; on the other hand, the stagnation of one channel of manufacture, or of commerce, is felt in all the rest” (Say 1971, p. 137).
Say’s views on public policies emanated directly from his understanding of the mechanism by which an economy thrived and grew. The state should not put into effect any policy that would prevent producers from keeping their profits or for income to be diverted to unproductive consumption rather than savings. Anything that promoted the ability to produce more implied the enhanced ability of everyone else to produce and consume more goods.
The broader definition of Say’s Law as it is customarily accepted relates to the idea that a general glut in commodities for the economy as a whole is impossible. Say, however, at least in the Treatise, never imagined the possibility of there being a general glut of all commodities, except as an aside (Baumol 1977, p. 156; Kates 1998, p. 24). He did recognize, though, that in real time one’s ability to make a purchase was not automatically equal to what he had intended when measured by the value of the product at the time of production. Gluts in “superabundant commodities,” as Say called them, might occur if “it has been produced in excess abundance, or because the production of other commodities has fallen short” (1971, p. 135). Neither of these causes could be attributed to anything economy-wide. Rather, gluts in any one commodity, even the superabundant kind, occurred, at the end of the day, not because of a dearth of money but because of a dearth of supply.
It was left to James Mill (1808) and Robert Torrens (1821) to elaborate on Say’s framework, allowing them to conclude that a general glut in the economy as a whole was a logical impossibility. Mill in turn influenced Say’s understanding of this issue, which he laid out in later editions of his Treatise (see also Say 1967 ). Torrens’s explanation was more consistent with Say’s perspective in that an economy-wide downturn could be explained by “miscalculations” and particular gluts in the market (Kates 1998, p. 36).
What emerged from these elaborations of Say’s original analysis was a generally held conceptualization that one could think about a price system that regulated the flow of resources and goods supplied within a theory of markets. Moreover this price system was understood to be independent from the identification of the absolute nature of those prices, which were determined solely by the stock of money at any moment of time—the so-called classical dichotomy.
In 1936 John Maynard Keynes, in his The General Theory of Employment, Interest, and Money, criticized this tradition of economic theory and policy that began with the writings of Say, what he referred to as “classical economics.” The intention of Say and others to show that output (and employment) in the economy emanated from activity at the level of the individual firm suffered from a logical flaw, in Keynes’s opinion, because the specification of the functional relationships at the level of the individual could be posited only if it was assumed that output as a whole was given and unchanging. Thus the method of describing an economy in terms of the behavior of individual supply had no theoretical validity except when output as a whole was fixed at the point where all resources were employed. Classical economics could explain relative movements in output and employment, but they had no method for considering changes in the level of output and employment as a whole. This conclusion followed from the view held by Say and his followers that no one would hold money as a store of value; money therefore had no essential properties in and of itself. Keynes therefore wished to consider, instead, a monetary economy “in which changing views about the future are capable of influencing the quantity of employment and not merely its direction” (1971, p. xxii).
From that criticism of what he considered to be an illogical theoretical system, Keynes sought to develop an alternative framework of analysis with his theory of effective demand. Here, he believed, one could think logically about the relationship between activity at the level of each individual or firm and industry as a whole (his alternative dichotomy) but without the necessary presumption that output was given at full employment. Keynes’s reframing specified those relationships in a form such that each realm (the individual firm or industry and industry as a whole) existed in the context of the other. Either could remain stable or fluctuate without any stipulation that whatever was produced in the economy had to use all of the resources that were available. Keynes therefore felt that he had formulated a general theory of employment and output that was not predicated on a price system within a theory of markets in the tradition of Say, independent of the determination of absolute prices in general. Instead, he set the goal of bringing questions of money and prices back into the theory of employment and output as a whole.
This Keynesian revolution, which was intended to overturn the economic theory and policy built on Say’s Law, never happened, at least according to one of Keynes’s closest students and colleagues, Joan Robinson. Keynes’s alternative vision of a monetary theory of production, as well as his mode of reasoning upon which that vision was built, was never embraced by the discipline. Economic theory and policy in the early twenty-first century therefore remained entrenched firmly in the dichotomous framework by which resource allocation is determined in a system of relative prices emanating from the rational behavior of individuals, while absolute prices are determined by the quantity of money.
Modern theoretical debate has been reduced to analyzing the speeds at which prices and quantities adjust. New classical economists, on the one hand, assume that prices adjust instantaneously, meaning that questions of quantity adjustments are never at issue—the classical dichotomy is therefore in place at all times, leading to a clear and limited set of policy prescriptions that eschew any form of discretionary public intervention. The only tool of macroeconomics is the control of inflation through the proper control of the money stock. New Keynesian economists, on the other hand, admit that markets may fail to resolve themselves in the short period, which could lead to greater movements in output than in prices. It should be emphasized that questions of employment and output by new Keynesians are still conceptualized and therefore framed as a mere generalization of individual market activity, the approach Keynes found to be illogical. In these intervals the classical dichotomy might very well be violated, perhaps necessitating policy intervention beyond just monetary policy. But even for most new Keynesian economists, it is just a matter of time before markets make their necessary adjustments, reestablishing the separation of real and monetary sectors.
Both schools of thought do recognize that institutional barriers to full resolution persist even over the longer period. This recognition has led them to construct theoretical edifices such as the “natural rate of unemployment” and the non-accelerating inflation rate of unemployment, allowing them to fit reality back into their theoretical vision. Once resolved, there has emerged a confluence of views on long-term public policies for both new classical and new Keynesian economists limited to the control of inflation by the monetary authorities and the shedding of external barriers to the free market mechanism, allowing it to resolve itself fully.
One should not be surprised that policy to promote real economic growth has led to legislation that intends to break down all barriers that might have prevented those who prospered (who made profits either by productive activity or in the form of dividends from equity holding) from keeping the greatest portion of those profits. For they who are the most successful in the market can be expected to increase supply by the greatest amount, “open[ing] a market for the products of all the other branches” (Say 1971, p. 137). These supply-side policies have been disavowed by some new Keynesian economists, although the motivation for their objections has come from political rather than economic foundations. The vision of economics and economic policy has progressed little indeed since Say’s Treatise, when he suggested that policies should not exist that take away profits from producers unnecessarily and that savings (immediately translating into investment because people do not want to hold onto their money/profits longer than they must) should be encouraged over unproductive consumption.
SEE ALSO Business Cycles, Empirical Literature; Business Cycles, Real; Economics, Classical; Economics, New Classical; Economics, New Keynesian; Investment; Involuntary Unemployment; Keynes, John Maynard; Mill, James; Natural Rate of Unemployment; Phillips Curve; Robinson, Joan; Savings Rate; Shocks; Voluntary Unemployment;Walras’ Law
Baumol, William J. 1977. Say’s (at Least) Eight Laws, or What Say and James Mill May Really Have Meant. Economica 44: 145–161.
Kates, Steven. 1998. Say’s Law and the Keynesian Revolution: How Macroeconomic Theory Lost Its Way. Cheltenham, U.K.: Elgar.
Keynes, John Maynard. 1971. The General Theory of Employment, Interest, and Money. In The Collected Writings of John Maynard Keynes. Vol. 7. London: Macmillan and New York: St. Martin’s. (Orig. pub. 1936.)
Mill, James. 1966. Commerce Defended. In Selected Economic Writings, ed. Donald Winch. Chicago: University of Chicago Press. (Orig. pub. 1808.)
Say, Jean-Baptiste. 1967. Letters to Mr. Malthus on Several Subjects of Political Economy. New York: A. M. Kelley. (Orig. pub. 1821.)
Say, Jean-Baptiste. 1971. A Treatise on Political Economy; or, The Production, Distribution, and Consumption of Wealth. New York: A. M. Kelley. (Orig. pub. 1803.)
Roy J. Rotheim