Say’s Law of Markets

The next classical law we will look at is a statement that no self-respecting Keynesian would recognize as a law at all. Say’s law of markets was propounded by Jean-Baptiste Say in 1803 in his book A Treatise on Political Economy. His original statement of it was as follows:

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.  

A more modern statement of the law of markets is this:

The production of an economic good or service increases aggregate demand by exactly the amount spent to buy raw materials and labor used to produce the product.

When the producer employs workers and buys materials, he puts demands on the economy. The money exchanged for these things passes to the suppliers, who can then use it to make their own demands on the economy.

One must be careful about how Say’s law is formulated, because it can easily be put (and often is) in a form that is obviously not true. Keynesians are most guilty of this, as was Keynes himself. In Chapter 2, Section VI of The General Theory of Employment, Interest and Money Keynes writes

From the time of Say and Ricardo the classical economists have taught that supply creates its own demand.

The emphasis here is mine. This formulation is obviously false since the mere fact that a businessman creates a good does not ensure that anyone will want to buy it. Nevertheless Keynesians constantly erect this straw man  in order to be able to knock it down. Their motivation would seem to be to disabuse us of the idea that suppliers of goods in the private sector can regenerate economic demand after a depression or recession has been entered. Economic crises in their view are always a failure of free markets, but our salvation from them can only be through government spending.

So how true is Say’s law in the formulation I have given it? On one hand it would appear to be almost a tautology. A producer goes out into the market place to buy the means to make his own good, and in the process of making this economic demand he increases aggregate demand. If it goes no further than this, the increment of aggregate demand added by the entrepreneur would seem to be equivalent dollar-for-dollar to the increment provided by a government stimulus program. One might argue that the federal government can spend a lot more in a single stimulus program than individual businessmen, which is usually true. Nevertheless, as a fraction of the economy, demands from the private sector always have outweighed federal expenditures, even during a recession.

However, the businessman’s increment to aggregate demand  often does go farther than what was just described. A businessman, if he is successful, will do a lot of analysis and planning to ensure his success. What he wants is to make a profit, and he will not hazard his capital unless he is sure that people will want to buy his good. When this is true and people want or need his product, then in this particular case supply has created its own demand. Picture Apple introducing the iPad into the market for the very first time. It is not a law that this will happen, but it is often the case.

When this happens, the demand produced through Say’s law is clearly superior to the government stimulus program. It is superior because it is self-sustaining. The producer’s demands for the raw materials to make his goods will continue because they are balanced by the revenues he makes in selling them.

The government stimulus program on the other hand is usually not considered to be a permanent activity. The government may continue the activity until the free-markets revive, even if they do not make a profit. Sadly, it is often the case that it does not produce any profit, with the value of the government’s invested assets greater than the value of the “stimulated” assets. [Consider Solyndra.] In those cases. which I believe to be the most probable, the government “stimulus” program is actually a drag on the economy because it consumes more wealth than it produces.

Even so, the government stimulus program will eventually end, and if the demand for the “stimulated” good has not been picked up by the private sector, the effect of the government’s stimulus will have proven temporary, President Obama’s major stimulus program, the American Recovery and Reinvestment Act of 2009, was finally budgeted for $831 billion and will last through 2019. Most of the money was planned to support existing government programs at both the state and federal level, and to give some expanded welfare support. With the exception of stimulus to “green” energy projects[See Solyndra again], there appears to be very little direct stimulus to the private sector.

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