October 14, 2007
I had an interesting question about Say’s Law, so I thought I’d bring that up. I talk about Say’s Law fairly extensively in my book, in Chapter 6. Today, however, we will try to condense the idea behind Say’s Law into the usual 1000 words or so. Often things are easier to understand in 1000 words than in 10,000.
I’ve never really seen Say’s Law put effectively into a few words, so I will “summarize” it thus: Say’s Law is the idea that economic rise and fall is the result of changes in production, not “demand.” This gets back to an idea which is very basic, but which most contemporary economists have no clue about. Economics is the study of how people make a living. An economy is fundamentally a system of production. Probably any mainstream economist will recognize that increasing wealth, by which we mean an increasing ability to consume (higher wages), is the result of increasing productivity. Someone has to make the stuff, right? However, our economic statistics today are largely measures of shopping. GDP, for example, is really a measure of shopping. It measures how much shopping the consumers did, how much shopping the corporations did, and how much shopping the government did. Thus, there is a strong tendency, among economists, that when there is a dip or decline in GDP, then the problem must be that someone wasn’t doing enough shopping.
This “lack of demand” is a real phenomenon, but Say’s Law indicates that the most common cause of a “lack of demand” is some sort of impairment in the productive system. When the productive system is impaired, then the effects are experienced as a “lack of shopping.” (Also, when the productive system is working well, it is experienced as “plenty of shopping.”) When I say “productive system,” most people think of a factory of some sort, and an “impairment in the productive system” is like a broken machine or something like that. This is almost never the case in a recession, except perhaps in wartime. Typically there is a factory that is capable of making 1000 widgets a day, but instead of selling 1000 widgets they are only able to sell 400 or so (at a profit at least).
We have to expand our idea of “impairment of the productive system” well beyond the mechanical metaphors. (Economics is full of mechanical metaphors today, although economies themselves are increasingly service-oriented.) We can recognize today that our vastly increased productivity is the result of organization, specialization, and trade. Only a hundred years ago, many Americans were farmers. Their economy was mostly within the household itself. They grew their own food to eat, and often built their own houses. They maintained their own transportation (horses). Once a week or so, they might go to the town and sell a little bit of their produce, and buy some hand tools or something of the sort, which they could not make themselves. Today this kind of self-sufficiency is very uncommon. Typically, we do very little for ourselves, but devote virtually all our labor and effort to some specialized job in trade for money. With this money we buy virtually everything we need and want for living. Thus, while the old-time farmer might have been 80% self-contained, we are probably about 20% self-contained today. Instead, we participate in huge networks of cooperation, doing work for others so that others may do work for us.
So, I would say that today’s “productive system” is one in which, instead of self-sufficiency, there is vast cooperation. Instead of building your own house, you hire a homebuilder, who has contractors and subcontractors, who has bank debt, bondholders and equity investors, who hires advertisers and salespeople, who sources materials from all over the globe, and so forth.
This system of cooperation is most easily impaired by high taxes and instability of money. We can take some extreme examples to illustrate what I mean. The homebuilder might be perfectly capable of building your house, in a physical sense. However, if the corporate tax is 100%, then no house will be built, because there is no profit in it. Corporations might then operate illegally to avoid the taxman. (Actually, corporations might then be capitalized via debt, as debt is tax-free today.) If the income tax was 100%, but the corporate tax was 0%, then the homebuilder would be anxious to build houses, but nobody would work for the homebuilder (legally), because they wouldn’t get paid. Also, the homebuilder would have no customers, because nobody would have any income to pay for the house. In an environment of high inflation, but reasonably low taxes, then you could pay for the house, but nobody would lend you the money to buy one, because they wouldn’t know if the money they got paid back in would be worth anything. Mortgage finance is a fairly new thing in Latin America and Eastern Europe, which have had many episodes of currency collapse and inflation. It has become more common only in the last five years or so. People there have traditionally built their houses out of current savings, adding a door here and a window there from month to month. (There is something to be said for this.) In a deflation, the “lack of demand” is caused by monetary distortion, and persists until prices have adjusted accordingly.
That’s Say’s Law in a nutshell: an economy is a system of productive cooperation; impairment of this system of productive cooperation results in economic decline; the most common cause of serious impairment of this productive system of cooperation is high taxes and monetary instability. From that we lead directly to the Magic Formula: