Economists Debate: Keynes v. Say

BY Paul Solman  August 28, 2012 at 10:05 AM EST

Paul Solman frequently answers questions from the NewsHour audience on business and economic news on his Making Sen$e page. Here is Tuesday’s query:

Name: Peter Eggenberger

Question: Most of the disagreements between Keynesians and anti-Keynesians about current economic problems seem to imply disagreements about whether or how quickly markets clear. Conservatives seem to believe in Say’s law of markets. I think you should do a program on Say’s law and its credibility.

Making Sense

Paul Solman: You’re right, Peter, I probably should. But until then, how about an answer here?

Say’s Law, named after a famous French economist, Jean Baptiste Say, is often laid down as “supply creates its own demand.” This is a foreshortening — some would say oversimplification or misstatement — of what Say meant. What Say actually wrote, in 1803:

“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. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands…But the only way of getting rid of money is in the purchase of some product or other. Thus the mere circumstance of creation of one product immediately opens a vent for other products.”

(See the Library of Economics and Liberty for the context.)


Public domain image of the portrait of Jean-Baptiste Say via Wikimedia Commons.

The most immediate problem with what Say says above, say Say nay-sayers, is the word “immediately.” Yes, it should generally be the case that if you create more of some good or service than you need, you will sell it — eventually — which in turn will necessitate someone else to create more of a good or service in order to get enough money to buy it. But the process doesn’t necessarily happen right away, as English economist John Maynard Keynes insisted more than a century after Say. Just look at the Great Depression, Keynes said. The first problem was that people created lots of products they were unable to sell in the short run. The second problem: when they did manage to sell some, they didn’t “get rid of the money” but stashed much it away in banks or even mattresses.

Nay, say Say yay-sayers. Even if you stash money in the bank, these anti-Keynesians argue, it will simply get loaned out again — recirculated, just as Jean Baptiste said it would. Keynesians disagree, of course, and today point to the more-than $1.5 trillion dollars on deposit at the Federal Reserve Bank right at the moment, not being loaned out at all.

But whatever you think of Keynes’ economic solutions to Depressions, his analysis of lag time is hard to refute. For awhile at least, if no one wants to borrow money, not even at low interest rates, the money can get stuck in the bank. Businesses only borrow and invest in the future if they have confidence in future buyers, Keynes thought. Or, as he unforgettably put it, their “decisions to take positive action, the full consequences of which will be spread out over many days to come, are the result of animal spirits — a spontaneous urge to action rather than inaction, not the weighted average of quantitative benefits multiplied by quantitative probabilities” [that product is today called "expected value].

“If the animal spirits are dimmed, and the spontaneous optimism falters,” Keynes concluded, businesses stop investing and producing, thus laying off consumers who stop buying, “and enterprise fades and dies.”

And that is the main theoretical problem with Say’s Law: that in terms of fear and paralysis, it won’t hold sway quickly enough.

There is another problem as well. Say thought that gluts could not exist, or at least not for long, because businesses respond quickly to what consumers really want. But suppose lots of people begin to produce things that, in the long run, nobody wants at all? Imagine an economy convinced that jetpacks, say, are the vehicles of the future. The little Bond-like back turbines soon begin selling like hotcakes and soon, millions upon millions are made, millions and millions of people employed by the jetpack industry. Then, five years years from the advent of the industry, let’s say, it is discovered that sustained jetpack use causes incurable vertigo (or lung damage or terminal scoliosis some other far-fetched condition). Production freezes. Jetpack debts cannot be repaid. Millions are laid off. If it sounds like a boom-and-bust cycle — maybe even the housing boom/bust that so many countries went through in the Aughts — it ought to. Such things have happened before. They have even happened recently, as with housing.

Conservative economists blame government interference for the booms — and thus the busts too. In the current environment, they blame the Fed for keeping interest rates too low, encouraging the housing boom, for example. A follower of Keynes would more nearly blame human nature — those “animal spirits” — and try to moderate them before they fly too high or sink too low. And some say that’s where the economic debate lies today: Say’s Law versus the law of human nature.

As usual, look for a second post early this afternoon. But please don’t blame us if events or technology make that impossible. Meanwhile, let it be known that this entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions