Say's Law
or the Law of Markets

Essay by
William H. Stoddard


July 2010

General overproduction is impossible in a market economy

John Maynard Keynes helped make Say's Law better known by singling it out in The General Theory of Employment, Interest, and Money as the assumption of classical economics whose rejection was central to his theories. But even three-quarters of a century after Keynes, it's hard to find a good exposition of the substantive content of Say's Law. Keynes himself didn't help, as W. H. Hutt remarked in A Rehabilitation of Say's Law, by summing it up as "supply creates its own demand". The supply of apples doesn't create the demand for apples; if it were that simple, no product or service would ever go unsold, no business would fail, and everyone would be rich. Anyone who wants to understand what Jean-Baptiste Say (1767–1832) was actually asserting needs to start from a more precise statement of his law. And pursuing such fuller understanding may result in concluding that Keynes underestimated the worth of Say's ideas.

Say's Law, or the Law of Markets, says that general overproduction is impossible in a market economy. That is, we cannot have a situation where everything people produce is going unsold because people can't or won't pay for all the output. Like natural laws in general, that is, it tells us that certain things are impossible.

The disaster of overproduction?

To give a fictional example, a classic example of the often satiric "social science fiction" of the 1950s, Frederik Pohl's "The Midas Plague", portrays a future where economic output and industrial productivity are so high that it's a strain for people to consume it all. But if people don't consume, the products will go unsold, and the economy will collapse! So people have a legal duty to consume mass quantities of everything; and because society still has rich and poor, the poor are required to consume more, living in huge mansions while their social superiors live in modest bungalows. Pohl's story starts with a poor but ambitious man married to a woman from a rich family, and examines the strains within their marriage.

Wild fantasy, like the premise of a Gilbert and Sullivan operetta? Perhaps. But many people have taken such concerns seriously. Karl Marx, for example, thought that the release of the productive forces under capitalism would yield so great an output that the starvation wages of the working class could not possibly pay for it all, leading to a general economic crisis and a socialist revolution. Popular economic writers such as Silvio Gesell and C. H. Douglas had the same concern, but believed that the cure was an ongoing expansion of the money supply to pay for the increased supply of goods and services — an idea picked up by the science fiction writer Robert A. Heinlein in his early novel Beyond This Horizon (1942). Keynes himself offers sympathetic comments on all three sets of theories, which most of his contemporaries rejected as obviously delusional.

The Law of Markets asserts that Pohl's nightmare can never happen. We may have too much of some products; but we won't have enough of others. We can always deal with unsold surpluses by shifting capital and labor to other sorts of production.

A simple barter economy

How is this point established? Let's start with a really simple example: A market based on barter involving only two goods. A fishing village catches fish; a farming village grows potatoes. By trading back and forth, both villages get a more varied diet.

Now, suppose that in a given year, the catch of fish is spectacular. The fishermen take their catch to market and come home with bags of potatoes and barrels of unsold fish. That is, they've caught more fish than the market can absorb. But that means that some of the fish don't swap for potatoes. If there were more potatoes, those fish wouldn't have to go unsold. There must be underproduction of potatoes in that year. With only two commodities, if one exceeds what the market will bear, the other falls short of it.

The next step is a trick called mathematical induction. Suppose that we know that for any given number of goods, some are overproduced and some underproduced. Now we introduce the producers of an added good into the market. What happens? The good trades for other goods that are already on the market. Suppose these are goods that were previously going unsold (that is, were overproduced). If the amount of the new good is small, there's not enough of it to use up all the unsold goods, which remain overproduced — but then the new good must be underproduced. As it gets larger, it may reach a point where it trades for all the remaining unsold goods; if so, the market is free of both overproduction and underproduction. A still larger point may exceed the quantity of unsold surplus goods, so that some of the new good is left over, which means that it's overproduced — but the other goods, the former surplus goods, have fallen short of the amount needed to trade for it, so they're now underproduced.

The new good might instead trade for goods that used to trade for something else — for underproduced goods. If it does, then it takes some of them away from the things they used to trade for. An increased amount of those things goes unsold — their overproduction gets worse — but that's because the underproduction of the goods they used to trade for has also gotten worse, now that they're being traded both for the old goods and for the new good.

This shows that if general overproduction is possible for a market with N goods, it's impossible for a market with N+1 goods. We can apply this as often as we need to. If there is any number of goods for which general overproduction is impossible, it's impossible for every larger number too. But we know that general overproduction is impossible for two goods. So in any possible market (if there aren't at least two goods, there's not a market), general overproduction is impossible. That's the Law of Markets!

Money is not itself an economic good

An argument sometimes put forth claims that the problems don't arise exactly from a violation of the Law of Markets, but from a process that has a similar effect. In a barter economy, this argument says, Say would be absolutely right. But economies of any complexity can't get by on barter alone. Rather, they develop a form of money. Instead of a particular good exchanging for another particular good, it's simply sold for money to anyone who wants it, and then some of the money buys the other particular good. This makes the process of exchange much more efficient, quite apart from the various other useful qualities of money. But, it's claimed, this opens up the prospect of a situation where money has been underproduced, and all other goods have been overproduced. And functionally, this has nearly the same effect as general overproduction of all goods: there are stocks of goods going unsold, and people being thrown out of work because there's no need to produce more. This is what Douglas, for example, argued, and the future economy of Beyond This Horizon is carefully designed to avoid the problem.

Say himself dismissed this possibility by arguing that the reason people want money is to use it to buy goods or hire services, so no one will take money out of circulation long enough to bring commerce and industry to a halt. Many Keynesians think that Say was being overoptimistic, and have proposed mechanisms by which a shortage of money could arise.

But there's a more basic point to be made about this claim: That it's strange, and perhaps perverse, to think of money as a good. In a monetary economy, what actually happens is that there is a steady flow of goods from producers toward consumers, and a steady counterflow of money. The use of money is to buy goods and services, but no one is using money to buy money.

David Hume made the point that money is not a good in any normal sense, by pointing out that if the quantity of money in a country were doubled, with no other alteration in its economy, people overall would be no better off. The people who first got the money would be able to spend it on more goods. But this would drive up the price of those goods, and the price of the materials and labor that went into them, and the laborers and the suppliers of material would themselves buy new goods, and drive up their prices ... and in the end, prices and wages would generally have doubled. The people who were contractually tied to payment at the old rates would be hurt, as would the people who didn't get the new money until late; other people would be richer — but there would not be any general increase in wealth.

We can recognize in this the root idea of The Wealth of Nations, by Hume's longstanding friend Adam Smith: the rejection of mercantilism, which supposes that a country gets rich by piling up gold and silver, for the belief that increased production means increased wealth. The Physiocrats, before Adam Smith, took steps toward developing their idea, though their narrow identification of "production" with agriculture led to confusion. But in this light, Say appears to be part of the great movement for the rejection of mercantilist doctrines.

If increasing the quantity of money in a country does not increase its wealth, then decreasing it should not decrease its wealth, unless the decrease is so drastic as to make monetary exchange as such impossible. (And in real history, the breakdown of monetary exchange seems to result from increases in the money supply at least as often as from decreases!) If for some reason less money is in circulation, the smaller amount is just as able to perform the functions of money as the larger. It's meaningful to talk about underproduction of wheat, or electricity, or stuffed animals, but not about underproduction of money.

This can be seen, further, in terms of the informational function of money and prices. To say that stuffed animals have been underproduced, or that there are not enough of them to meet the demand, is the same as saying that more resources — more labor, raw materials, and plants and equipment — need to be directed to the stuffed animal industry. But in what meaningful sense could one speak of directing more resources to the money industry, or of expending more resources in creating money? The reason that inflation has occurred so often over the past two and a half centuries is precisely that it takes a negligible amount of resources to produce a piece of paper money, it takes no more to produce one of larger denomination (and it may take less — the quality of banknotes from the German hyperinflation is not impressive), and it takes even less to make an entry on an electronic ledger.

Wealth by economic means, or by political means

Ever since Frederic Bastiat, libertarians have distinguished between "the economic means" of gaining wealth, which is working to produce things that other people want, and "the political means", which is taking what other people have by force, or threatening them with harm to make them surrender it. Say's Law is all about the economic means; it tells us that the cure for overproduction of some good or service is to increase the output of some other, underproduced good or service, so that there will be enough of it to exchange for the overproduced one. But to fully understand Say's Law, we must recognize the existence of a third means of gaining wealth: the monetary means, or a quantitative increase in the medium of exchange. This is different from both the other two, and the differences are important.

The economic means naturally increases the quantity of wealth, and makes society better off. People will not voluntarily spend money on buying a product unless it has more value to them than the money — that is, than the other things the money might buy. The millionaire, or billionaire, who got rich by voluntary exchange necessarily gave other people things of even more value than his wealth, however great it is. The pursuit of wealth through the economic means is the ongoing effort to direct productive resources into activities that benefit other people as much as possible.

The political means rests on threatening other people with harm great enough so that giving up their money, and the things it could buy, is a lesser evil. Doing this means spending resources on ways of making other people worse off. It creates, not positive value, but negative value. The magnitude of wealth gained in this way is a measure of the magnitude of the negative value the rich person has created, and of the resources they have wasted in doing so. And the more that a society's laws allow and encourage exchanges based on negative value, the more they attract resources away from production to waste.

The monetary means: creating zero value

The monetary means represents a third option: the creation of zero value. An increase in the quantity of money neither adds to human well-being overall, nor subtracts from it. It simply moves wealth around from some people to other people. The resources consumed by people who rely on the monetary means are wasted, but they are passively wasted, rather than being spent on actively inflicting or threatening injury. The harm that results is indirect: On one hand, a transfer of goods and services away from people who have engaged in productive activity, or their beneficiaries, by a kind of invisible taxation; on the other hand, an erosion of the capital structure that makes production possible in the long run, to encourage more spending in the short run — which seems to be what Keynes means by "investment".

More precisely, the monetary means can be purely the creation of zero value. There's a small element of positive value in the production of commodity money — that is, of gold and silver — if only because they have nonmonetary uses. And there's an element of negative value in the issue of money backed by legal tender laws, which forbid people to refuse to accept monetary payment. The importance of this element, though, is somewhat exaggerated. On one hand, legal tender laws can become ineffective when a monetary system is badly abused; on the other, the value of money is partly determined by international markets in which legal tender laws have no effect — it isn't American legal tender laws that have kept the Chinese willing to hold dollars. These small elements of positive and negative value can affect the long-term evolution of a form of money; but the immediate effects of money creation can be understood by viewing it as creating zero value.

And these three categories together explain what's wrong with another Keynesian notion: The need to increase aggregate demand. In Keynes's view, aggregate demand exists whenever anyone offers money for anything. In Say's perspective, that's not true. Demand is created by supply: The fisherman creates demand for wheat by catching fish. Offering to buy things with money earned in production increases aggregate wealth and aggregate demand; but money acquired through theft, plunder, or taxation represents a decrease in aggregate wealth and aggregate demand. And offers based on created money represent no change in aggregate wealth; they amount to paying with the illusion of wealth, the same illusion that Adam Smith and David Hume tried to dispel.


 © 2010 William H. Stoddard

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