by Jerry O’Driscoll
A friend with Keynesian leanings recently remarked that “it’s all about Say’s Law.” He was referring to the contemporary debates over macroeconomic policy. He was correct, but few economists on any side of the debates understand that is the issue, or why it is important.
Say’s Law was anticipated by Adam Smith in the Wealth of Nations when he said: “What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too.” It was a long-run proposition, in line with the focus of classical economists on economic growth.
In Classical Economics Reconsidered, Thomas Sowell describes Say’s Law as “a cluster of related propositions contributed and refined by a number of individuals.” Sowell lists six major propositions of which three were never seriously in dispute. The final one was the center of the controversy: there can be no general glut of goods.
The classicals all agreed there can be disequilibrium: over-supply and under-supply of goods in individual markets. In Sowell’s words: “The fundamental disagreement was over the the classical denial of an equilibrium aggregate output.”
Fast forward to the Hayek/Keynes debates of the 1930s. In the first round, the debate concerned Keynes’ Treatise on Money and Hayek’s criticism of it. Keynes and Hayek agreed on the big issue: the quantity theorists of the day were misguided in juxtaposing aggregate monetary demand against the aggregate supply of goods. Demand and output must be disaggregated. Both men remained broadly in the classical tradition. Hayek criticized Keynes’ theoretical framework, and Hayek may fairly be said to have won the first round of the debate.
The General Theory, and the controversies surrounding it, marked the second round of he debate. Now Keynes presented his ideas in terms of aggregate demand and supply. There could be a general glut of goods because of an aggregate-demand failure. Keynes adopted the position of the dissenters from classical orthodoxy (though he completely misconstrued Say’s Law).
Keynes’ victory was more polemical than substantive. In the General Theory, he adopted the position of the quantity theory that he had rejected in the Treatise on Money: aggregating monetary demand. On policy, his rejection of Say’s Law had an embarrassingly large number of predecessors going back at least to Sismondi (who actually understood Say’s Law). Hayek withdrew from the battlefield to fight other wars, and the profession was largely won over to the new mode of thinking. Hayek never accepted the concept of aggregate demand and, in that sense, remained a classical economist.
Much of the current debate is really over Smith’s original formulation: does savings add to or subtract from aggregate demand? Smith said savings is its own source of demand, while Keynes postulated that an increase in savings equated to an increase in the demand for money (liquidity preference).
It is all about Say’s Law. In my next post, I will address the current controversies and link them to the debate over Say’s Law.