Say What, Production Opens a Demand for Products?

“I shall suggest that, fairly interpreted, Say’s law of markets survives as the most fundamental economic law in all economic theory.” – William H. Hutt [1]

 

More than two centuries ago, a tremendously important economic principle was brought to prominence. This principle today goes by the name Say’s Law, or Say’s Law of Markets. It is named after the writings of Jean-Babtiste Say especially in his second edition of A Treatise on Political Economy published in 1814 (first edition published in 1803). [2] In the chapter that developed the concept of what would later be known as Say’s Law, [3] Say set out to refute the assertion that if it weren’t for a lack of demand, production would always be abundant. This is what Say writes in the opening paragraph of the chapter,

It is common to hear adventurers in the different channels of industry assert, that their difficulty lies not in the production, but in the disposal of commodities; that products would always be abundant, if there were but a ready demand, or market for them. When the demand for their commodities is slow, difficult, and productive of little advantage, they pronounce money to be scarce; the grand object of their desire is, a consumption brisk enough to quicken sales and keep up prices. But ask them what peculiar causes and circumstances facilitate the demand for their products, and you will soon perceive that most of them have extremely vague notions of these matters; that their observation of facts is imperfect, and their explanation still more so; that they treat doubtful points as matter of certainty, often pray for what is directly opposite to their interests, and importunately solicit from authority a protection of the most mischievous tendency.

A few pages later, he writes what later became adopted as the foundation of Say’s Law, [4]

It is worth while to remark, that 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” and “…the mere circumstance of the creation of one product immediately opens a vent for other products. [5]

The popular, and frequently misinterpreted, definition of Say’s Law, [6] allegedly coined by Keynes, [7] is that supply creates its own demand. Say himself however never made that statement, [8] a statement which appears to imply that anything produced will be sold: [9]

In its crude and colloquial form, Say’s Law is frequently understood as supply creates its own demand, as if the simple act of supplying some good or service on the market was sufficient to call forth demand for that product. It is certainly true that producers can undertake expenses, such as advertising, to persuade people to purchase a good they have already chosen to supply, but that is not the same thing as saying that an act of supply necessarily creates demand for the good in question. This understanding of the law is obviously nonsensical as numerous business and product failures can attest to. If Say’s Law were true in this colloquial sense, then we could all get very rich just by producing whatever we wanted.

Say hence never implied that supply necessarily equals demand. Keynes, on the other hand, appears to have assumed that supply always equals demand when he wrote: “Thus Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output…” [10] Such an assumption infer that there could never be a glut of any commodity or product. Perhaps Keynes never understood Say’s Law as, again, Say himself never assumed supply would necessarily always be equal to demand (and that there hence indeed could be a glut of certain goods) when he wrote: [11]

…how does it happen, that there is at times so great a glut of commodities in the market, and so much difficulty in finding a vent for them? Why cannot one of these super-abundant commodities be exchanged for another? I answer that the glut of a particular commodity arises from its having outrun the total demand for it in one or two ways; either because it has been produced in excessive abundance, or because the production of other commodities has fallen short.

Due to the confusion easily fostered, intended or not, by the short-hand definition of Say’s law that supply creates its own demand, a more accurate and informative definition or descpription would be that it is production which opens a demand for products, [12] or there can be no demand without supply [13] or, alternatively, that all power to demand is derived from production and supply. [14] Horwitz explains more of what Say actually did say,

If we want to get a more accurate understanding of Say’s Law, perhaps we should consult what Say himself had to say about his supposed law. In the passage where he gets at the insight behind the notion that supply creates its own demand, Say writes: “it is production which opens a demand for products. Thus the mere circumstance of the creation of one product immediately opens a vent for other products.” Put another way, Say was making the claim that production is the source of demand. One’s ability to demand goods and services from others derives from the income produced by one’s own acts of production. Wealth is created by production not by consumption. My ability to demand food, clothing, and shelter derives from the productivity of my labor or my nonlabor assets. The higher (lower) that productivity, the higher (lower) is my power to demand.

Horwitz concludes the section by explaining,

…Say’s Law has nothing to do with an equilibrium between aggregate supply and aggregate demand, but rather it describes the process by which supplies in general are turned into demands in general. It is always the level of production which determines the ability to demand.

A key lesson from Say’s Law is that production (supply) comes first and that consumption (demand) follows, or is derived from, production. As it’s not really money we demand, but instead the goods and services we can buy with money, and as the only way we can attain money is through exchanging goods and services for money, it is ultimately production that is the source of demand. In Say’s own words: “Money performs but a momentary function in this double exchange; and when the transaction is finally closed, it will always be found, that one kind of commodity has been exchanged for another.” [15] Unequivocally, if we want to consume more, we first need to produce more.

In its simplest form, Say’s Law is an economic tautology: [16] “one cannot consume without first producing, and what one produces becomes a basis for determining what one consumes.” One needs to have something available for consumption in order to consume; and having something to consume means that it first needs to be produced. If nothing is produced then there will be nothing to consume is the common sense message.

Before the time when money became the medium of exchange, people had to produce some other good or service in order to have something to offer in an exchange. If you did not produce something others wanted you would have nothing to offer in an exchange, making you unable to demand anything. This principle is however no different under indirect exchange (where money is used) as one still needs to produce something, or sell previously acquired assets, in order to acquire money for then to acquire the goods wanted. In a money economy, consumers must first buy money with their production for then to sell their money in exchange for the goods and services they demand. Of course, savings are a source of demand, but they will eventually be depleted unless they are replenished through production. Borrowings unbacked by savings (i.e. credit and money expansion) are also a source of demand, but they would eventually have to be repaid with future production as consumption without production is unsustainable.

The fallacy of those denying Say’s law lies in failing to recognise that demand can only ever increase in a sustainable fashion through increased production; that is, they fail to recognise that demand is only limited by production [18] and instead blame production gluts in certain industries on a deficiency of demand and a scarcity of money. It’s almost as they treat demand as an independent entity that at times stands in the way of some producers being able to sell all their produce. This view is the victim of an important economic fallacy; that one somehow can transition from production to consumption-led growth. [19] One of Say’s contributions was to demonstrate by applying economic logic that “…consumption and production are interrelated, as opposed to being two separate and independent activities…” [20]

In conclusion, Say’s Law underscores the importance of production as the driver of demand. Production increases economic wealth while consumption decreases it, something Say explicitly recognised when he wrote: [21]

…if the nation be in thriving condition, the gross national re-production exceeds the gross consumption.

Economic growth, which leads to increased wealth, is therefore created through the act of producing more than is consumed and employing the difference in investments that increase production still further. For there to be something to consume, something first has to be produced. The only way therefore to increase consumer demand in a sustainable fashion and without reducing wealth and depleting savings, is to first increase production before increasing consumption. Production therefore precedes consumption. It is production that drives consumption and not the other way around. It really is that straight forward and represents no “chicken or egg paradox” to economics whatsoever. Additionally, Say explains that encouraging consumption is of no benefit to commerce, firstly because demand in general is “brisk” relative to production, and secondly because the difficulty lies in supply (producing the means for consumption) and not in actually stimulating demand (consumption). [22] Any economic policy aiming to improve citizens’ living standards must therefore stimulate production, not consumption; Say explains: [23]

Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption.

Broadly speaking, a most important lesson from Say’s law is that it highlights the superior importance of production over consumption; if you produce (supply), consumption (demand) will follow. Grasping this has always been important. But it’s acutely important today as the surge in “spend ourselves to richest” economic policies implemented especially during the last decade, supposedly meant to revive economic growth, are having disastrous, but predictable, effects for many, if not most, developed nations. It’s almost as Say was writing about today’s economic situation in the U.S. and most countries in the EU when he in the passage below described an economy in decline: [24]

In a community, city, province, or nation, that produces abundantly, and adds every moment to the sum of its products, almost all the branches of commerce, manufacture, and generally of industry, yield handsome profits, because the demand is great, and because there is always a large quantity of products in the market, ready to bid for new productive services. And, vice versa, wherever, by reason of the blunders of the nation or its government, production is stationary, or does not keep pace with consumption, the demand gradually declines, the value of the product is less than the charges of its production; no productive exertion is properly rewarded; profits and wages decrease; the employment of capital becomes less advantageous and more hazardous; it is consumed piecemeal, not through extravagance, but through necessity, and because the sources of profit are dried up. The labouring classes experience a want of work; families before in tolerable circumstances, are more cramped and confined; and those before in difficulties are left altogether destitute. Depopulation, misery, and returning barbarism, occupy the place of abundance and happiness.

Explicitly recognised by Say’s law is that there can be no such thing as a general “overproduction” as, at the end of the day, products are bought with products; “It is because the production of some commodities has declined, that other commodities are superabundant.” [25] Say is pointing out that there can be too many goods produced of a particular kind, but that there can never be too many goods produced of all kinds. Writes Hazlitt: “In sum, Say’s Law was merely the denial of the possibility of a general overproduction of all goods and services” [26] This insight, that too much production in some areas are accompanied by too little production in other areas, is essential in understanding economic imbalances and with it the business cycle. As Anderson writes (quoting Thomas Sowell): “Disequilibrium in the economy can exist only because the internal proportions of output differ from consumer’s preferred mix – not because output is excessive in the aggregate.” [27] Say submitted that such a disequilibrium does not arrive by natural means and can only truly come about through “some violent means” : [28]

…there must needs be some violent means, or some extraordinary cause, a political or natural convulsion, or the avarice or ignorance of authority, to perpetuate this scarcity on the one hand, and consequent glut on the other. No sooner is the cause of this political disease removed, than the means of production feel a natural impulse towards the vacant channels, the replenishment of which restores activity to all the others. One kind of production would seldom outstrip every other, and its products be disproportionately cheapened, were production left entirely free.

In essence, Say is pointing out that overproduction of some goods and underproduction of others is no inherent feature of a free market economy. For demand to equal supply, “…the proportions must be right…there must be equilibrium.” [29] It therefore takes some special effort to not only distort this equilibrium in the first place, but, more importantly and of greater consequence, to also “perpetuate” the disequilibrium. Say suggests in the passage above that interference in the market by politicians or some other authority may bring about such imbalances between supply and demand as reflected in scarcity of some goods and gluts of others.

 

[1] (Hutt, 1974, p. 3).

[2] Allegedly, it was the U.S. economist Fred Manville Taylor who in 1925 first coined the term “Say’s Law” when he wrote: “I shall therefore put the proposition we have discussed in the form of a principle. This principle, I have taken the liberty to designate Say’s Law; because, though recognized by many earlier writers, it was particularly well brought out in the presentation of Say (1803)” (Meng, 2006, p. 296).

[3] (Say, 1971, pp. Chapter XV., Book I).

[4] (Meng, 2006, p. 296).

[5] (Say, 1971, pp. 134-135).

[6] (Anderson W. L., 2009, p. 50).

[7] Hutt writes: Today’s textbooks usually express Say’s law most carelessly, using a description of the law which, I think, Keynes was the first to use. It asserts, they tell their readers (without mentioning Keynes) that “supply creates its own demand” (Hutt, 1974, p. 3). Keynes actually did write those exact words in his General Theory when he explained three assumptions he had made the classical theory (theories developed by the classical economists) depend on. The third of these were: “that supply creates its own demand in the sense that the aggregate demand price is equal to the aggregate supply price for all levels of output and employment” (Keynes, 1935, p. 14). He again made reference to the same statement when he on the next page wrote: “The classical doctrine, on the other hand, which used to be expressed categorically in the statement that “Supply creates its own Demand….”

[8] It was not without reason (Horwitz, 1997) described one of the problems in the social sciences when he wrote the following in an article about Say’s Law: “One of the problems in the world of ideas, particularly in the social sciences, is that the insight behind old ideas can get lost as new ideas crowd the intellectual landscape. Often, the historian of ideas has the thankless task of reminding his colleagues that what they think some long-dead writer said is not, in fact, what he was talking about at all.”

[9] (Anderson W. L., 2009).

[10] Keynes writes (where Z is the aggregate supply price of the output from employing N men, the relationship between Z and N being written Z=f(N) = Aggregate Supply Function, and where D is the proceeds which entrepreneurs expect to receive from the employment of N men, the relationship between D and N being written D=f(N) = Aggregate Demand Function):

The classical doctrine, on the other hand, which used to be expressed categorically in the statement that “Supply creates its own Demand” and continues to underlie all orthodox economic theory, involves a special assumption as to the relationship between these two functions. For “Supply creates its own Demand” must mean that f(N) and f(N) are equal for all values of N, i.e. for all levels of output and employment; and that when there is an increase in Z( = f(N)) corresponding to an increase in N, D( =f(N)) necessarily increases by the same amount as Z. The classical theory assumes, in other words, that the aggregate demand price (or proceeds) always accommodates itself to the aggregate supply price; so that, whatever the value of N may be, the proceeds D assume a value equal to the aggregate supply price Z which corresponds to N.  (Keynes, 1935, p. 15).

[11] (Say, 1971, p. 135).

[12] (Say, 1971, p. 133).

[13] (Say’s Law, Mises Wiki, 2016).

[14] (Hutt, 1974, p. 27).

[15] (Say, 1971, p. 134).

[16] (Anderson W. L., 2009, p. 58).

[18] (Hazlitt, 1959, p. 37).

[19] The roots of this fallacy

[20] (Anderson W. L., 2009, p. 50).

[21] (Say, 1971, p. 139).

[22] (Say, 1971, p. 139).

[23] (Say, 1971, p. 139).

[24] (Say, 1971, p. 140).

[25] (Say, 1971, p. 135).

[26] (Hazlitt, 1959, p. 36).

[27] (Anderson W. L., 2009, p. 49).

[28] (Say, 1971, p. 135).

[29] (Anderson B. M., 1949, p. 390).

Also see: Why Say’s law is always true

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