Say’s Law and the Keynesian Revolution: How Macroeconomic Theory Lost Its Way by Steven Kates

by | Oct 9, 2019 | Books, Economics

Steven Kates refutes Keynes’s caricature of the classical economists. Ultimately it is always goods that are traded for goods. Say’s Law, properly understood, explains both what causes unemployment and how to solve it..

John Maynard Keynes ended his famous 1936 book, The General Theory of Employment, Interest and Money, by pointing out,

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly believed. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”

The recent proposed solutions to the financial crises in southeast Asia and Russia and to the continuing economic depression in Japan, as well as to the persistent high unemployment rates in many western European economies, have demonstrated the truth of Keynes’s remark, because the “academic scribbler of a few years back” who still dominates the economic policies of governments around the world is none other than John Maynard Keynes himself. Turn to the opinion pages of leading newspapers in the United States and Europe and read the policy proposals of the governments on both sides of the Atlantic, as well as in Japan, and the predominant chorus calls for “demand stimulus” through government spending and “easy money” through interest-rate manipulation. Even the dean of the Chicago school of economics, Milton Friedman, and a leading monetarist, Allen Meltzer, have called for “printing money” to solve the economic woes of Japan.

It is true that reference is frequently made to the need for longer-run “structural reforms” on the supply side of these economies to make them more efficient and competitive. But the usual suggestion is that it is “aggregate demand” that needs to be stimulated in the short run through various government monetary and fiscal policies to get these countries “off the floor” right now. And in this appeal to short-run “demand-management” policies, the voice “in the air” heard by men in authority is that of John Maynard Keynes.

In his book, Say’s Law and the Keynesian Revolution, Steven Kates, chief economist for the Australian Chamber of Commerce and Industry, thoroughly demonstrates that Keynes misrepresented and then criticized the classical economists’ theory of the “law of markets” and their explanation of the causes of economic depressions.

In The General Theory, Keynes said that the classical economists had believed that “supply creates its own demand,” and that therefore unemployment was impossible, since every product offered on the market was guaranteed a buyer. Since periods of depression and widespread unemployment had happened in the past and one was being experienced then in the 1930s, clearly the classical economists had been wrong. “Aggregate demand” could be too low relative to the “aggregate supply” being offered by producers on the market. Government spending needed to fill the gap left by private-sector demand to ensure full employment for all.

Kates refutes Keynes’s caricature of the classical economists. He clearly explains what they really understood as “the law of markets,” why extensive unemployment sometimes occurred, and what they saw as the solution to the problem. Beginning with Jean-Baptiste Say and then refined by James Mill, Robert Torrens, and John Stuart Mill, the law of markets was stated in the following way: Ultimately it is always goods that are traded for goods. If Robinson Crusoe, alone on his island, supplies himself with the berries he picks from the bush, it is because he has a demand for them. If Robinson now wants some commodity that Friday has in his possession, after the latter has moved to the island, he must have some means to pay for it. He must offer some good in exchange to acquire it. He plans to supply just that quantity of commodity “A” that he believes will be sufficient to buy the amount he desires of commodity “B” owned by Friday.

This clearly requires Robinson to correctly estimate what commodity Friday might be willing to take in trade and the price Friday would be willing to pay (the amount of “B” Friday is willing to give) to purchase the quantity of “A” that Robinson wants to sell. Clearly, Robinson will not be able to successfully sell all he wants to offer if he incorrectly guesses that Friday wants “A” at all, or if he wrongly estimates the price Friday is willing to pay for “A.”

In the more complex market economy, people no longer directly barter goods one for the other. Rather, they first sell to consumers the goods they bring to market for money and then use the money they have earned to reenter the market as buyers to purchase what others have for sale. But the fundamental “law of markets” still holds true: each participant in the market must first supply some good to earn the money that enables him to demand other goods. And, again, failure to correctly estimate what goods others will be willing to buy and the prices they might be willing to pay results in unsold supply. If it is labor that is being supplied, the result can be unemployment if the supplier is not offering the labor skills that others are interested in hiring or if he asks more in the form of wages than others think his labor services are worth.

Kates points out that the classical economists emphasized that as long as men have unsatisfied wants, there is always more work and production to be done. Demand, in general, can never too small in comparison with the supply, in general, that is offered on the market. But there can be mismatches between the individual supplies offered on the market relative to the individual demands for particular goods. But in these cases, the problem is not a failure of demand in general but rather a failure to supply the specific goods actually demanded on the market or wrongly pricing them, resulting in some particular supplies’ going unsold.

In contemporary Europe, mass unemployment is caused by wages that are set too high relative to the demand for various labor services and by workplace regulations that make employing more workers too expensive from the employers’ point of view. And in contemporary Japan, the inflationary boom of a few years ago resulted in misdirected investments in excess of actual market demands for various products. But rather than allow markets in Japan to adjust through bankruptcies and capital investment write-offs, as well as changes in the patterns of labor employment, the Japanese government has attempted to keep unprofitable businesses afloat and workers employed in particular lines of production where there is clearly not enough demand, given the wages Japanese labor unions insist upon.

Say’s Law, properly understood, explains both what causes unemployment and how to solve it. But the ghost of Keynes continues to point economic policy in the direction of inflationary demand stimulus in an attempt to bring markets back into balance.

LINK: Say’s Law and the Keynesian Revolution: How Macroeconomic Theory Lost Its Way

Dr. Richard M. Ebeling is the recently appointed BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel. He was formerly professor of Economics at Northwood University, president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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