Current Crisis And Say’s Law

bsnicon1In light of the current Keynesian-style government fiscal stimulus measures introduced to try to tackle the economic slowdown, the series looking at economic theories within the context of the present situation examines the work of Jean-Baptiste Say and classical economic theories.

Say’s Law, one of the core tenets of classical macroeconomics, states that “aggregate supply creates its own aggregate demand”. Classical economics emphasises the equilibrium between supply and demand as key for a balanced economy and suggests that recession and unemployment are caused by a mismatch between supply and demand rather than, for Keynesians, a lack of consumption.

Say (1767-1832) was a French economist who advocated saving rather than spending and a focus on production instead of consumption. In fact, he believed that  consumption destroyed wealth and only production could create it. Say’s Law makes supply a precondition for demand because, in order to buy something, he believed that you must first sell something.

This is crucial for economic growth, because the desire to generate purchasing power motivates productive effort and invention. It also has major implications for how governments respond to downturns and periods of high unemployment. While Keynes wrote that aggregate demand and the use of fiscal spending is the key to economic recovery, classical economists believe that spending capital on Consumption without saving and investing it in production could mean slower potential future growth.
Say believed that production, not consumption, is the primary challenge for an economy and that increasing production is only possible by increasing capital
(saving) and then investing it, ie putting it to productive use. Significantly, he proposed that the amount of available capital is depleted by consumption.

This was emphasised by John Stewart Mill, when he wrote:

“…to consume less than is produced, is saving; and that is the process by which capital is increased.”

For classical economists, earned income is not just spent or hoarded, as Keynes suggested, but instead it is either consumed or invested. Money employed in consumption is necessary to sustain quality of life and for pleasure but does not generate economic growth.

In contrast, invested money increases productive capacity, thereby boosting the wealth available for future consumption and investment. This point is
crucial – while both consumption and investment can create or sustain employment, only saving, which leads to investment, reaps future benefits.

According to this theory, economic growth occurs when consumers are employed in productive activity. However, when unemployed consumers spend money received from the government without producing anything, the stock of capital is reduced and, therefore, high levels of unemployment can cause economic slowdown or contraction. Even in an economy with low unemployment, high consumer spending is primarily an effect rather than a cause of economic wellbeing.

This contradicts the current government policy proposals that concentrate on spending rather than saving as a tool to help in the economic slowdown.
The notions that it is easier to spend revenue than to increase it and that increasing production might not be as easy as boosting consumption, do not appear to be taken into consideration by current policies. Therefore, if you believe Say’s hypothesis, economic recovery will be despite the proposed massive deficit spending of some governments rather than because of it.

Perhaps even more importantly, using capital for consumption without growing it through saving and investing it in production could result in slower potential future growth.

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