Thursday, September 23, 2010

Keynes and Say's Law

Commenter Sebastian raises a point that seems to be one of the few points he raises on here: that Keynes bungled Say's Law and that he doesn't buy into Mill's fourth law.

In The General Theory Keynes wrote this:

"From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product... It is true that it would not be easy to quote comparable passages from Marshall’s later work or from Edgeworth or Professor Pigou. The doctrine is never stated today in this crude form. Nevertheless it still underlies the whole classical theory, which would collapse without it. Contemporary economists, who might hesitate to agree with Mill, do not hesitate to accept conclusions which require Mill’s doctrine as their premise."

He clearly didn't foresee all the hand-wringing this would cause. In retrospect, he probably should have written this:

"From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product... It is true that it would not be easy to quote comparable passages from Marshall’s later work or from Edgeworth or Professor Pigou. The doctrine is never stated today in this crude form. Nevertheless it still underlies the whole classical theory, which would collapse without it. Contemporary economists, who might hesitate to agree with Mill, do not hesitate to accept conclusions which require Mill’s doctrine as their premise."

Then we could focus on the real point: effective demand. What we have with the classics and anyone that could be described as new classics is a failure to grasp this point. I don't care about fiscal policy. Forget about it. I'm talking about understanding the way the economy works. The thing is, even Say and Mill recognized this at certain times. But theorizing the economy is a monumental task and people aren't always consistent when they do it. People slip into pretending that "the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product".

There's been a lot of talk about how scientific economics is and that if it were scientific it wouldn't bounce around so much and there wouldn't be much disagreement. One of the things that encourages me is realizing that a lot of people have recognized this principle of effective demand for centuries. As Peter Boettke says, it all boils down to the debate between Malthus and Say. And the debate extended further before that. So it's not like we have new-fangled ideas popping up all the time. The fundamental work-horse of both sides has been out in the open and argued over for a while. People have essentially been leaning one way or another on this fundamental point that Keynes raises.

The second thing that makes me more positive about how scientific economics is is realizing how artificial a lot of the disagreements are. We act as if the different dynamics and phenomenon we theorize about contradict each other when usually they don't. To borrow a point from Daniel Klein (which makes me cringe a little, I admit) - we have a tendency to think of models as theories when they aren't*. Presumably there are many ways to model a single theory. You can also model lots of important processes without having a full-blown theory attached to it, and these models don't have to conflict on the theoretical level. We often make the mistake of confusing "different models" with "contradictory theories". They're not the same thing.

*In this article, Klein and Romero claim that The Journal of Economic Theory doesn't do economic theory - just economic modeling. Strictly speaking I think they're right, but it's an awfully belabored point when all they're really trying to say is "models aren't the same as theories". If the journal were called The Journal of Theoretical Economics or if one were to say "the economists who publish their models in this journal theorize about the economy", I think both those uses of the root word "theory" are fine. Strictly speaking a model is not a theory, but this largely boils down to quibbling over a journal title that none of the current editors came up with.

6 comments:

  1. I only devote so much time to clearing up misconceptions about Say's Law because, to a Keynesian, it "underlies the whole classical theory, which would collapse without it". This is not so. Say's Law is subject to a large number of qualifications, and in the words of Hutt "all power to demand is derived from production and supply" - but there is no guarantee that this will result in "effective demand". While Say did not have a satisfactory theory of recessions, that they can occur is entirely congruent with the "Law" of Markets.

    If the classicals ever assumed a fully-coordinated and correctly proportioned market, it was subject to a large number of theoretical qualifications that would all have to be met to keep the economy sitting at the maximum production boundary point of the PPF. It is almost pointless to debate such a quaint assertion that the power to demand stems from production, but for the Keynesian insistence that the validity (or lack thereof) of Say's Law belies the ability of the laissez faire economy to reach equilibrium.

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  2. BTW, you might find this of interest, it is an interview with R Garrison, with a question relating to the supposed similarities between Menger and Keynes on the question of money:

    http://www.auburn.edu/~garriro/a1interview.htm

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  3. Sebastian you're still missing the point. Keynes said and I've said that nobody strictly believes Say's Law, however conceived. It's rarely a conscious thing. I have said this at least twice now so please stop repeating that point. But some of the most important departures between the proto-Keynesian/Keynesian and the classical position (I assume this terminology is clear even if it's probably a little haphazard) come up when the classics ACT LIKE all those assumptions hold.

    As Keynes said:
    "It is true that it would not be easy to quote comparable passages from Marshall’s later work or from Edgeworth or Professor Pigou. The doctrine is never stated today in this crude form. Nevertheless it still underlies the whole classical theory, which would collapse without it. Contemporary economists, who might hesitate to agree with Mill, do not hesitate to accept conclusions which require Mill’s doctrine as their premise."

    Nobody is saying they don't recognize the details and the caveats (although certainly some truly don't recognize the details and the caveats) - the point is simply that for the most part, people reject Keynesianism an embrace classicism when they act as if all those assumptions held. I doubt many people consciously do it.

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  4. Thanks - I'll look at that and I really need to read Hutt too.

    Do you have any thoughts on Sowell's book that Hutt references in his preface?

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  5. Thank God. After all this time, that's all I really wanted to hear you say. By the way, it's hardly a sin on the part of the classicals to discuss the theory of a perfectly functioning economy - as Hayek said, "Before we can meaningfully ask what might go wrong, we should first understand how things could ever go right." It's certainly no worse than constructing a "general theory" while assuming an insoluble link between output and homogeneous labour units in addition to a constant real wage.

    I too need to read Hutt. That reference comes from Steven Horwitz's essay on Say's Law - Hutt is also extensively referenced in Horwitz's "Macroeconomics and Microfoundations".

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  6. 1. Waiting for me to say what? I've been saying the same thing over and over :) I think you just want me to vehemently disagree with me.

    2. It's not a sin to theorize a perfectly functioning economy. It's problematic (still not a sin) to act like those conditions hold all the time.

    "It's certainly no worse than constructing a "general theory" while assuming an insoluble link between output and homogeneous labour units in addition to a constant real wage."

    Keynes called this a "first approximation", and before even getting into his employment function he went into all the details that all his detractors always bring up anyway. In other words, people aren't really bringing anything new to the table by critiquing the employment function with the exact same arguments that Keynes himself critiqued it with!

    I've said in the past (not sure if you've seen these posts), that that output-employment link is the most fruitful one for economists to look into now (not that they haven't been looking into it for decades), and it's one I'm interested in looking into more closely personally.

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