[Editor’s note: Energy Secretary Rick Perry on Thursday declared “you put the supply out there and the demand will follow.” It appears that Perry was attempting to invoke Say’s Law, and many professional economists and pundits quickly took to mocking both Perry and Say’s Law for making assertions contrary to modern Keynesian orthodoxy. Below, economist Per Bylund explains what Say’s Law really says, and why it’s a good thing.]
Few concepts are as misunderstood as the so-called Say’s Law. In part, this is the fault of John Maynard Keynes, who needed to do away with it to make room for interventionist policy. How do you do away with a “Law” that had been core to economists’ understanding of the market economy for 150 years? You misrepresent it. Strawmen are so much easier to knock over than the real thing.
Hence, the “Law” is presently known, in Keynes’ terms, as “supply creates its own demand,” which is obviously untrue.
Originally, however, the meaning was different. It also had a different name. Economists prior to Keynes tended to refer to it as the Law of Markets, because it describes in very simple terms the fundamentals of how a market functions. Jean Baptiste Say was the one to express the law in the simplest way, which may be why it has come to bear his name.
Say noted 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.”1 This means that “As each of us can only purchase the productions of others with his own productions — as the value we can buy is equal to the value we can produce, the more men can produce, the more they will purchase.”2
In other words, production precedes consumption and anyone’s demand is constituted by supply.
The Law of Markets thus summarizes the nature of market actions where production is specialized under the division of labor. Specifically, that we produce to sell, with the intention to then use the proceeds to buy what we really want. Market production is in other words indirect and not undertaken to directly satisfy one’s own wants. We produce to satisfy other people’s wants, and can thereby satisfy our own by purchasing what others produce.
The benefit is that there is a separation between what I want to consume and what I produce, which means we can each specialize in producing something we are comparatively good at instead of producing only what we want to consume. It also means we can specialize in producing only one thing instead of a multitude, thereby cutting switching costs, develop skills and expertise, and consequently increase outputs.
But while universal specialization under the division of labor means that overall output is significantly increased, it also means we become dependent on each other. Not only do we need to sell what we produce to others in order to get the means necessary, but we need to also trade with those who produce what we want to satisfy our wants. We become interdependent. This is why Mises stated that “Society is division of labor and combination of labor. In his capacity as an acting animal man becomes a social animal.”3
This “social animal” benefits from, engages in, and in fact arises out of market (inter)action. As we can only benefit ourselves by properly aligning our productive efforts with what other people want, we must understand other people. By doing so, we can better anticipate what needs and wants they have and then busy ourselves with attempting to meet those needs. And because production takes time, production must precede demand.
Because demand is unknown, production is necessarily speculative and entrepreneurial. Actual demand will be discovered when the goods are presented to potential buyers. Entrepreneurs are therefore forecasters, project appraisers, and risk-takers; in an advanced economy they advance funds to owners of labor, land, and capital, and only recoup this investment if they succeed in selling the product.
At the same time, the consumers can only buy if they have themselves engaged in production that satisfies other people’s needs — because otherwise they will only have the willingness but not the ability to buy (and that is not demand). This is not a circular argument, but an explanation for economic growth. The ability to sell goods in the market and thus engage in specialized production requires prior investment. So to specialize one needed to first produce demanded goods in excess of one’s own wants. The same is true today: development of a new good requires investment, and that investment is speculative because actual demand cannot be known until it is too late.
The implication is that there can never be a general glut, in the economy and therefore no deficiency in aggregate demand. It is certainly possible for there to exist a surplus or shortage of any particular commodity, which happens regularly as entrepreneurs fail to precisely anticipate and therefore meet market demand, but only in the short term.
As all production is undertaken to sell the goods produced to then purchase goods that better satisfy the producer’s want, the inability to sell becomes an inability to demand. We cannot demand unless we first produce the means to demand. It is thus not a demand deficiency that someone is unable to sell what he or she produces, and as a result cannot demand goods in the market. Rather, it is a production failure that causes a reduction in effective demand — an entrepreneurial failure.
If government stimulates demand, then this only subsidizes those goods that have been produced at too high cost. Consequently, the entrepreneurial errors are propped up and production therefore remains misaligned with demand.
So it is easy to see why proponents of interventionism would want to do away with the Law of Markets. If demand is not constituted by supply, then markets may not clear and government must save us from ourselves.
