In the February issue of Quadrant, Steven Kates laments the resurrection of Keynes, and warns his readers not to fall for the doctrines of a man who denied one of the key laws of economics. According to Kates, Say’s Law
is a proposition that since 1936 every economist has been explicitly taught to reject as the most certain obstacle to clear thinking and sound policy. Economists have thus been taught to ignore the one principle most necessary for understanding the causes of recessions and their cures. Worse still, they have been taught to apply the very measures to remedy downturns that are most likely, from the classical perspective, to push them into an even steeper downward spiral.
Anyone who takes the trouble to follow up Footnote 3 will find Kates’s thesis unravelling immediately:
3. It might be hard for non-economists to appreciate just how deeply felt the rejection of Says Law is. Such attitudes are, however, not universal. Schumpeter, in full knowledge of what Keynes had written, was himself still able to write Says Law is obviously true. It is neither trivial nor unimportant. ( 1986: 617)
‘Deeply felt’ apparently refers to the economist’s sense of despair that such a hard won insight as Say’s Law was jettisoned at the instigation of this wrongheaded Cambridge demagogue. Schumpeter is presented as a bastion of sanity and a beacon of hope that truth will prevail.
However, it turns out that Schumpeter’s first sentence, when rendered completely, is actually ‘As stated, Say’s Law is obviously true.’ Like every other serious scholar of economic thought — that is, the ones who don’t have an axe to grind — Schumpeter recognises that Say’s Law covers a cluster of distinct but interrelated propositions which the early classical economists, including Say, Malthus, Ricardo and James Mill, tended to muddle, one with the other, in the most excruciating fashion. This particular section of his History of Economic Analysis is devoted to unpicking the tangle and isolating the proposition that constituted a genuine insight — that is, both true and non-trivial.
Next Schumpeter considers Keynes. And guess what? It turns out that ‘Keynes, of course, never meant to contradict the proposition that has been called Say’s Law above. (p.623)’ So what is Kates playing at?
Say’s Law of Markets emerged out of the debate on free trade, when the enlightened voices pointed out that Country A can’t expect to sell its exports to B and C unless it’s prepared to import their goods as well. Each country’s exports give it the wherewithal to import goods of equivalent value from other countries. Say noticed that the principle applies to domestic trade as well: as long as producers intend to spend the proceeds from the sale of their products — and why wouldn’t they? — their combined output constitutes a fund adequate to purchase that same output.
This was always a point worth making, and was at the time a useful corrective to the popular wisdom that a nation should be wary of producing too much in the aggregate, just as an individual enterprise or industry may overestimate its market and produce too much of a particular good. The most lucid exposition of the argument, discussed at some length in Kates’s own book, comes from JS Mill, who couldn’t have made it clearer that was refuting arguments by Lauderdale and Sismondi (and Malthus on a bad day) that a country could simply produce too many goods, necessitating government measures to restrain the over-production. He pointed out that demand could never be insufficient, neither in the sense that purchasing power is insufficient to pay for the goods (covering the costs of production), nor in the sense that the public’s desire to acquire commodities in general would be satiated. There could be a mismatch between the particular good’s supply and demand, but that was all. It didn’t matter if sellers deferred their consumption, because they would use their saving to expand their capital; to the classical economists this meant employing more workers, who would do their spending for them.
Both Schumpeter and Kates quote parts of this passage from Mill’s Principles:
I have already described the state of the markets for commodities which accompanies what is termed a commercial crisis. At such times there is really an excess of all commodities above the money demand: in other words, there is an under-supply of money. From the sudden annihilation of a great mass of credit, every one dislikes to part with ready money, and many are anxious to procure it at any sacrifice. Almost everybody therefore is a seller, and there are scarcely any buyers; so that there may really be, though only while the crisis lasts, an extreme depression of general prices, from what may be indiscriminately called a glut of commodities or a dearth of money. But it is a great error to suppose, with Sismondi, that a commercial crisis is the effect of a general excess of production. It is simply the consequence of an excess of speculative purchases. It is not a gradual advent of low prices, but a sudden recoil from prices extravagantly high: its immediate cause is a contraction of credit, and the remedy is, not a diminution of supply, but the restoration of confidence.
The problem for the Keynes-as-vandal thesis is that there’s not a word here that Keynes would have disagreed with. But unfortunately he often wrote as if the classical economists had maintained something far more extreme, namely that recession and unemployment were a logical impossibilities, and in doing so he created unnecessary confusion.
Such an interpretation was definitely not justified, as Kates himself documents at length in his book Say’s Law and the Keynesian Revolution. But instead of concluding, like Schumpeter, Blaug, Sowell and every other authoritative scholar to have considered the issue, that Keynes caricatured the classical theory and exaggerated the disagreements in order to enhance his own credentials as a theoretical revolutionary, Kates is bent on beating up the difference. He wants to turn the tables on Keynes, casting him as the real captive of logical error.
Kates tries to achieve this by means of two pieces of subterfuge, deployed at every step of his argument. The first is to use the terms ‘demand deficiency’ and ‘over-production’ interchangeably. More precisely, every time he presents this or that author’s rebuttal of the former — that is, of the Lauderdale-Sismondi over-production theory sketched above — he summarises by saying that the author has demonstrated that demand deficiency — and by implication Keynes’ theory — is a logical impossibility. Now, there might be some contexts in which the two terms refer to the same thing, but this is not one of them: the simple fact of the matter is that Keynes did not subscribe to the over-production fallacy that Say and Mill usefully refuted, any more than he believed in the physiocratic theory of value or the mercantilist analysis of trade.
The second ploy involves some peculiar word play about causality. Although the classics agreed with Keynes that recessions occur, and that they occur because households and firms delay their purchases, Kates assures us every few pages that there is a key difference. Keynes attributed the slack spending to a failure of demand, by which Kates means ‘demand having suddenly evaporated for no good reason’, as he puts it in the Quadrant piece. By contrast, the classics (knowing that demand failure, aka overproduction, is logically impossible), attributed it to other causes, like a shortage of credit, the collapse of an asset bubble, or a crisis of confidence in the face of uncertainty over energy prices.
Do those other causes sound a million miles from what Keynes was talking about? Did Keynes claim that a failure of demand was some kind of spontaneous psychological event that couldn’t in turn be attributed to other events further up the chain of causation? Would the classics have denied that unemployed workers cut back on their spending? Would they have objected to calling this a lack of demand? No, no, no and no. But, having shown us that the classics acknowledged there was not enough spending, Kates will not rest until he has shown that Keynes’ deficient demand concept was something altogether different.
Even when confronted with the awkward fact that AC Pigou (Keynes’ favorite ‘classic’) recommended public works expenditure as a means to dampen ‘industrial fluctuations’ (the title of his book) by ‘transfer[ring] demand from good times to bad’, Kates insists that ‘Pigou seems to understand demand in a Say’s Law sense’. He opts for this kind of contortion every time his thesis is starkly contradicted by the evidence.
Kates’s book was praised for its scholarship, and it covers a huge number of writers, but there’s scarcely any analysis at all. In fact one gets the feeling that the impressive parade of authors serves as a distraction from analytical issues. Say’s Law is a straightforward proposition, is the message: either you get it or you don’t, and the purpose of Kates’ long survey is to sort the goats from the sheep.
One can acknowledge that a given supply of goods to the market entails both the willingness and ability to pay for it. The question is when that ability will be exercised. That’s the point of the concept of effective demand, but Kates barely discusses the meaning of the term.
The main difference between Keynes and the others was that he went a step further in investigating the consequences of the drop in demand, highlighting in particular that when firms cut production in response, this will cause a further decline in spending. (If anything Kates should be happy with these induced falls in demand, because they are actually induced by reductions in supply!) The truly original part of Keynes’ contribution was to identify a level of activity that generates just enough effective demand to sustain itself, and to characterise this a kind of equilibrium. It’s not an equilibrium in the Walrasian sense that everyone is happy at the prevailing prices: there is still involuntary unemployment after all. But the unemployed workers find it impossible to signal the future demand for commodities that would justify firms in hiring them — a catch 22 that deserves the term equilibrium even if it isn’t one in the usual sense of the term.
In fact the bulk of the disputes between Keynes and the classical economists (starting from Mill) boil down to empirical questions concerning the ability of the system to right itself without government intervention, and in particular: whether a general price adjustment can by itself reignite spending; and whether investment is primarily constrained by credit (undoubtedly the case in Mill’s day) or by expectations of future sales (more important in Keynes’s). But none of these are disagreements about fundamental economic logic.
Nonetheless, we are confronted with this wearying phenomenon of the self-styled classical economist, often these days wearing an ‘Austrian’ badge, claiming either that Keynes was a duffer who couldn’t grasp Say’s Law in the first place — which is a bit like accusing Rutherford of failing to comprehend the plumb pudding model of the atom — or that he was a prankster who beguiled whole generations of economists into accepting a patently absurd doctrine.
The narrow purpose of this campaign is easy enough to see. It lays down a foundation that makes it easier dismiss Keynesian economics with ridicule rather than engaging with the arguments. It provides the army of ‘Austrian’ autodidacts with another useful talking point, to add to the one about how Keynes didn’t understand that saving is necessary for capital formation, and the one about how Keynes thought governments could generate any amount of growth just by spending more.
The broader purpose of the demonisation of Keynesian macroeconomics is no harder to fathom. It forms part of long-term program to discredit government involvement in the economy, which includes protesting against any increase in either tax or government spending, irrespective of the macroeconomic contingencies of the day. At the same time, it’s just further evidence that common sense nostrums are heroically resilient, whether we’re talking about the Ptolemaic solar system against Copernicus, the design argument against Darwin or the Treasury View against Keynes.