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I was intrigued by the review that Philipp Bagus wrote of The Errors of Keynes (Los Errores de la Vieja Economía), a book written in Spanish by Juan Ramón Rallo, part of which deals with Say’s Law.

An important understanding is taking hold, that the road to unwind Keynesian economics travels through Say’s Law. Keynes himself could not have been clearer about the significance of Say’s Law to the entire structure of his argument. Keynes emphasized, over and over again, in The General Theory (TGT) that he was reversing the conclusions of those who believed Say’s Law to be true. Thus, there are two things that need to be done if you are going to refute Keynes. First, you have to know what Say’s Law is. Then you have to show it is valid.

There is a huge problem that must be overcome in order to make any headway in refuting Keynes and revitalizing Say’s Law. All economists are brought up on Keynesian demand side theory and, unless corrected, it infuses every aspect of their thought. Even while recognizing that it is the structure of demand that is key, they still hang onto the level of demand as an integral part of how they approach economic problems.

Classical economists have explained Say’s Law by arguing that “a general glut is impossible”; there can never be a deficiency of demand. This is axiomatic, you must know it in your bones if you are to understand the Classical theory of the trade cycle. Hoarding never causes a recession. Too much saving is never the problem. An economy never suffers from demand deficiency. After a recession begins people become tentative because of a lack of confidence, this is a common view everywhere on the Classical side of the Keynes-Classical divide, but that was not the point being made by Keynes. He was trying to prove that demand deficiency was, of itself, the nature of the recessionary problem and that public spending was the necessary answer to bring recessions to an end.

With this in mind, let me take you to the reviewer’s discussion of Say’s Law.

Let’s have a look of some of Rallo’s arguments, beginning with Keynes’s famous critique of Say’s Law. Keynes’s distorted version of Say’s Law in TGT states that supply creates its own demand. Rallo vindicates Say’s Law in its original version: In the long run, the supply of a good adjusts to its demand. Ultimately, goods are offered to buy other goods (money included). One produces in order to demand, which implies that a general overproduction is impossible [in the long run]. Say’s Laws leads us straight forward to the most innovative argument in Rallo’s book that addresses the old argument against hoarding. Even harsh critics of Keynes, for example from the monetarist or neoclassical camp, admit that Keynes was at least right in that hoarding is a destabilizing and dangerous activity. Rallo, however, proves and emphasizes the social function of hoarding. To demand money is not to demand nothing from the market. Hoarding is the natural response of savers and consumers to a structure of production that does not adjust to their needs. It is a signal of protest to entrepreneurs: “Please offer different consumer and capital goods! Change the structure of production, since the composition of offered goods is not appropriate.” [Emphasis and additional text mine]

Rallo thus attempts to controvert Keynes by confirming everything he wrote. People really do hoard, Rallo argues, and store money rather than spend. There really is a deficiency of demand in the short-to-medium term that may finally work itself out in the long run, in three-to-five years perhaps. Overproduction is impossible, but only “ultimately,” and in the meantime it can occur. Involuntary unemployment does apparently occur because of some problem on the demand side of the economy due to hoarding. However, rather than this deficiency of demand being a bad thing, it’s a good thing, since the hoarding allows business to think about what to do next. But if you are Keynesian such as Krugman, it also licenses the government to come to the rescue with a stimulus package that will short-circuit this delay. Here is the example from the review to show how hoarding can work:

In a situation of great uncertainty, it is even prudent to hoard and not immobilize funds for the long run. Rallo provides us a visual example. Let’s assume that uncertainty increases because people expect an earthquake. They start to hoard, i.e., they increase their cash balance, which gives them more flexibility. This is completely rational and beneficial from the point of view of market participants. The alternative is to immobilize funds through government spending. The public production of skyscrapers is not only against the will of the more prudent people; it will also prove disastrous if the earthquake is realized.

A government should not build skyscrapers when everyone expects an earthquake! Does one need economic theory to make such an argument? But if the economy has gone quiet and there are useful things a government can do—perhaps reinforcing existing buildings against future earthquake damage—why wouldn’t that make sense within the terms of this argument? It’s a metaphor that doesn’t hold up, it doesn’t explain why Keynes is wrong, and it would certainly never convince a Keynesian.

Let me get to the problem expressed in this paragraph in the review:

As Rallo points out in contrast to TGT, it is not aggregate supply or aggregate demand that is important, but their composition. If, in a depression with a distorted structure of production, in a liquidity trap situation, aggregate demand is boosted by government spending, the existing structure cannot produce the goods that consumers want most urgently. The solution is not more spending and more debts, but debt reduction and the liquidation of malinvestments to make new and sustainable investments feasible. [Emphasis mine]

I absolutely agree with him that the solution is to leave recovery to the private sector as they find their way toward profitable outcomes. But to use “aggregate demand” in the same sentence as “structure of production” must leave the argument confused. Even more certainly, to include mention of “a liquidity trap” will bar entry to the world of Classical economics. Demand is constituted by supply; according to Say’s Law, supply is demand. Aggregate demand and aggregate supply are not two separate entities. There is no such thing as an independent force that can be described as aggregate demand.

If you want to get to the essence of Say’s Law you must never think in terms of aggregate demand and aggregate supply. Just drop it from all conceptual discussions of the economy and I think, although I can’t be sure, you will find yourself necessarily thinking about issues in the same way as the Classical economists. As I have argued in my Say’s Law and the Keynesian Revolution (Elgar 1998), if you want to defeat Keynesian economics, you need to wage war on the very notion of aggregate demand. Nothing else will do.