But Say is often credited with a theory that "supply creates its own demand." Say in fact never said this, but it could be implied from his 1803 work A Treatise on Political Economy which is organized into three Books: the Production of Wealth, the Distribution of Wealth and The Consumption of Wealth. Within his writing is the concept that in process of production (creating supply) money is spent on rent, interest, labor and raw materials. It is in the payment of these fees that the concept of "supply creating its own demand" comes into play. The central idea is that in the process of creating goods, the money spent will create a level of demand within the economy. Again, Say never in fact says this directly, but many have inferred it from his writing.
The primary critique of this idea came from Keynes in his work The General Theory of Employment, Interest and Money. In the Introduction to the French edition, Keynes makes the following points:
I believe that economics everywhere up to recent times has been dominated, much more than has been understood, by the doctrines associated with the name of J.-B. Say. It is true that his 'law of markets' has been long abandoned by most economists; but they have not extricated themselves from his basic assumptions and particularly from his fallacy that demand is created by supply. Say was implicitly assuming that the economic system was always operating up to its full capacity, so that a new activity was always in substitution for, and never in addition to, some other activity. Nearly all subsequent economic theory has depended on, in the sense that it has required, this same assumption. Yet a theory so based is clearly incompetent to tackle the problems of unemployment and of the trade cycle. Perhaps I can best express to French readers what I claim for this book by saying that in the theory of production it is a final break-away from the doctrines of J.-B. Say and that in the theory of interest it is a return to the doctrines of Montesquieu.
In Says defense, I don't think he was attempting to talk about the business cycle. Nor was there much mention of overall economic activity and how that would play into Say's overall theories and explanations. Say was really attempting to simply explain what he saw as the macro-level economy and how it functioned -- which was the central theme of most economists writing around Say's time. Put a different way, I believe that the early macro-econoimsts' work reflects the state of the discipline at that time; they had figured out there was this thing called an "economy" and were trying to learn about all it's various pieces. However, I do believe that Keynes was right in the implication many took from Say's overall works, which is that in creating an environment wherein supply is allowed to form and proliferate with as little interference as possible, demand naturally follows.
I mention the above debate to highlight the fact that in our present situation, we're already trying these ideas associated with supply side economics (or trying to increase supply) with no real success.
Corporate and personal taxes as a percent of GDP are already near 60 year lows. The theory of low taxation is that it will put more money in the pockets of consumers and businesses, who will in turn spend it. In addition, a low level of taxation is supposed to encourage the formation of businesses. These have had the desired result.
Non-financial corporate business is already swimming in cash. And
Corporate profits after tax are already near highs. In short, balance sheets have already increased. Finally,
Equipment and software investment (read, business investment) has already rebounded.
In short, supply side (read, Say's policies) are already in place. But Say's law of "supply creates its own demand" isn't working as advertised.
The reason it's not working is that monetary velocity is incredibly low:
The above charts tell us that people are hoarding cash rather than spending it.
Ultimately, what's going on here? The real answer is that in the middle of a debt deflation recovery, people hoard cash. The entire process is explained by Irving Fisher in his paper, "The Debt Deflation Theory of Great Depressions." However, here is the essence of his writing:
(1) Debt liquidation leads to distress setting and to (2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes (3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be (4) A still greater fall in the net worths of business, precipitating bankruptcies and (5) A like fall in profits, which in a " capitalistic," that is, a private-profit society, leads the concerns which are running at a loss to make (6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to (7) Pessimism and loss of confidence, which in turn lead to (8) Hoarding and slowing down still more the velocity of circulation. The above eight changes cause (9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest. Evidently debt and deflation go far toward explaining a great mass of phenomena in a very simple logical way.
Note that the economy is through the worst parts of the above cycle of events. However, now the economy is dealing with a slowing macro level environment from the EU and China, leading to concern and a "freezing" of activity.
The bottom line is that -- as Keynes correctly noted -- the policies outlined by adherents to Says law are ineffective in dealing with a period when employment of resources is below full potential.
John Maynard Keynes (2011-01-20). THE GENERAL THEORY OF EMPLOYMENT, INTEREST AND MONEY (UPDATED w/LINKED TOC) (Kindle Locations 4350-4355). Classics-Unbound. Kindle Edition.
John Maynard Keynes (2011-01-20). THE GENERAL THEORY OF EMPLOYMENT, INTEREST AND MONEY (UPDATED w/LINKED TOC) (Kindle Locations 4337-4350). Classics-Unbound. Kindle Edition.
John Maynard Keynes (2011-01-20). THE GENERAL THEORY OF EMPLOYMENT, INTEREST AND MONEY (UPDATED w/LINKED TOC) (Kindle Locations 4336-4337). Classics-Unbound. Kindle Edition.
John Maynard Keynes (2011-01-20). THE GENERAL THEORY OF EMPLOYMENT, INTEREST AND MONEY (UPDATED w/LINKED TOC) (Kindle Location 341). Classics-Unbound. Kindle Edition.
John Maynard Keynes (2011-01-20). THE GENERAL THEORY OF EMPLOYMENT, INTEREST AND MONEY (UPDATED w/LINKED TOC) (Kindle Locations 334-341). Classics-Unbound. Kindle Edition.
