Jean-Baptiste Say's Law of Markets: A Fundamental Conceptual Integration
by Edward W. Younkins

John-Baptiste Say (1767-1832) is one of the most important and insightful thinkers in the history of economic science. Say was a major proponent of Adam Smith’s self-directing economic system of competition, natural liberty, and limited government. He frequently praised the Scotsman’s work, publicized it, and described his own work as mainly an elaboration of Smith’s The Wealth of Nations. In fact, however, the economic doctrines and analysis of this “French Adam Smith” went further than, and departed from, Smith’s ideas on some important points. For example, he stated that Smith’s The Wealth of Nations was without a method; was obtuse, unclear, and unconnected; and included far too many digressions and divergences.

An Overview

Say understood that natural law underpins economic behavior making it orderly, predictable, and universal. He stressed reason’s role in economic analysis, wealth creation, and the earning of profit. Viewing economics as a discipline capable of attaining universal truths, his economic method was that of an essentialist and a realist.

He disliked ivory tower theory but was also skeptical of blind empiricism and the accumulation of mathematical and statistical facts without relating them to theory. Say emphasized the observation of the facts of reality at the same time he dismissed rationalism. To do this he derived economic laws by induction. He believed that economics should begin with the reason and experience of the human person rather than with abstract mathematics and statistical analyses. After laws and theories were formulated, he believed in then testing them with observations and facts. Say presented his economic ideas using precise and simple language that was easily understood.

Say’s farsighted analysis made him a precursor of the Austrian school of thought. He connected with the Austrians with respect to methodology, his emphasis on the importance of entrepreneurship, monetary theory, and value theory.

Say, the first professor of political economy in France, introduced free-market economics to Europe in general and to France in particular. This great hero in the history of economic thought presented the true laws of political economy in his 1803 masterpiece, A Treatise on Political Economy.

Say invented the term “entrepreneur” and emphasized the vital and creative roles of the entrepreneur in the economy as forecaster, project appraiser, and risk taker. He saw that effective entrepreneurs must possess the moral qualities of judgment and perseverance, and also have a knowledge of the world. Say realized that wealth is essentially and originally metaphysical and the result of creativity, ideas, imagination, and innovation. He thereby placed the role of the entrepreneur at the hub of economic theory. Say understood that economic advancement requires entrepreneurs and the accumulation of capital.

Rejecting the labor theory of value that was held by Adam Smith and other classical economists, Say states that the basis for value is utility—the capability of a good or service to meet some human desire. He maintained a subjective utility theory of value rather than a labor theory of value. Say understood that it was the way and the extent to which potential customers value a good or service that determine its value and whether or not it is produced. He recognized that the prices of goods and services reflect their utility to the buyer and that prices of factors of production are imputed from the prices of the goods produced. He differentiated between use value and exchange value, but like Aristotle wrongly concluded that all exchange transactions must involve the exchange of equal values. Say thus fell short of the economic thought of the Austrians, like Carl Menger, who recognized the necessity of positive-sum transactions through which both the buyer and the seller gain utility. In addition, Say came close to discerning, but fell a bit short of discovering, marginal utility theory.

Historical Context

Let’s take a look at the historical context in which Say wrote. The prevailing doctrine at this time was mercantilism which held that money (particularly gold and silver) creates wealth and stimulates economic growth. Mercantilists were worried that there are limits to growth, concerned about the likelihood of business cycles, and believed that at certain points there will not be sufficient purchasing power. They claimed that business slumps would occur when producers produced too much and that there would be waiting periods during which demand would catch up. This idea of excess supply is known as the “glut of commodities” doctrine. To remedy the existence of an excess supply of commodities some economists proposed the stimulation of extra demand through money creation. This proposed solutions was known as “consumptionism.” The idea was that the goods are already here so that production must not be the problem. Instead, they saw the production of consumption as the problem. This led to the proposal that the government and the banking system should artificially activate the extra needed demand by bringing new credit and new money into existence. This pronouncement was termed “credit creationism.” Worried about the scarcity of money during economic crises, economists saw the solution as “to find more money and spend it.” They mistakenly thought that spending and consumption is the engine of economic growth.

Say attacked the scarcity of money doctrine at the turn of the 18th century by taking on the “glut of commodities” hypothesis and the “credit creationists.” He contended that it is not money that creates demand but rather is the production of goods and services. According to Say, money is merely a medium or mechanism of exchange and the real cause of economic depression is the scarcity of other products and services. It follows that when the economy starts to recover it is because production has gone up, followed by consumption. Production leads to more consumption rather than the other way around. In order for consumers to exist, there must first be producers.

Say’s Law of Markets

J.B. Say, the original supply-sider, seeing that production is the source or cause of consumption, placed supply over demand in the hierarchy of economics. A person’s ability to demand goods and services from others proceeds from the income produced by his own acts of production. His level of production determines his ability to demand. Demanding products requires having money which, in turn, requires a prior act of supply. The production of goods causes income to be paid to those who produce. In other words, a person sells his labor services or assets for money which he then uses to demand products. In the end, when exchanges have been effected, it will be found that a person has paid for goods and services with other goods and services. The demand for any commodity is a function of the supply of other commodities. The need to offer a good to demand another good is obvious in a barter economy but also applies in a money or indirect exchange economy.

Wealth is created by production and not by consumption. Consumption actually uses up utility or wealth. Demand (i.e., consumption ) follows from the production of wealth. People demand from the wealth their production created. What a person demands is predicated upon what he supplies. Say thus recognized that all men are both producers and consumers and that if a person wants to obtain a good he must provide something in return that is desirable to another. Money is the necessary means to acquire the goods that one desires. However, in order to procure money, a person must first produce a good or service that will exchange for money. No one can legitimately demand something before first supplying a product or service of value to others.

Say’s Law of Markets, a key component of the classical school of economics, describes the process through which supplies in general are translated into demands in general. For Say, the balance between aggregate supply and aggregate demand is an ex ante identity. From this perspective, supply equals demand only because of, and to the amount of, people’s demand for other goods. Demand is supply seen from another angle. Because supply is demand there cannot be an excess of supply over demand. The demand for products can be said to be rooted in the production of products.

Say never did write the phrase “supply creates its own demand.” That phrase can be attributed to John Maynard Keynes who misunderstood and misinterpreted Say’s Law of Markets. Keynes thought that Say meant that the supply of a particular good is the demand for that good. What Say stated was that the supply of a good constitutes demand for everything that is not that good. Aggregate supply thus creates its own aggregate demand. Within the context of a free market system, the supply of each producer makes up his demand for the supplies of other producers. Therefore, in the aggregate, demand always equals supply and the general overproduction of goods is meaningless and impossible. There is a direct interconnection in the economy between the acts of producers (i.e., suppliers) and the presence of any aggregate equivalent demand for these products and services by the same producers who provided them.

According to Say, it was possible to have a surplus or a shortage of any specific commodity. Production can be misdirected and too much of some products can be produced for which there is insufficient demand. He said that gluts of production did not occur through general overproduction, but instead through overproduction of certain goods in proportion to others which were underproduced. Say thus admits that there can be short-term gluts of a particular commodity. The market, left to its own devices, permits such imbalances to be corrected through adjustments of prices and costs. Any disequilibrium in the economy exists only because the internal proportions of output differ from the proportions preferred by consumers not because production is excessive in the aggregate. It follows that Say’s Law in no way implies that all products will ultimately be demanded in the market. The supply of a good does not guarantee it will be an effective demand by the producer of that good for other goods. If inventory does not sell, prices will be cut until, and if, it does. It follows that lower prices of some goods means that people have more money to spend on other goods and services. Through the price system supply and demand adjust and markets clear if the market system is left free to perform the balancing and proportioning functions. It is through the change of prices that today’s supplies are rationed among today’s demanders. Prices bring about proper proportions and price signals communicate information for future allocation and supply decisions.

Say understood human nature and the fact that people tend to be rational but are not omniscient. It follows that overproduction of particular commodities by individuals firms and producers is possible when mistakes have been made. The glut of a specific commodity can arise from its production in excessive abundance outrunning the total demand for it or from the short fall in the production of other commodities. A glut can only take place temporarily when too many means of production are applied to one type of product and not enough to others. This type of disequilibrium is normally quickly remedied in a free market economy as market incentives and rational self-interest lead to adjustments in production, prices, marketing strategies, and so on. People have a rational self-interest in correcting their errors.

What about savings? People do not spend all of the wealth that their production created. The demand for current goods and services fails to match the value of what has been produced as people choose to hold some of it in monetary form. According to Say, savings is beneficial and better than consumption because it is used in the production of capital goods or in additional production. Contrariwise, consumption does not provide a stimulus to wealth. When production exceeds consumption, the difference is savings which goes toward the production of investment goods and investment is the basis for future growth. Such a reinvestment process is fueled by entrepreneurs. If money is stored in the form of bank-created money such as checking accounts, the held-back consumption power will be transferred to borrowers from the bank that created it. In other words, the power to consume is shifted to the borrower. There will be no deficiency in aggregate demand as long as the banking system is free to carry out the process of transforming depositors’ savings into borrowers’ spending. As long as savings are reinvested in productive uses in the aggregate there need be no decreases in income, production, or consumption. Say argued that savings searching for profits goes quickly into investments for production.

Higher rates of savings bring about higher rates of subsequent growth in aggregate output. This takes place because someone else borrows the money that will produce an even greater number of goods. It follows that people need incentives for working, saving, investing, and risk-taking. Say’s insight was that incomes are always totally spent on commodities satisfying current wants (i.e., consumption) or on commodities satisfying future wants (i.e., savings accumulation) and that savings are essential if the economy is to grow. Demand thus comes from supply whenever you demand it. People save in order to expand their production or to live on their savings when and as they need them. Savings buy time for people to do more than just work. It could be said that consumption is the final cause of production and that saving is the efficient cause of production. Say taught that income not devoted to consumption will be spent on investment and that the market would automatically and fairly rapidly return toward equilibrium.

Say contended that money is a neutral mechanism through which aggregate supply is transformed into aggregate demand. He viewed money as an intermediate good or conduit that enables people to buy. Like Menger, Say described the spontaneous evolution of a commodity to become money. He favored commodity money and free banking. In Say’s system, money serves chiefly as a medium of exchange and was not explicitly identified as a store of wealth. Say denounces state manipulation of money through debasement of the value of currency. He observes that such manipulation of monetary values confuses the pricing system. He viewed inflation as a monetary phenomenon rather than the result of excessive employment and economic growth.

Say viewed interest rates as the price of credit. He understood that market-determined interest rates perform the function of a market clearing price for money. However, he did not explicitly recognize or discuss the relationship between interest rates and time preferences as did the later Austrian thinkers.

Say on Government Interference

According to Say, the cause of, or reason for, an excess supply of goods is an excess demand for money of which there is shortage. In turn, an excess demand for, or general shortage of goods can only come about if there is an excess supply of the commodity that goods trade against, which is money. It follows that both a deficiency and an overabundance of money undermine the process of converting the savings of depositors into the spending of borrowers. If a general glut of products were to exist it would not be the cause of recession but rather than effect of a recession caused by conditions (e.g., the actions of central bankers) which have caused gross misallocations of productive resources, unemployment, and the accumulation of inventory. Consumers would thus have less purchasing power due to the reduced demand for those goods until inventories are used up and misallocated resources become redirected.

Say is highly critical of taxation and loans to the government because they reduce the wealth to be exchanged in the private sector. He says that taxation injures production because it thwarts the accumulation of productive capital and that loans to the government remove productive capital from society only to be carelessly spent by government. The reduced capital available means that fewer goods will be exchanged and a subsequent decline in wealth. Say thus viewed taxation as slavery and condemned government spending. He also noted that as the size of government increases, the range of efforts to redistribute wealth expands.

Seeing taxation as confiscatory and involuntary, Say understood the coercive nature of taxation and that taxation is the enemy of economic affluence. Taxation decreases the capital available in an economy by redirecting private investment to expenditures by the state. He saw that taxation not only destroys capital, it also inhibits the functioning of a free market and lowers citizens’ standards of living. Noting that taxation and its related expenditures do more harm than good, Say states that the proper tax is the lowest possible tax.

According to Say, the goal of good government is to stimulate production while the goal of bad government is to foster consumption. He observes that an economy that stresses demand over supply is on the road to relative decline and stagnation. He also maintains that if business cycles occur then they are due to government intervention that impedes market forces and market clearing. Production and freedom are the concerns of good government. Say’s discourse on government intervention provides a clear demonstration of the ineffectiveness of fiscal policy as a wealth creator.

Keynes Denies But Does Not Refute Say’s Law

John Maynard Keynes (1883-1946) thought that Say and the other classical economists were saying that market economies will never create general gluts or shortages and that every increase in production constitutes its own demand. According to the classicals, this would be true only if goods and services are assigned without misallocation among all types of produce in the proportion which private interests dictate. In that situation only, the income generated by sales would be sufficient to purchase the quantity of goods available to be bought. Keynes mischaracterized Say’s Law of Markets as “supply creates its own demand” and said that the law states that there is no obstacle to full employment and that full employment is the rule. Observing that full employment does not exist, Keynes concluded that Say’s Law does not hold. Keynes misunderstood and/or misrepresented Say’s views by claiming that they denied the possibility of depressions and unemployment. Keynes had singled out Say making him the antithetical background for his own views on how markets behave and the role that the government should play in the economy.

Keynes, the underconsumptionist, unlike Say, thought that production and consumption are disconnected activities. In addition, in the Keynesian system, saving and investment are not two perspectives of the same phenomenon. Instead, he saw them as two separate, unequal, and often discoordinated activities. For Keynes, the decision to save is not automatically coordinated with the amount of investment needed and desired by businessmen. He says that whether or not entrepreneurs and businessmen invest depends upon a number of subjective and irrational psychological factors instead of simply depending on the availability of savings at a low interest rate. According to Keynes, too much savings in the economy is the cause of the unemployment of resources. He contended that the Saysian system was only true in the special case of when savings equals investment. He says that, because this is rarely the case, economists need a general theory to explain unemployment. Keynes believed that the breakdown of Say’s Law came about because of a lack of aggregate demand which results from the disequilibrium of planned savings and planned investment. For Keynes, savings can be too high or too low. Either way, he considers savings to be dangerous, self-defeating, and the source of the problem. According to Keynes, savings is a destructive “leakage” from the economy. In the end, after a series of convoluted discourses, Keynes concludes that (1) when savings are less than investment, government action is necessary to stimulate investment and (2) when savings are greater than investment, government action is needed to encourage consumption expenditures. In both cases, it is up to the government to step in.

Keynes’ solution to unemployment is an increase in government spending. His theory thus shifts from the classical economists’ concern with production to a concern with consumption. He said that when supply outstrips demand some goods will not be sold and, as a result, production and employment will be cut back. His proposed solution is to increase consumption through government spending. Keynes says that general overproduction is the problem and the men are unemployed because they have produced too much. His proposed solution is to stimulate consumption and beat down production. He says that “aggregate demand” can be too low relative to “aggregate supply” and that government spending is needed to fill the gap left by private-sector demand to ensure full employment. For Keynes, spendthrifts, rather than savers, are virtuous. He holds that both consumer spending and government spending are the means to economic growth. His spending theory has enjoyed great popularity with statists who equate government spending with economic stimulus.

Keynes’ solution for stimulating the economy is to have the government spend money thus bridging the gap between savings and investment. He advocates government schemes to pump up consumption such as printing and spending new money (which debases the currency and results in inflation), deficit spending, public works projects, higher taxes on producers, and the punitive graduated income tax which puts more money in the hands of the poor who are said to spend a greater portion of their income.

Keynes maintains that sometimes people want to hoard money instead of saving it. When this money is withheld from investment the result in unemployment which, in turn, causes overproduction. Unemployed people are not able to buy the previous output of products and depression results. According to Keynes, there will be an absence of savings during a depression as people withdraw money to survive. He goes on to say that (1) without savings there will be no investment; (2) without investment there will be no employment; (3) without employment there will be no spending; and (4) without spending there will be unsold goods.

Keynes explains that savings can overshoot the demand for investment in capital equipment resulting in excess savings and the withdrawal of funds from circulation and from the necessary sufficient demand for goods. Drawing money away from the purchase of finished commodities makes them less profitable at the very same time that firms are seeking to set up additional capital resources to produce finished commodities. Keynes maintains that a deficiency of purchasing power is inevitable resulting in an increased supply of, and a diminished demand for, products. As a result, profitable production cannot be continued and crises and depression begin. Keynes’ solution for preventing or alleviating depressions is to either reduce the amount of savings or to stimulate consumption through government spending and/or the issuance of new money.

Keynes says that in a free market interest rates fail to perform the function of a market clearing price and that wage rates do not adjust. The result is underconsumption and unemployment in an unregulated economy. As a cure to bolster consumption, he proposed state management of the money market to supplement fiscal policies with respect to taxation and government spending.

Although Keynes was the most significant and substantial critic of Say’s Law, he never really does refute it. Reality cannot be denied. Of course, Keynes’ belief that he had invalidated Say’s Law remains his most enduring legacy—a legacy that has crippled economic theory to this day. Contrary to Keynes, overproduction is not the problem. Rather, the problem is government intervention that penalizes production causing both capital and producers to go on “strike.” For example, the Great Depression was due to government policies including high income taxes, quotas and tariffs, abandonment of the gold standard (i.e., objective money), and various and numerous regulations and controls.

Government efforts to stimulate the economy via direct spending and efforts to stimulate consumer spending are counterproductive. When the government spends an investment it must expropriate money from businesses to do so thus ensuring a misallocation of resources. Government should get out of the way by reducing taxation, spending, regulations, and government control of money and the interest rate.

Say’s Law: A Powerful Economic Truth

Say’s Law, a landmark achievement of integration in economic science, is an essential foundation for a reality-based macroeconomic theory. It reflects the interconnectedness, reality, and harmony of human economic behavior in a free market economy. To produce requires rationality and self-interest. It is irrational and contrary to man’s nature not to produce or to produce less than one needs to produce. Production is both necessary and primary for man’s existence. Say thus recognized the fact that it is production that opens the demand for products. He saw that money is not the cause of prosperity but rather is its effect. This fact is eloquently stated in Ayn Rand’s novel Atlas Shrugged (1957, 387) through her character Francisco d’Anconia who said: “Money is made possible only by the men who produce … When you accept money in payment for your effort, you do so only on the conviction that you will exchange it for the product of the effort of others.” Say’s Law is implicit throughout all of Francisco’s “money speech.”

The full explanatory power of Say’s Law of Markets is that, because of the integration of all individual markets into one functioning system, it has to be the reality that government does not have to be concerned with artificially stimulating demand. There is one harmonious self-correcting system. Markets clear if not interfered with. Such a system leads to stability, justice, peace, and prosperity. It is no wonder that many consider Say’s Law to be the broadest, most powerful, and most fundamental conceptual integration in the discipline of economics.

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