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February 21, 1998
The Accidental Inventor of Today's Capitalism
In This Article
In Reality, a Model Of Flexibility Adjustments Made by Keynes What if Spenders Don't Spend?
By LOUIS UCHITELLE
e came of age in the French Revolution. In the spirit of the times, he greatly admired Benjamin Franklin and Thomas Jefferson. And when the Bourbons managed to get their throne back in 1814, a discouraged Jean-Baptiste Say almost emigrated to America. He even wrote to Jefferson, asking how much he would have to pay to purchase a working cotton farm near Jefferson's own Virginia spread.
"I specify the neighborhood of Charlottesville," Say wrote from his home in Paris, "because it is neither so close to the seaports to make the land too expensive, nor so distant as to present the rigors of a new settlement."
The Say family -- there were five children -- never came to America. Say considered himself too old, at 47, to go through such a stressful relocation. (Jefferson agreed.) But the economic theory he popularized in a French best seller eventually made the journey. And today a pithy "law of markets" that bears Say's name has become American capitalism's guiding aphorism. It stands as a warning against undue tinkering with markets, even when they are out of whack, as they are now, in Asia, in a particularly Saysian way.
What is arguably the most famous "law" in economics is just five words: "Supply creates its own demand." Build a field and the players will come. Manufacture 10 cars and the buyers will materialize. That is how markets work. Just leave them alone, let them be free, and demand will automatically meet supply at a robust level.
The people who make the 10 cars, or supply the metal and parts that go into the cars, earn from their efforts the income to then buy the cars.
Say certainly believed this. So did most of the other great thinkers in the early days of the Industrial Revolution, before recessions and slumps had been recognized as the downside of capitalism or had entered very much into anyone's thinking. In the opening sentence of "The Wealth of Nations," Adam Smith, the father of free market capitalism, laid down virtually the same "law" as Say -- although taking 48 words to make the point.
Say, who died in 1832 at age 65, is one of the stranger figures in economic history.
He never actually wrote "supply creates its own demand." His best seller, the "Treatise on Political Economy," published in 1803 -- seven years after Smith's great work -- is full of the concept, but not the famous five words.
"I do not see how the products of a nation in general can ever be too abundant, for each such product (through payment of wages, profits, etc.) provides the means for purchasing another," Say wrote. "The mass of products composes the mass of a nation's wealth, and wealth is no more inconvenient to nations than it is to private persons."
A century after the Frenchman's death, John Maynard Keynes attributed Say's law to Say, and made him famous. It was the Great Depression of the 1930's, and free market concepts were ripe for attack. Supply certainly was not creating its own demand. There was supply, but no buyers. And Keynes singled out Say, making him the foil for his own view of how markets work and the role government should play in keeping markets on track. Keynes was successful, but in making his case, he may have cut a corner or two, perhaps editing Say to suit his needs.
"Before Keynes, the way I would have heard about Say is not that supply creates its own demand but that overproduction is not possible," Paul Samuelson, the Nobel laureate in economics, said in an interview. He was a graduate student in 1936, the year that Keynes published his most famous work, "The General Theory of Employment, Interest and Money," the book that elevated Jean-Baptiste Say to star villain status.
Mark Blaug, a British economist, agreed. "Say seems to us a tremendously important figure, but it is a case in which Keynes really elevated him," Mr. Blaug said. "What he was was a very good teacher of Adam Smith to French readers. In the 19th century, the French learned their Smith by reading Say. He was mainly a popularizer."
In Reality, a Model Of Flexibility
The irony is that of all the early 19th-century thinkers, Say was perhaps the most flexible. David Ricardo and James Mill were more dogmatic in their adherence to what is now known as Say's law of markets. And when Thomas Malthus objected to that law, Ricardo took him on far more than did Say, who could see two sides of an argument.
"If in a society composed of 10,000 families," Say wrote, "5,000 engaged in making crockery vases, and 5,000 in making shoes, this society would undoubtedly have too many vases and too many shoes, and would lack many things no less favorable to its well being. But it is also evident that this inconvenience would arise not from producing too much, but from not producing exactly what is wanted."
Say thought such distortions could occur, but not for long, not when people lack so much of everything. "I live at this moment in one of the richest regions of France," he wrote. "Yet of 20 houses there are 19 in which, on entering them, I see none but the coarsest food, nothing to serve the well being of families, none of the things that the English call comfortable; not enough beds for all members of the family to lie on, not enough furniture for them to sit at ease at their meals; not enough linen, nor of soap, for proper laundering, etc."
Malthus, the gloomiest thinker of his generation, is a pivotal figure in economic history, a sort of early Keynesian. He is most famous for his prediction that the demand for food would outrun the supply. He also argued that the supply of goods could outrun the demand for them, resulting in unemployment among the suppliers. Say eventually found some merit in Malthus's argument, and that angered Ricardo.
"The aphorism attributed to Say probably evolved over the decades after Say's lifetime," William Baumol, a Princeton economist and historian, said. "There is no one villain. But what is becoming increasingly clear to people who write about the history of ideas is that Keynes overstated what Say thought. Say in some sense is a victim of history."
Whatever the case, Ricardo won the great debate with Malthus. But nearly 200 years later, nothing is resolved. The central issue in economics is still this question: Will supply and demand balance on their own at a high enough level to put everyone to work? Or can the balance come at a much lower level, requiring government to step in with job-creating measures?
The 20th century opened with the Saysians in the great majority. From the early 1930's to the early 1980's, Malthus and Keynes, his spiritual descendant, held sway.
A "mixed economy" became the standard -- part free market, part government intervention. Since then, however, Say's law has reasserted itself.
Ricardo's initial victory is reflected today in deregulation, in the privatization of state enterprises, in the expanding global market and, most recently, in the commentary on the Asian crisis.
The Asian collapse is a result of too much government meddling, modern Saysians argue.
The Korean Government, for example, pushed companies to borrow when they should not have borrowed and to manufacture too many cars, semiconductors, steel products and other things when there was no ready market for them. The markets, left to themselves, would have balanced supply and demand at a healthy level and Asia would not be in crisis today, the Saysians hold.
"If business people persist in producing the wrong things, for whatever reason, then you can have a situation where they cannot sell what they make," said Deirdre N. McCloskey, an economic historian at the University of Iowa.
Still, Keynes made a permanent dent in Saysian thinking. The argument evolved in this fashion:
Supply does create its own demand, as Say maintained, but under limited circumstances. When a farmer comes to market with a basket of eggs, a weaver with a bolt of cloth and a potter with a vase, each is offering his own "income" for sale to the others, in exchange for their incomes. Supply and income are interchangeable, and there cannot be too much supply, because the supply always generates the income to purchase it.
"For professional economists, there is this marvelous appeal of the nicely working model, the clockwork economy in which everything matches everything else," said Robert M. Solow, a Nobel laureate in economics. "If you believe in Say's law, then you can believe that there is no need for public policy, for a government role in the economy. Just stay out of the market's way."
The Saysian model assumes, however, that people accumulate income with the intention of spending it right away, if not on consumer goods, then on investment in a new loom, for instance, or a new factory -- another form of spending, financed through savings. There are other built-in assumptions. Lacking a role of its own, money is mainly a reflection of the value of goods and services. And interest rates adjust to the needs of the marketplace with its automatic matching of supply and demand.
Keynes changed the assumptions. Money, he argued, does have a role, and spending isn't automatic. When people become uncertain, or panicky, they keep their money, their incomes, in their pockets. And investors hold back when they don't anticipate an adequate return on their investments, even if savings are plentiful and interest rates low. Indeed, investment is independent of savings, in Keynes's view, coming first and generating income and savings in its wake.
Supply, in any case, exceeds demand when spenders hold back. Prices can drop to offset this reluctance, and supply and demand can once again move into equilibrium. But if prices get so low that they wipe out profits and fail to cover costs, the new equilibrium will foster layoffs, cost-cutting, bankruptcy and unemployment.
Out of this thinking came a role for government. The Federal Reserve's periodic adjustments of the nation's interest rates are a now standardized meddling in the marketplace with the stated intention of promoting full employment, among other goals. And for all the cutbacks in welfare and other public programs, the Federal Government, not the marketplace, is still entrenched as the provider of unemployment pay for the jobless, numerous subsidies for business, and health insurance for the poor and elderly.
Say would have been surprised. Government had become an obstacle for him. While he welcomed the French Revolution and the new freedom it brought, Napoleon was trouble. The two men differed on taxes and tariffs, both of which Napoleon imposed, and on trade, which Napoleon restricted over Say's objections. When Say's famous "Treatise on Political Economy" appeared, Napoleon suppressed it for a while.
The return of Louis XVIII to the throne, after Napoleon's defeat, seemed to promise more government meddling, and a discouraged Say thought of emigration to America.
"I would rather live in a free country," he wrote to Jefferson, "and can hardly flatter myself that this country will ever become such."
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