Captain Haddock
- Location: Marlinspike Hall
- Registered: 8 Oct 2012
- Posts: 8,397
#1
Dunno if anyone else is interested but the Economist is doing a six week summer series on six big ideas
Number 4 is the [U]Natural[/U] Rate of Unemployment which might get a few on here hot under the (clerical?) collar.
Just read the first one which I found interesting never having studied economic theory.
I'll post them on here for anyone that's interested.
Here's
The Theory of the Firm
Enjoy
https://www.economist.com/news/economics-brief/21725542-if-markets-are-so-good-directing-resources-why-do-companies-exist-first-ourReginald Barrington likes this
"The world is still a weird place, despite my efforts to make clear and perfect sense of it".
Dr. Hunter S Thompson
Guest 1881- Registered: 16 Oct 2016
- Posts: 1,071
#2
...perhaps there is some irony in the fact that you need to subscribe to read the article you've posted, oh Captain, my Captain.
Just because you don't take an interest in politics doesn't mean that politics won't take an interest in you. PERICLES.
Ross Miller
- Location: London Road, Dover
- Registered: 17 Sep 2008
- Posts: 3,709
#3
interesting well written piece
"Dream as if you'll live forever. Live as if you'll die today." - James Dean
"Being deeply loved by someone gives you strength,
While loving someone deeply gives you courage" - Laozi
Captain Haddock- Location: Marlinspike Hall
- Registered: 8 Oct 2012
- Posts: 8,397
#4
The Bishop wrote:...perhaps there is some irony in the fact that you need to subscribe to read the article you've posted, oh Captain, my Captain.
Ross and Reg appear to be able to access it?
"The world is still a weird place, despite my efforts to make clear and perfect sense of it".
Dr. Hunter S Thompson
Guest 1881- Registered: 16 Oct 2016
- Posts: 1,071
#5
Captain Haddock wrote:Ross and Reg appear to be able to access it?
You’ve reached your article limit
Sign up to keep reading or subscribe now to get the complete experience.
Subscribe: 12 weeks for £12
From the website.
Just because you don't take an interest in politics doesn't mean that politics won't take an interest in you. PERICLES.
Captain Haddock- Location: Marlinspike Hall
- Registered: 8 Oct 2012
- Posts: 8,397
#6
Just for you your Grace:-
ONE morning, an economist went to buy a shirt. The one he chose was a marvel of global production. It was made in Malaysia using German machines. The cloth was woven from Indian cotton grown from seeds developed in America. The collar lining came from Brazil; the artificial fibre from Portugal. Millions of shirts of every size and colour are sold every day, writes Paul Seabright, the shirt-buying economist, in his 2004 book, “The Company of Strangers”. No authority is in charge. The firms that make up the many links in the chain that supplied his shirt had merely obeyed market prices.
Throwing light on the magic of market co-ordination was a mainstay of the “classical” economics of the late-18th and 19th centuries. Then, in 1937, a paper published by Ronald Coase, a British economist, pointed out a glaring omission. The standard model of economics did not fit with what goes on within companies. When an employee switches from one division to another, for instance, he does not do so in response to higher wages, but because he is ordered to. The question posed by Coase was profound, if awkward for economics: why are some activities directed by market forces and others by firms?
His answer was that firms are a response to the high cost of using markets. It is often cheaper to direct tasks by fiat than to negotiate and enforce separate contracts for every transaction. Such “exchange costs” are low in markets for standardised goods, wrote Coase. A well-defined task can easily be put out to the market, where a contractor is paid a fixed sum for doing it. The firm comes into its own when simple contracts of this kind will not suffice. Instead, an employee agrees to follow varied and changing instructions, up to agreed limits, for a fixed salary.
Coase had first set out his theory while working as a lecturer in Dundee, in 1932, having spent the prior academic year in America, visiting factories and businesses. “The nature of the firm”, his paper, did not appear for another five years, in part because he was reluctant to rush into print. Though widely cited today, it went largely unread at first. But a second paper, “The problem of social cost”, published in 1960, by which time he had moved to America, brought him to prominence. It argued that private bargaining could resolve social problems, such as pollution, as long as property rights are well defined and transaction costs are low (they rarely are). He had been asked to expound his new theory earlier that year to a sceptical audience of University of Chicago economists. By the end of the evening, he had won everyone around. Coase was invited to join the university’s faculty in 1964; and there he remained until his death in 2013 at the age of 102.
In 1991 Coase was awarded the Nobel prize for economics, largely on the strength of these two papers. But as late as 1972, he lamented that “The nature of the firm” had been “much cited and little used”. In a strange way, Coase himself was partly to blame. The idea of transaction costs was such a good catch-all explanation for tricky subjects that it was used to close down further inquiry. In fact, Coase’s paper raised as many difficult questions as it answered. If firms exist to reduce transaction costs, why have market transactions at all? Why not further extend the firm’s boundaries? In short, what decides how the economy as a whole is organised?
Almost as soon as Coase had wished for it, a body of more rigorous research on such questions began to flourish. Central to it was the idea that it is difficult to specify all that is required of a business relationship, so some contracts are necessarily “incomplete”. Important figures in this field include Oliver Williamson, winner of the Nobel prize in economics in 2009, and Oliver Hart and Bengt Holmstrom, who shared the prize in 2016. These and other Coase apostles drew on the work of legal theorists in distinguishing between spot transactions and business relations that require longer-term or flexible contracts.
Spot markets cover most transactions. Once money is exchanged for goods, the deal is completed. The transaction is simple: one party wants, another supplies. There is little scope for dispute, so a written contract can be dispensed with. If one party is unhappy, he will take his business elsewhere next time. Spot markets are thus largely self-policing. They are well suited to simple, low-value transactions, such as buying a newspaper or taking a taxi.
Things become trickier when the parties are locked into a deal that is costly to get out of. Take a property lease, for instance. A business that is evicted from its premises might not quickly find a building with similar features. Equally, if a tenant suddenly quit, the landlord might not find a replacement straight away. Each could threaten the other in a bid for a better rent. The answer is a long-term contract that specifies the rent, the tenure and use of the property. Both parties benefit.
But for many business arrangements, it is difficult to set down all that is required of each party in all circumstances. In such cases, formal contracts are by necessity “incomplete” and sustained largely by trust. An employment contract is of this type. It has a few formal terms: job title, work hours, initial pay and so on, but many of the most important duties and obligations are not written down. It is thus like a “mini-society with a vast array of norms beyond those centred on the exchange and its immediate processes”, wrote Mr Williamson. Such a contract stays in force mostly because its breakdown would hurt both parties. And because market forces are softened in such a contract, it calls for an alternative form of governance: the firm.
One of the first papers to elucidate these ideas was published in 1972 by Armen Alchian and Harold Demsetz. They defined the firm as the central contractor in a team-production process. When output is the result of a team effort, it is hard to put the necessary tasks out to the market. That is because it is tricky to measure the contribution of each member to the finished work and to then allocate their rewards accordingly. So the firm is needed to act as both co-ordinator and monitor of a team.
Chain tale
If a team of workers requires a firm as monitor, might that also be true for teams of suppliers? In some cases, firms are indeed vertically integrated, meaning that suppliers of inputs and producers of final goods are under the same ownership. But in other cases, suppliers and their customers are separate entities. When is one set-up right and not the other?
A paper published in 1986 by Sanford Grossman and Mr Hart sharpened the thinking on this. They distinguished between two types of rights over a firm’s assets (its plant, machinery, brands, client lists and so on): specific rights, which can be contracted out, and residual rights, which come with ownership. Where it becomes costly for a company to specify all that it wants from a supplier, it might make sense to acquire it in order to claim the residual rights (and the profits) from ownership. But, as Messrs Grossman and Hart noted, something is also lost through the merger. The supplier’s incentive to innovate and to control costs vanishes, because he no longer owns the residual rights.
To illustrate this kind of relationship, they used the example of an insurance firm that pays a commission to an agent for selling policies. To encourage the agent to find high-quality clients, which are more likely to renew a policy, the firm defers some portion of the agent’s pay and ties it to the rate of policy renewals. The agent is thus induced to work hard to find good clients. But there is a drawback. The insurance firm now has an incentive of its own to shirk. While the agent is busting a gut to find the right sort of customers, the firm can take advantage by, say, cutting its spending on advertising its policies, raising their price or lowering their quality.
There is no set-up in which the incentives of firm and agent can be perfectly aligned. But Messrs Grossman and Hart identified a next-best solution: the party that brings the most to any venture in terms of “non-contractible” effort should own the key assets, which in this case is the client list. So the agent ought to own the list wherever policy renewals are sensitive to sales effort, as in the case of car insurance, for which people tend to shop around more. The agent would keep the residual rights and be rewarded for the effort to find the right sort of client. If the insurance firm shirks, the agent can simply sell the policies of a rival firm to his clients. But in cases where the firm brings more to the party than the sales agent—for example, when clients are “stickier” and the first sale is crucial, as with life insurance—a merger would make more sense.
This framework helps to address one of the questions raised by Coase’s original paper: when should a firm “make” and when should it “buy”? It can be applied to vertical business ties of all kinds. For instance, franchises have to abide by a few rules that can be set down in a contract, but get to keep the residual profits in exchange for a royalty fee paid to the parent firm. That is because the important efforts that the parent requires of a franchisee are not easy to put in a contract or to enforce.
The management of ties between a firm and its “stakeholders” (its customers, suppliers, employees and investors) is another variation on this theme. A firm often wants to put restraints on the parties it does business with. Luxury-goods firms or makers of fancy sound equipment may ban retailers from discounting their goods as a way to spur them to compete with rivals on the quality of their shops, service and advice.
Inside the cubicle
If one of the challenges set by Coase was to explain where the boundary between firms and markets lies, another was for economic analysis not to cease once it reached the factory gate or office lobby. A key issue is how agreements are structured. Why, for instance, do employment contracts have so few formal obligations? One insight from the literature is that a tightly specified contract can have perverse outcomes. If teachers are paid according to test results, they will “teach to the test” and pay less regard to other tasks, such as inspiring pupils to think independently. If chief executives are paid to boost the firm’s short-term share price, they will cut investment projects that may benefit shareholders in the long run.
Mr Holmstrom and Paul Milgrom established that where important tasks are hard to monitor, and where a balance of activities is needed, then a contract should shun strong incentives tied to any one task. The best approach is to pay a fixed salary and to leave the balance of tasks unspecified. A related idea developed by Mr Hart and John Moore is of a job contract as a “reference point” rather than as a detailed map. Another insight is that deferred forms of pay, such as company pension schemes and promotions based on seniority, help cement long-term ties with employees and reward them for investing in skills specific to the relationship.
Coase noted in 1937 that the degree to which the mechanism of price is superseded by the firm varies with the circumstances. Eighty years on, the boundary between the two might appear to be dissolving altogether. The share of self-employed contractors in the labour force has risen. The “gig economy” exemplified by Uber drivers is mushrooming.
Yet firms are unlikely to wither away. Prior to Uber, most taxi drivers were already self-employed. Spot-like job contracts are becoming more common, but flexibility comes at a cost. Workers have little incentive to invest in firm-specific skills, so productivity suffers. And even if Mr Seabright’s shirt was delivered by a set of market-based transactions, the supply chains for complex goods, such as an iPhone or an Airbus A380 superjumbo, rely on long-term contracts that are often “incomplete”. Coase was the first to spot an enduring truth. Successful economies need both the benign dictatorship of the firm and the invisible hand of the market.
"The world is still a weird place, despite my efforts to make clear and perfect sense of it".
Dr. Hunter S Thompson
Guest 1881- Registered: 16 Oct 2016
- Posts: 1,071
#7
Reducing legislation and extolling the virtues of neo-liberal 'put it out to tender' has a very Victorian laissez-faire feel and consequence to it. Spot markets are a simple concept and I agree that they are self-policing, by and large. Compilations arise when we enter into contracts such as "the EU" and privatise WITHOUT sufficient safeguards for the public. Neo-liberalism, which has its antecedence in phrases such as "A well-defined task can easily be put out to the market, where a contractor is paid a fixed sum for doing it" from Coase's firm theory, has proven that even well-considered theorems are prone to negative human interference (i.e. greed) either by short-changing the client (us) or over-charging them. Regulation of our former family silver, the privatised industries, has been inadequate at best. I might cite the Energy sector, Water, Royal Mail, North Sea Oil...
Just because you don't take an interest in politics doesn't mean that politics won't take an interest in you. PERICLES.
Captain Haddock- Location: Marlinspike Hall
- Registered: 8 Oct 2012
- Posts: 8,397
#8
Perceptive comments there Your Grace if I might say so. Mankind should strive for, but as we both know, will never reach perfection on this earth.
With all of its imperfections I still believe capitalism to be the 'best' system available for the general well-being and advancement of mankind.
As Churchill said 'The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries.'
Today it's 'Human Capital'.
https://www.economist.com/news/economics-brief/21725757-becker-made-people-central-focus-economics-second-our-series-big"The world is still a weird place, despite my efforts to make clear and perfect sense of it".
Dr. Hunter S Thompson
Guest 1881- Registered: 16 Oct 2016
- Posts: 1,071
#9
Thank you for your unexpected compliment. Very generous.
On the concept of Capitalism, John Maynard Keynes stark statement about trusting the most extremely greedy human beings to be concerned about the most needy in society sums it up. (I paraphrase of course.)
Might I request a copy 'n' paste of the above article?!
Just because you don't take an interest in politics doesn't mean that politics won't take an interest in you. PERICLES.
Captain Haddock- Location: Marlinspike Hall
- Registered: 8 Oct 2012
- Posts: 8,397
#10
Gary Becker’s concept of human capital
[U]Becker made people the central focus of economics. The second in our series on big economic ideas[/U]
WHY do families in rich countries have fewer children? Why do companies in poor countries often provide meals for their workers? Why has each new generation spent more time in school than the one that came before? Why have earnings of highly skilled workers risen even as their numbers have also increased? Why should universities charge tuition fees?
This is an incredibly diverse array of questions. The answers to some might seem intuitive; others are more perplexing. For Gary Becker, an American economist who died in 2014, a common thread ran through them all: human capital.
Simply put, human capital refers to the abilities and qualities of people that make them productive. Knowledge is the most important of these, but other factors, from a sense of punctuality to the state of someone’s health, also matter. Investment in human capital thus mainly refers to education but it also includes other things—the inculcation of values by parents, say, or a healthy diet. Just as investing in physical capital—whether building a new factory or upgrading computers—can pay off for a company, so investments in human capital also pay off for people. The earnings of well-educated individuals are generally higher than those of the wider population.
All this might sound obvious. As far back as Adam Smith in the 18th century, economists had noted that production depended not just on equipment or land but also on peoples’ abilities. But before the 1950s, when Becker first examined links between education and incomes, little thought was given to how such abilities fit with economic theory or public policy.
Instead, economists’ general practice was to treat labour as an undifferentiated mass of workers, lumping the skilled and unskilled together. To the extent that topics such as training were thought about, the view was pessimistic. Arthur Pigou, a British economist who is credited with coining the term “human capital”, believed there would be an under-supply of trained workers because companies would not want to teach skills to employees only to see them poached by rivals.
After the second world war, when America’s GI bill helped millions complete high school and university, education started to receive more attention from economists, Becker among them. The son of parents who had never got beyond the eighth grade but who filled his childhood home with discussions about politics, he wanted to investigate the structure of society. Lectures by Milton Friedman at the University of Chicago, where Becker completed his graduate studies in 1955, showed him the analytical power of economic theory. Doctoral degree in hand, Becker, then in his mid-20s, was hired by the National Bureau of Economic Research to work on a project calculating returns on schooling. What seemed a simple question led him to realise that no one had yet fleshed out the concept of human capital. In subsequent years he developed it into a full-fledged theory that could be applied to any number of questions and, soon enough, to issues previously seen as outside the realm of economics, from marriage to fertility.
One of Becker’s earliest contributions was to distinguish between specific and general human capital. Specific capital arises when workers acquire knowledge directly tied to their firms, such as how to use proprietary software. Companies are happy to pay for this kind of training because it is not transferable. By contrast, as Pigou suggested, firms are often reluctant to stump up for general human capital: teach employees to be good software programmers and they may well jump ship to whichever company pays them the most.
But this was just the beginning of his analysis. Becker observed that people do acquire general human capital, but they often do so at their own expense, rather than that of employers. This is true of university, when students take on debts to pay for education before entering the workforce. It is also true of workers in almost all industries: interns, trainees and junior employees share in the cost of getting them up to speed by being paid less.
Becker made the assumption that people would be hard-headed in calculating how much to invest in their own human capital. They would compare expected future earnings from different career choices and consider the cost of acquiring the education to pursue these careers, including time spent in the classroom. He knew that reality was far messier, with decisions plagued by uncertainty and complicated motivations, but he described his model as an “economic way of looking at life”. His simplified assumptions about people being purposeful and rational in their decisions laid the groundwork for an elegant theory of human capital, which he expounded in several seminal articles and a book in the early 1960s.
His theory helped explain why younger generations spent more time in schooling than older ones: longer life expectancies raised the profitability of acquiring knowledge. It also helped explain the spread of education: advances in technology made it more profitable to have skills, which in turn raised the demand for education. It showed that under-investment in human capital was a constant risk: young people can be short-sighted given the long payback period for education; and lenders are wary of supporting them because of their lack of collateral (attributes such as knowledge always stay with the borrower, whereas a borrower’s physical assets can be seized). It suggested that there was no fixed number of good jobs but that highly paid work would increase as economies produced more skilled graduates who generated more innovation.
The becklash
Human capital could also be applied to topics beyond returns to individuals from education. The idea was a powerful variable in explaining why some countries fared far better than others: to promote income growth over many years, heavy investment in schooling was necessary. It shed light on why firms in poor countries tended to be more paternalistic, providing dormitories and canteens: they reaped immediate productivity gains from rested, well-fed workers. It informed big increases in the numbers of women studying law, finance and science since the 1950s: the automation of much household work meant that women could invest more in building their careers. And it helped explain the shrinkage of families in wealthy countries: if increasing value is placed on human capital, parents must invest more in each child, making large families costly.
But any theory that attempts to explain so much is bound to encounter pushback. Many critics bristled at Becker’s market-driven logic, which seemed to reduce people to cold, calculating machines. Although “human capital” is an unsightly term—in 2004 a panel of German linguists deemed Humankapital the most offensive word of the year—it is the task of social science to identify and refine concepts that would otherwise be fuzzy. It took Becker’s framework to make the importance of education explicit, and to put people at the heart of economics.
Within the discipline, some objected that Becker had overstated the importance of learning. Education matters not because it imparts knowledge, critics said, but because of what it signals about the people who complete university, namely that they are disciplined and more likely to be productive workers. In any case, people of greater abilities are the ones who are most likely to get higher degrees in the first place.
Yet increasingly sophisticated empirical analyses has revealed that the acquisition of knowledge is in fact a big part of what it means to be a student. Becker himself highlighted research findings that one quarter of the rise in per-person incomes from 1929 to 1982 in America was because of increases in schooling. Much of the rest, he insisted, was a result of harder-to-measure gains in human capital such as on-the-job training and better health.
He was also fond of pointing to the success of Asian economies such as South Korea and Taiwan, endowed with few natural resources other than their populations, as proof of the value of investing in human capital—and in particular of building up education systems. Becker’s original analysis focused on the private benefits to students, but economists who followed in his footsteps expanded their field of study to include the broader social gains from having well-educated populations.
The importance of human capital is now taken for granted. What is more controversial is the question of how to cultivate it. For those inclined to support a bigger state, one interpretation of Becker’s analysis is that the government ought to pour money into education and make it widely available at a low cost. For a conservative, the conclusion might be that the private gains from education are so big that students should bear the costs of tuition.
Although Becker’s academic writings rarely strayed into policy prescriptions, his popular writings—a monthly Businessweek column that began in the 1980s and blog posts in later years—offer a measure of his views. For starters, he talked of “bad inequality” but also “good inequality”, an unfashionable idea today. Higher earnings for scientists, doctors and computer programmers help motivate students to tackle these difficult subjects, in the process pushing knowledge forward; from this perspective, inequality contributes to human capital. But when inequality gets too extreme, the schooling and even the health of children from poor families suffer, with their parents unable adequately to provide for them. Inequality of this sort depresses human capital, leaving society worse off.
As for the debate about whether government-funded universities should raise tuition fees, Becker thought that only fair, given that their graduates could expect higher lifetime earnings. Rather than subsidising students who go on to become bankers or lawyers, he argued that it would be more productive for the government to fund research and development. Yet, concerned by mounting inequality in America, he thought that more should be done to invest in early childhood education and improve the state of schools.
The knowledge economy
Becker applied his own prodigious reserves of human capital well beyond education. He used his “economic approach” to look at everything from the motives of criminals and drug addicts to the evolution of family structures and discrimination against minorities. In 1992 he was awarded the Nobel prize for extending economic analysis to new spheres of human behaviour. He remains one of the most cited economists of the past half-century.
Mr Becker’s way of doing economics, initially a radical challenge to convention, came under attack as it went mainstream. The rise of behavioural economics, with its emphasis on limits to rationality, undercut his depiction of people as rational agents seeking to maximise welfare. Improvements in data collection and analysis also gave rise to more detailed empirical research, instead of the wide-ranging concepts that he favoured.
Yet precisely because Mr Becker’s analysis touched on so much, it still has a lot to offer. Consider the debate on how governments ought to respond to disruptive technological change. From the standpoint of human capital, one answer is obvious. Technological advances mean that the knowledge that people acquire in school is becoming obsolete more quickly than before. At the same time, longer life expectancies mean that the returns on mid-career training are higher than in the past. It is therefore both necessary and possible to replenish human capital by designing better systems for lifelong learning.
This is just one element of the response to technological disruption but it is a vital one. Becker never intended that his theory of human capital explain everything in economics, only that it explain a little about a lot. On this count his work remains indispensable.
"The world is still a weird place, despite my efforts to make clear and perfect sense of it".
Dr. Hunter S Thompson
Guest 745- Registered: 27 Mar 2012
- Posts: 3,370
#11
money should work like a central heating system.
water moving from room to room warming everyone.
but if you pump some of the water of to the Cayman Islands and just let it stagnate, we all get a bit colder. same with economies.
Captain Haddock- Location: Marlinspike Hall
- Registered: 8 Oct 2012
- Posts: 8,397
#12
https://www.economist.com/news/economics-brief/21726050-third-brief-our-series-looks-reasoning-made-jean-baptiste-say
Overcapacity and undercapacitySay’s law: supply creates its own demand
The third brief in our series looks at the reasoning that made Jean-Baptiste Say famous
IN 1804 Jean-Baptiste Say enrolled in the National Conservatory of Arts and Crafts in Paris to learn the principles of spinning cotton. The new student was 37 years old, points out his biographer, Evert Schoorl, with a pregnant wife, four children and a successful career in politics and letters trailing behind him. To resume his studies, he had turned down two lucrative offers from France’s most powerful man, Napoleon Bonaparte. The ruler would have paid him handsomely to write in support of his policies. But rather than “deliver orations in favour of the usurper”, Say decided instead to build a cotton mill, spinning yarn not policy.
Napoleon was right to value (and fear) Say’s pen. As a pamphleteer, editor, scholar and adviser, he was a passionate advocate for free speech, trade and markets. He had imbibed liberal principles from his heavily annotated copy of Adam Smith’s “The Wealth Of Nations” and bolstered his patriotic credentials in battle against Prussian invaders. (During breaks in the fighting, he discussed literature and political economy with other learned volunteers “almost within cannonballs’ reach”.)
His greatest work was “A Treatise on Political Economy”, a graceful exposition (and extension) of Smith’s economic ideas. In Say’s time, as nowadays, the world economy combined strong technological progress with fitful demand, spurts of innovation with bouts of austerity. In France output of yarn grew by 125% from 1806 to 1808, when Say was starting his factory. In Britain the Luddites broke stocking frames to stop machines taking their jobs.
On the other hand, global demand was damaged by failed ventures in South America and debilitated by the eventual downfall of Napoleon. In Britain government spending was cut by 40% after the Battle of Waterloo in 1815. Some 300,000 discharged soldiers and sailors were forced to seek alternative employment.
The result was a tide of overcapacity, what Say’s contemporaries called a “general glut”. Britain was accused of inundating foreign markets, from Italy to Brazil, much as China is blamed for dumping products today. In 1818 a visitor to America found “not a city, nor a town, in which the quantity of goods offered for sale is not infinitely greater than the means of the buyers”. It was this “general overstock of all the markets of the universe” that came to preoccupy Say and his critics.
In trying to explain it, Say at first denied that a “general” glut could exist. Some goods can be oversupplied, he conceded. But goods in general cannot. His reasoning became known as Say’s law: “it is production which opens a demand for products”, or, in a later, snappier formulation: supply creates its own demand.
This proposition, he admitted, has a “paradoxical complexion, which creates a prejudice against it”. To the modern ear, it sounds like the foolhardy belief that “if you build it, they will come”. Rick Perry, America’s energy secretary, was ridiculed after a recent visit to a West Virginia coal plant for saying, “You put the supply out there and the demand will follow.”
To grasp Say’s point requires two intellectual jumps. The first is to see past money, which can obscure what is really going on in an economy. The second is to jump from micro to macro, from a worm’s eye view of individual plants and specific customers to a panoramic view of the economy as a whole.
Firms, like coal plants and cotton mills, sell their products for money. But in order to obtain that money, their customers must themselves have previously sold something of value. Thus, before they can become a source of demand, customers must themselves have been a source of supply.
What most people sell is their labour, one of several “productive services” on offer to entrepreneurs. By marshalling these productive forces, entrepreneurs can create a new item of value, for which other equally valuable items can then be exchanged. It is in this sense that production creates a market for other products.
In the course of making his merchandise, a producer will pay wages to his workers, rent to his landlord, interest to his creditors, the bills of his suppliers and any residual profits to himself. These payments will at least equal the amount the entrepreneur can get for selling his product. The payments will therefore add as much to spendable income as the recipients’ joint enterprise has added to supply.
That supply creates demand in this way may be easy enough to grasp. But in what sense does supply create its “own” demand? The epigram seems to suggest that a coal plant could buy its own coal—like a subsistence farmer eating the food he grows. In fact, of course, most producers sell to, and buy from, someone else.
But what is true at the micro level is not true at the macro level. At the macro level, there is no someone else. The economy is an integrated whole. What it purchases and distributes among its members are the self-same goods and services those members have jointly produced. At this level of aggregation, the economy is in fact not that different from the subsistence farmer. What it produces, what it earns, and what it buys is all the same, a “harvest” of goods and services, better known as gross domestic product.
From head to foot
How then did Say explain the woes of his age, the stuffed warehouses, clogged ports and choked markets? He understood that an economy might oversupply some commodities, if not all. That could cause severe, if temporary, distress to anyone involved in the hypertrophied industries. But he argued that for every good that is too abundant, there must be another that is too scarce. The labour, capital and other resources devoted to oversupplying one market must have been denied to another more valuable channel of industry, leaving it under-resourced.
Subsequent economists have tried to make sense of Say’s law in the following way. Imagine an economy that consists only of shoes and hats. The cobblers intend to sell $100-worth of shoes in order to buy the equivalent amount of hats. The hatters intend to sell wares worth $80 so as to spend the same sum at the cobbler’s. Each plan is internally consistent (planned spending matches revenue). Added together, they imply $180 of sales and an equal amount of purchases.
Sadly, the two plans are mutually inconsistent. In the shoe market the producers plan to sell more than the consumers will buy. In the hat market the opposite is the case. A journalist, attentive to the woes of the shoe industry, might bemoan the economy’s egregious overcapacity and look askance at its $180 GDP target. Cobblers, he would conclude, must grasp the nettle and cut production to $80.
The journalist might not notice that the hat market is also out of whack, in an equal and opposite way. Hat-buyers plan to purchase $100 from producers who plan to sell only $80. Unfortunately, this excess demand for hats cannot easily express itself. If cobblers can only sell $80 of shoes, they will only be able to buy the equivalent amount of hats. No one will see how many hats they would have bought had their more ambitious sales plans been fulfilled. The economy will settle at a GDP of $160, $20 below its potential.
Say believed a happier outcome was possible. In a free market, he thought, shoe prices would quickly fall and hat prices rise. This would encourage shoe consumption and hat production, even as it discouraged the consumption of hats and production of shoes. As a result, both cobblers and hatters might sell $90 of their good, allowing the economy to reach its $180 potential. In short: what the economy required was a change in the mix of GDP, not a reduction in its level. Or as one intellectual ally put it, “production is not excessive, but merely ill-assorted”.
Supply gives people the ability to buy the economy’s output. But what ensures their willingness to do so? According to the logic of Say and his allies, people would not bother to produce anything unless they intended to do something with the proceeds. Why suffer the inconvenience of providing $100-worth of labour, unless something of equal value was sought in return? Even if people chose to save not consume the proceeds, Say was sure this saving would translate faithfully into investment in new capital, like his own cotton factory. And that kind of investment, Say knew all too well, was a voracious source of demand for men and materials.
But what if the sought-after thing was $100 itself? What if people produced goods to obtain money, not merely as a transactional device to be swiftly exchanged for other things, but as a store of value, to be held indefinitely? A widespread propensity to hoard money posed a problem for Say’s vision. It interrupted the exchange of goods for goods on which his theory relied. Unlike the purchase of newly created products, the accumulation of money provides no stimulus to production (except perhaps the mining of precious metals under a gold or silver standard). And if, as he had argued, an oversupply of some commodities is offset by an undersupply of others, then by the same logic, an undersupply of money might indeed entail an oversupply of everything else.
Say recognised this as a theoretical danger, but not a practical one. He did not believe that anyone would hold money for long. Say’s own father had been bankrupted by the collapse of assignats, paper money issued after the French Revolution. Far from hoarding this depreciating asset, people were in such a rush to spend it, that “one might have supposed it burnt the fingers it passed through.”
In principle, if people want to hold more money, a simple solution suggests itself: print more. In today’s world, unlike Say’s, central banks can create more money (or ease the terms on which it is obtainable) at their own discretion. This should allow them to accommodate the desire to hoard money, while leaving enough left over to buy whatever goods and services the economy is capable of producing. But in practice, even this solution appears to have limits, judging by the disappointing results of monetary expansions since the financial crisis of 2007-08.
Say it ain’t so
Today, many people scoff at Say’s law even before they have fully appreciated it. That is a pity. He was wrong to say that economy-wide shortfalls of demand do not happen. But he was right to suggest that they should not happen. Contrary to popular belief, they serve no salutary economic purpose. There is instead something perverse about an economy impoverished by lack of spending. It is like a subsistence farmer leaving his field untilled and his belly unfilled, farming less than he’d like even as he eats less than he’d choose. When Say’s law fails to hold, workers lack jobs because firms lack customers, and firms lack customers because workers lack jobs.
Say himself faced both a ruinous shortage of demand for his cotton and excess demand for his treatise. The first edition sold out quickly; Napoleon blocked the publication of a second. Eventually, Say was able to adapt, remixing his activities as his own theory would prescribe. He quit his cotton mill in 1812, notes Mr Schoorl. And within weeks of Napoleon’s exile in 1814, he printed a second edition of his treatise (there would be six in all). In 1820 he began work once again at the Conservatory in Paris—not this time as a student of spinning, but as France’s first professor of economics, instructing students in the production, distribution and consumption of wealth. He considered it a “new and beautiful science”. And, in his hands, it was. "The world is still a weird place, despite my efforts to make clear and perfect sense of it".
Dr. Hunter S Thompson