In the recent Say’s Law thread, poster Steven Shaw links to Steve Keen’s “Nudge Nudge, Wink Wink, Say No More” - a paper in which Say’s Law is determined to be fallacious:
The interesting thing about Mr. Keen’s argument seems to me to be how it so quickly falls apart once it is revealed that it depends logically on Marx’s theory of profit, which in turn depends upon his labor theory of value. Moreover, to the untrained eye Mr. Keen’s critique of Say’s Law appears to be a quite accurate description of economic cause and effect in a capitalist economy. Indeed, Mr. Keen is reported to be something of a popular figure in Australia. However, upon closer inspection, his argument readily falls apart.
I think this may go to show, or at least reinforce, the critical importance of the fundamental economic laws. In this case, namely, those which contribute to value theory in particular, and to profit theory as well.
The post below is written, on the one hand, for those interested in seeing first hand one type of argument that free market detractors level against Say’s Law - in this case an argument based firmly upon the labor and profit theories of Marx, but with a Keynesian conclusion. On the other hand, the post is written for anyone perhaps somewhat new (or not) to Austrian economics who may be interested in learning something about the importance of the distinctions among different value theories, as well as the distinctions among different profit theories (Not that different theories are discussed; rather, the importance of their accuracy is illustrated).
First, a brief summary of Marx’s labor theory of value is made, and subsequently a brief analysis is made of Mr. Keen’s argument. Included also, however, is a discussion of Bohm-Bawerk’s refutation of Marx’s labor theory of value. Further, by way of contrast to Marx, a summary of the Misean and Rothbardian conceptions of profit is discussed. And finally, a discussion of Say’s Law vis-'a-vis Austrian profit theory is also included, where it is shown that Say’s theory takes account of temporary supply imbalances, and by so doing comports quite well with the Austrian conception of profit.
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Examination of Mr. Keen’s argument:
If anyone sees things which should be corrected or added, feel free and please do - I claim no expertise in Austrian economics. I’ve taken the time to carefully reconstruct Mr. Keen’s contra-Say argument below (however superficially) and to construct a relatively careful response to it (however superficial). The process was beneficial and instructive to me as someone learning Austrian economics, so I’m posting here in case others might find the result of it to be also.
Based on Steve Keen’s critique of Say’s Law, I can understand why Mr. Keen’s ideas have gained traction in Australia: His argument is well articulated and seemingly a very credible description of how capitalism works. To my reading, however, his argument nonetheless completely fails at a critical point - namely, its reliance on Marx’s theory of profit. Thus if Marx is incorrect regarding the nature and origin of profit, then so too is Mr. Keen, and his critique of Say’s Law is revealed to be baseless.
Briefly, Mr. Keen’s argument against Say’s Law relies primarily on Marx’s theory of profit, which itself originates in Marx’s labor theory of value.
In Marx’s analysis, all value derives from the labor time necessary for a good to be produced. Thus, all value derives exclusively from the efforts of workers. Consequently, profits to the capitalist are nothing less than value seized from workers. From this view, capitalists hire workers to labor for an agreed upon length of time, the workers produce salable commodities during this period, and the capitalist subsequently pays the workers a wage which is less than the value of the commodities they’ve produced.
Now, Say’s Law describes a free market economy in which general demand deficiencies caused by endogenous phenomena are impossible. However, Mr. Keen - with Marx’s analytics in hand - takes exception to the following:
Say:
Every producer asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product; for we do not consume money, and it is not sought after in ordinary cases to conceal it: thus, when a producer desires to exchange his product for money, he may be considered as already asking for the merchandise which he proposes to buy with this money. It is thus that the producers, though they have all of them the air of demanding money for their goods, do in reality demand merchandise for their merchandise*. (**A Treatise on Political Economy, p. 134;* emphasis added by Mr. Keen)
According to Mr. Keen:
Marx conceded that, if the sole motivation of exchange is consumption, then aggregate supply is aggregate demand.
Indeed:
Of the part of the revenue in one branch of production (which produces consumable commodities) which is consumed in the revenue of another branch of production, it can be said that the demand is equal to its own supply (in so far as production is kept in the right proportion). It is the same as if each branch itself consumed that part of its revenue. Here there is only a formal metamorphosis of the commodity: C-M-C’ Linen-money-wheat. (Marx 1861: 233)
However, Mr. Keen posits:
As Marx showed far better than did Keynes, the conditions under which Say’s Law is correct are not those of a capitalist economy.
According to Marx, and Mr. Keen, a second dynamic of commodity and money exchange occurs within capitalist economies, one which Say and his admirers fail to account for:
The circuit C-M-C starts with one commodity, and finishes with another, which falls out of circulation and into consumption. Consumption, the satisfaction of wants, in one word, use-value, is the end and aim. The circuit M-C-M+, on the contrary, commences with money and end with money. Its leading motive, and the goal that attracts it, is therefore mere exchange-value. (Marx 1867:148)
Accordingly, alleges Mr. Keen:
…a capitalist’s supply, if he is successful, is greater than his demand. There is an inherent inequality at the core of capitalist society, and the simple balance of Say’s Law collapses. In its place arises a far more complex vision of the functioning – and potential malfunctioning – of a market economy.
…
In an uncertain world, expectations of what and how much to produce will necessarily be sectorally and in the aggregate incorrect to at least some degree. The prospects for turning a physical surplus into real financial gain will depend on financial conditions and the distribution of income. Euphoric expectations during a boom may lead capitalists to produce too much of everything relative to the future ability of the system to finance their sale at a profit, while excessive debt and depressed expectations during a slump may lead to a self-fulfilling spiral into depression. As Minsky argued, this perspective can be seen as Keynes’s essential argument in the General Theory.
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Critique of the Labor Theory of Value:
Why Mr. Keen is satisfied to argue upon a Marxian foundation - and do so unequivocally and without qualification - is puzzling. I’m no expert in value theory or the history of its successive formulations, but I thought it widely recognized today that labor theories of value have long ago been discredited and well succeeded by subjective value theory. Perhaps someone knowledgeable in this area could shed some light.
For instance, in Bohm-Bawerk’s 1890 exegesis and refutation of Marx’s labor theory of value, Bohm-Bawerk states:
I venture on a field already traversed many a time, and by distinguished writers. I can scarcely hope then to bring forward much that is new." (Capital and Interest, p. 375)
For a penetrating criticism of the labor theory, see Bohm-Bawerk’s chapter on Marx in Capital and Interest. As for Bohm-Bawerk, he concludes his analysis with this:
If what I have said is true, the socialist Exploitation theory…is not only incorrect, but, in theoretical value, even takes one of the lowest places among interesting theories. However serious the fallacies we may meet among the representatives of some of the other theories, I scarely think that anywhere else are to be found together so great a number of the worst fallacies - wanton unproved assumption, self-contradiction, and blindness to facts. The socialists are able critics, but exceedingly weak theorists. (Capital and Interest, p. 390)
Whether Bohm-Bawerk is correct or not is up to the reader to decide. Notice, however, Bohm-Bawerk readily qualifies his argument. He admits to providing no final proof and instead acknowledges the possibility that his conclusions are wrong. And this despite these conclusions being supported by the highest degree of intellectual exaction. By way of contrast, Mr. Keen and Mr. Marx offer no such qualifications. Indeed, as Bohm-Bawerk goes great lengths to point out, Marx’s labor theory is extremely flimsy both theoretically and empirically.
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The Austrian Analysis of Profit:
Austrian profit theory rests upon the edifice of subjective value theory. For and outstanding, though shy of complete, exposition of subjective value theory, see Menger’s Principles of Economics. For outstanding expositions of Austrian profit theory see Mises’ Profit and Loss and Rothbard’s Man, Economy, and State, pp. 509-556.
Here’s Mises on profit (from Profit and Loss) - it’s too good to simply paraphrase:
“The consumers’ preference for definite articles may he open to condemnation from the point of view of a philosopher’s judgment. But judgments of value are necessarily always personal and subjective. The consumer chooses what, as he thinks, satisfies him best. Nobody is called upon to determine what could make another man happier or less unhappy. The popularity of motor cars, television sets and nylon stockings may be criticized from a “higher” point of view. But these are the things that people are asking for. They cast their ballots for those entrepreneurs who offer them this merchandise of the best quality at the cheapest price.”
…
"Entrance into the ranks of the entrepreneurs in a market society, not sabotaged by the interference of government or other agencies resorting to violence, is open to everybody. Those who know how to take advantage of any business opportunity cropping up will always find the capital required. For the market is always full of capitalists anxious to find the most promising employment for their funds and in search of the ingenious newcomers, in partnership with whom they could execute the most remunerative projects.
People often failed to realize this inherent feature of capitalism because they did not grasp the meaning and the effects of capital scarcity. The task of the entrepreneur is to select from the multitude of technologically feasible projects those which will satisfy the most urgent of the not yet satisfied needs of the public. Those projects for the execution of which the capital supply does not suffice must not be carried out. The market is always crammed with visionaries who want to float such impracticable and unworkable schemes. It is these dreamers who always complain about the blindness of the capitalists who are too stupid to look after their own interests. Of course, the investors often err in the choice of their investments. But these faults consist precisely in the fact that they preferred an unsuitable project to another that would have satisfied more urgent needs of the buying public."
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"Profits are never normal. They appear only where there is a maladjustment, a divergence between actual production and production as it should be in order to utilize the available material and mental resources for the best possible satisfaction of the wishes of the public. They are the prize of those who remove this maladjustment; they disappear as soon as the maladjustment is entirely removed. In the imaginary construction of an evenly rotating economy there are no profits. There the sum of the prices of the complementary factors of production, due allowance being made for time preference, coincides with the price of the product.
The greater the preceding maladjustments, the greater the profit earned by their removal. Maladjustments may sometimes be called excessive. But it is inappropriate to apply the epithet “excessive” to profits."
…
“But it is not the capital employed that creates profits and losses. Capital does not “beget profit” as Marx thought. The capital goods as such are dead things that in themselves do not accomplish anything. If they are utilized according to a good idea, profit results. If they are utilized according to a mistaken idea, no profit or losses result. It is the entrepreneurial decision that creates either profit or loss. It is mental acts, the mind of the entrepreneur, from which profits ultimately originate. Profit is a product of the mind, of success in anticipating the future state of the market.”
…
"There is no harm in a businessman’s endeavors to enrich himself by increasing his profits. The businessman has in his capacity as a businessman only one task: to strive after the highest possible profit. Huge profits are the proof of good service rendered in supplying the consumers. Losses are the proof of blunders committed, of failure to perform satisfactorily the tasks incumbent upon an entrepreneur. The riches of successful entrepreneurs is not the cause of anybody’s poverty; it is the consequence of the fact that the consumers are better supplied than they would have been in the absence of the entrepreneur’s effort. The penury of millions in the backward countries is not caused by anybody’s opulence; it is the correlative of the fact that their country lacks entrepreneurs who have acquired riches. The standard of living of the common man is highest in those countries which have the greatest number of wealthy entrepreneurs. It is to the foremost material interest of everybody that control of the factors of production should be concentrated in the hands of those who know how to utilize them in the most efficient way.
…
The average wage earner thinks that nothing else is needed to keep the social apparatus of production running and to improve and to increase output than the comparatively simple routine work assigned to him. He does not realize that the mere toil and trouble of the routinist is not sufficient. Sedulousness and skill are spent in vain if they are not directed toward the most important goal by the entrepreneur’s foresight and are not aided by the capital accumulated by capitalists. The American worker is badly mistaken when he believes that his high standard of living is due to his own excellence. He is neither more industrious nor more skillful than the workers of Western Europe. He owes his superior income to the fact that his country clung to “rugged individualism” much longer than Europe. It was his luck that the United States turned to an anticapitalistic policy as much as forty or fifty years later than Germany. His wages are higher than those of the workers of the rest of the world because the capital equipment per head of the employee is highest in America and because the American entrepreneur was not so much restricted by crippling regimentation as his colleagues in other areas. The comparatively greater prosperity of the United States is an outcome of the fact that the New Deal did not come in 1900 or 1910, but only in 1933.
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Neither does the average man comprehend that profits are indispensable in order to direct the activities of business into those channels in which they serve him [the average man] best. He looks upon profits as if their only function were to enable the recipients to consume more than he himself does. He fails to realize that their main function is to convey control of the factors of production into the hands of those who best utilize them for his own purposes. He did not, as he thinks, renounce becoming an entrepreneur out of moral scruples. He chose a position with a more modest yield because he lacked the abilities required for entrepreneurship or, in rare cases indeed, because his inclinations prompted him to enter upon another career."
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Austrian Profit Theory and Say’s Law:
Briefly, Mises’ above analysis appears to comport with Say’s Law. In real terms, at the beginning of the production process, business owners exchange commodities for other commodities (i.e. factors of production) which the entrepreneur believes are currently undervalued. In this case, in order to acquire the factors of production the business owner must first produce commodities which factor owners will demand. Goods are exchanged for goods.
According to Say, from an economy-wide point of view, goods are always exchanged for goods of commensurate value, and therefore a general oversupply is impossible. (If, instead, goods of lesser value were accepted in exchange for goods of higher value, then an oversupply of the less valuable goods and an undersupply of the higher value goods would result in all markets across the economy.)
Say:
It is worth while to remark, that a product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value. (A Treatise on Political Economy, p. 134)
However, the entrepreneur’s case represents an exception to Say’s general rule. For if the entrepreneur is correct in his identification of unmet consumer demands, or in his assessment that currently satisfied consumer demands could be met more efficiently, then the entrepreneur purchases goods which the market has currently undervalued and underpriced.
Rothbard:
The capitalist-entrepreneur buys factors or factor services in the present; his product must be sold in the future. He is always on the alert, then, for discrepancies, for areas where he can earn more than the going rate of interest. Suppose the interest rate is 5 percent; Jones can buy a certain combination of factors for 100 ounces; he believes that he can use this agglomeration to sell a product after two years for 120 ounces. His expected future return is 10 percent per annum. If his expectations are fulfilled, then he will obtain a 10-percent annual return instead of 5 percent. The difference between the general interest rate and his actual return is his money profit (from now on to be called simply “profit,” unless there is a specific distinction between money profit and psychic profit). In this case, his money profit is 10 ounces for two years, or an extra 5 percent per annum.
What gave rise to this realized profit, this ex post profit fulfilling the producer’s ex ante expectations? The fact that the factors of production in this process were underpriced and undercapitalized-underpriced in so far as their unit services were bought, undercapitalized in so far as the factors were bought as wholes. In either case, the general expectations of the market erred by underestimating the future rents (MVPs) of the factors. This particular entrepreneur saw better than his fellows, however,and acted on this insight. He reaped the reward of his superior foresight in the form of a profit. (Man, Economy, and State with Power and Market, pp. 509-510)
But if this were the case simultaneously in markets all across the economy, then Say’s Law surely would be powerless to explain such an economy. However, the exchange of goods of incommensurate value in any particular market is not long-lasting.
Rothbard:
His action, his recognition of the general undervaluation of productive factors, results in the eventual elimination of profits, or rather in the tendency toward their elimination. By extending production in this particular process, he increases the demand for these factors and raises their prices. This result will be accentuated by the entry of competitors into the same area, attracted by the 10-percent rate of return. Not only will the rise in demand raise the prices of the factors, but the increase in output will lower the price of the product. The result will be a tendency for a fall in the rate ofreturn back to the pure interest rate. (Man, Economy, and State with Power and Market, p. 510)
Therefore, oversupply will occur in particular markets at particular times for temporary durations. This ought not
invalidate Say’s Law, however, for Say himself countenanced the likelihood that temporary imbalances in particular market would indeed occur in a free market economy.
Say:
But it may be asked, if this be so, how does it happen, that there is at times so great a glut of commodities in the market, and so much difficulty in finding a vent for them 1 Why cannot one of these superabundant commodities be exchanged for another? I answer that the glut of a particular commodity arises from its having outrun the total demand for it in one or two ways; either because it has been produced in excessive abundance, or because the production of other commodities has fallen short.
It is because the production of some commodities has declined, that other commodities are superabundant. To use a more hackneyed phrase, people have bought less, because they have made less profit :*and they have made less profit for one or two causes; either they have found difficulties in the employment of their productive means, or these means have themselves been deficient.
It is observable, moreover, that precisely at the same time that one commodity makes a loss, another commodity is making excessive profit.f And, since such profits must operate as a powerful stimulus to the cultivation of that particular kind of products, there must needs be some violent means, or some extraordinary cause, a political or natural convulsion, or the avarice or ignorance of authority, to perpetuate this scarcity on the one hand, and consequent glut on the other. No sooner is the cause of this political disease removed, than the means of production feel a natural impulse towards the vacant channels, the replenishment of which restores activity to all the others. One kind of production would seldom outstrip every other, and its products be disproportionately cheapened, were production left entirely free. (A Treatise on Political Economy, p. 135)
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Conclusion.
But to focus exclusively on the fact of whether Say’s Law is valid or invalid is to miss the most important point. What counts most in all of this is whether the economics, based as they are on fundamental accounts of value and profit, are correct. Is the Marx/Keynes/Keen explanation of value and profit the more persuasive, along with the economics it necessarily implies; or instead is the Say/Menger/Mises explanation the more persuasive? I think it’s quite clear that the Classical Liberal/Austrian conception of economic cause and effect is the vastly superior. However, of course, one need judge for oneself.