Why Your Grandfather's Economics Was Better Than Your
Why Your Grandfather's Economics Was Better Than Your
STEVEN KATES
RMIT UNIVERSITY
I would like to thank Joe Salerno for his kind invitation to present the Ludwig von
Mises lecture for 2010, in this way giving me the opportunity to present these views
on the classical theory of the cycle and Say’s Law to a wider audience. I would also
like to thank my good friend, Peter Smith, who provided excellent and sympathetic
advice on an earlier draft of this paper.
3
4 The Quarterly Journal of Austrian Economics 13, No. 4 (2010)
Ludwig von Mises took the fight up to the socialist dogmas of the early
twentieth century and showed on paper that no economy could ever
solve the problem of allocating resources without a price mechanism,
free markets and private property. Who doesn’t know it now? He knew
it eighty years ago.
1
Keynes was at the time completing the essay for inclusion in his Essays in Biography
which would be published the following year.
Steven Kates: Why Your Grandfather’s Economics Was Better than Yours… 7
The idea that we can safely neglect the aggregate demand function is
fundamental to the Ricardian economics, which underlie what we have
been taught for more than a century. Malthus, indeed, had vehemently
opposed Ricardo’s doctrine that it was impossible for effective demand to
be deficient; but vainly. For, since Malthus was unable to explain clearly
(apart from an appeal to the facts of common observation) how and why
effective demand could be deficient or excessive, he failed to furnish an
alternative construction; and Ricardo conquered England as completely
as the Holy Inquisition conquered Spain. Not only was his theory
accepted by the city, by statesmen and by the academic world. But
controversy ceased; the other point of view completely disappeared; it
ceased to be discussed. The great puzzle of Effective Demand with which
Malthus had wrestled vanished from the economic literature. (Keynes,
1936, p. 32, emphasis added.)
2
Keynes discussed a number of these in the General Theory, referring to them as his
“brave army of heretics” (Keynes, 1936, p. 371), a band of brothers that included
Bernard Mandeville, Malthus, Major Douglas, Silvio Gesell and J.A. Hobson.
8 The Quarterly Journal of Austrian Economics 13, No. 4 (2010)
This is not excess supply for individual goods and services, the
“particular glut” whose existence no one had ever denied, but
an actual excess supply of all goods taken together, that is, a
“general glut.” Keynes made the possibility of demand failure
the culminating point at the end of the introductory chapters of
the General Theory.
For the vast majority of the economics profession even now, this
is the way in which Say’s Law and its implications are understood.
It is the very meaning of the Keynesian Revolution. Mises made
the same point in 1950:
Lord Keynes’s main contribution did not lie in the development of new
ideas but “in escaping from the old ones,” as he himself declared at the
end of the Preface to his “General Theory.” The Keynesians tell us that
his immortal achievement consists in the entire refutation of what has
come to be known as Say’s Law of Markets. The rejection of this law,
they declare, is the gist of all Keynes’s teachings; all other propositions of
his doctrine follow with logical necessity from this fundamental insight
and must collapse if the futility of his attack on Say’s Law can be demon-
strated. (Mises, 1950 [1980])
The exuberant epithets which these admirers have bestowed upon his
work cannot obscure the fact that Keynes did not refute Say’s Law. He
rejected it emotionally, but he did not advance a single tenable argument
to invalidate its rationale. (Mises, 1950 [1980])
3
As an interesting parallel, Keynes, too, was the most famous economist of his time
after having written his Economic Consequences of the Peace at the end of World War
I. It had also been a worldwide sensation in its time.
12 The Quarterly Journal of Austrian Economics 13, No. 4 (2010)
4
For historical accuracy I will note that these arguments had been first brought
together by James Mill in 1808 where he, too, specifically invoked the théorie
des debouches to explain why demand deficiency is a fallacious explanation for
recession. It is for this reason that in my view James Mill had been the first to
properly state “Say’s Law” (see Kates, 1998, pp. 24–29).
Steven Kates: Why Your Grandfather’s Economics Was Better than Yours… 13
price. But something more than this is meant. For after a crisis the ware-
houses are overstocked with goods in almost every important trade;
scarcely any trade can continue undiminished production so as to afford
a good rate of profits to capital and a good rate of wages to labour. And
it is thought that this state of things is one of general over-production.
We shall however find that it really is nothing but a state of commercial
disorganisation. (Marshall and Marshall, 1879 [1881], p. 154)
The assertion that saving renders the purchasing power of the consumer
insufficient to take up the volume of current production although
made more often by members of the lay public than by professional
economists, is almost as old as the science of political economy itself.
The question of the utility of ‘unproductive’ expenditure was first raised
by the Mercantilists, who were thinking chiefly of luxury expenditure.
The idea recurs in those writings of Lauderdale and Malthus which gave
rise to the celebrated Théorie des Débouchés of James Mill and J.B. Say,
and in spite of many attempts to refute it, permeates the main doctrines
of socialist economics right up to Tugan-Baranovsky, Thorstein Veblen
and J.A. Hobson. But while in this way the idea has found a greater
Steven Kates: Why Your Grandfather’s Economics Was Better than Yours… 15
5
The existence of this critique of Catchings and Foster may also help explain why
Hayek, having invested the time and effort in dealing with their arguments,
almost completely ignored Keynes’ attempt to achieve the same result. By the time
Keynes wrote, Hayek may well have found trying to explain the fallacies in such
reasoning completely stale. To have bothered responding to Keynes in the detail
required would have for him involved going over old ground.
16 The Quarterly Journal of Austrian Economics 13, No. 4 (2010)
It is only because our exchanges are made through money that we have
any difficulty in perceiving that an increase in supply is (not “causes”) an
increase in demand…. An increase in the supply of cloth is an increase in
the demand for other things; and vice versa, an increase in the supply of
anything else may constitute a demand for cloth. What is divided among
the members of society is the goods and services produced to satisfy its
wants; and the same goods and services are both Supply and Demand.
(Clay, 1916, p. 242)
received into what one wishes to buy.6 Keynes had accused classical
economists of confusing a barter economy with the operation of a
money economy, but from the first statements on Say’s Law by Say
himself that had never been the case. Here is J.B. Say, in the fourth
edition of his Treatise,7 trying to explain the obvious.
Commodities, says Say, are ultimately paid for not by money, but by
other commodities. Money is merely the commonly used medium
of exchange; it plays only an intermediary role. What the seller wants
ultimately to receive in exchange for the commodities sold is other
commodities. (Mises, 1950 [1980])
6
This is the formula used by Marx to explain the classical mechanisms associated
with the law of markets but was used by him as a criticism.
7
It is the fourth edition that has been the one translated into English because that
was the latest edition available when Malthus published his Principles in 1820.
There would be a fifth edition in French that has not been translated.
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This book has its origin in a resolution adopted by the Assembly of the
League of Nations in September 1930 by which it was decided that an
attempt should be made to co-ordinate the analytical work then being done
on the problem of the recurrence of periods of economic depression.
Steven Kates: Why Your Grandfather’s Economics Was Better than Yours… 19
Torrens was not the first to make this point, but he made it very
well. A lack of proportion between supply and demand is the
cause of a descent into recession. The problems of recession are
due to structural problems in an economy, not because of a failure
of demand. And it required an understanding of the law of markets
to understand that recessions occur when what has been produced
does not coincide with what those with incomes want to buy.
In these passages, Torrens captured the theory that became
during the following century the common ground amongst the
Steven Kates: Why Your Grandfather’s Economics Was Better than Yours… 21
8
There was, however, an under-consumptionist literature which argued that too
little demand from consumers was the systematic cause of economic recession.
This was at the time almost entirely the province of economic cranks, as Keynes’
reference to the “brave army of heretics” plainly shows. Hobson was seen as the
leading exponent of this view as both Keynes (Keynes, 1936, pp. 364–370) and
Haberler (1937, p. 115) make clear.
22 The Quarterly Journal of Austrian Economics 13, No. 4 (2010)
flimsy a straw man. Becker and Baumol could not have been more
explicit in dealing with this caricature of classical theory, which they
labeled “Say’s Identity.” In discussing what they term “the clearest
statement on the point”—Mill’s second essay in his Essays on Some
Unsettled Questions of Political Economy—they wrote:
9
The downturn in activity, because the cycle is cyclical, will end at some stage with
an upturn. What is evident already, however, is that the spending programs which
have been introduced have not been factors in generating recovery. Indeed, not
only have they been of virtually no use in creating a net addition to employment
they have also coincided with deteriorations in economic conditions generally
that have been unexpected by those who introduced the stimulus programs. The
argument has been made that economic conditions would have been even worse
than they were had these programs not been introduced even though at the time
of their introduction, the expectation was that there would be a generally rapid
upturn in activity and the labor market. None of this has occurred, as anyone
looking at these programs from a classical perspective would have expected.
Steven Kates: Why Your Grandfather’s Economics Was Better than Yours… 25
REFERENCES
Bagehot, Walter. 1873. Lombard Street: A Description of the Money Market.
London: John Murray, 1919.
Steven Kates: Why Your Grandfather’s Economics Was Better than Yours… 27
Kates, Steven. 1998. Say’s Law and the Keynesian Revolution: How Macro-
economic Theory Lost its Way. Edward Elgar: Cheltenham.
——. 1936. The Collected Writings of John Maynard Keynes. Vol. VII: The
General Theory of Employment, Interest and Money. Donald Moggridge,
ed. London: The Macmillan Press Ltd.
Marshall, Alfred and Marshall, Mary Paley. 1879. The Economics of Industry.
2nd ed. London: Macmillan and Co., 1881.
Mill, James. 1808. Commerce Defended. 2nd ed. In Winch, Donald, ed. James
Mill: Selected Economic Writings. Edinburgh: Oliver and Boyd Ltd,
1966, pp. 85–159.
Mises, Ludwig von. 1950. “Lord Keynes and Say’s Law.” In Planning for
Freedom: And Sixteen Other Essays and Addresses. 4th ed. South Holland,
Ill.: Libertarian Press, 1980. Quotations are taken from the website
version of this article: http://mises.org/daily/1803.
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Smith, Adam. 1776. An Inquiry into the Nature and Causes of the Wealth of Nations.
Edwin Cannan, ed. Chicago: University of Chicago Press, 1976.