"Most people are in arrested development and cannot use logic." Jacob.
"Competition and capitalism are hated to-day because of their tendency to destroy poverty and privilege." William Hutt
"America is unique in that our economy is totally dependent on global charity." Peter Schiff

Sunday, June 19, 2011

Say's Law, the James Mill version.

LK quotes Thomas Sowell as saying that the classical version of Say's Law is a six story layer cake, an edifice built on six assumptions.

Here's the first:
"(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill]."

I tried to find the source for that wording of the principle. James Mill never said it. It is apparently Thomas Sowell's paraphrase of Mill. Sowell says he got it from page 81 of Mill's Commerce Defended, but Mill never said any words remotely like it. [TBH, I am not at all sure Mill agreed with the idea Sowell ascribes to him. It sounds suspiciously like th e"buy back the product" fallacy]. In any case, this is what Mill meant, Smiling Dave style:

Imagine twenty children sitting in a circle, each with some unique toy in his grasp. Each dislikes his toy and wants a different one, and is willing to trade it for another toy. How many toys are needed to make sure every child gets rid of his toy?
The answer is, obviously, the same amount as there are toys to be gotten rid of. And indeed there is no need to bring in any toys from the outside, since every child is willing to part with his toy. The very toys that are being sold [by one child] are precisely the toys being bought [by another]. Taken as a group, the children have bought 20 toys, and paid for them with those same twenty toys [by having them change hands].

The idea though, is that the twenty toys bought are the twenty toys sold.

I want to expound a bit on what Mill said. Here is a quote from page 81 of that marvelous work:

The Economistes and their disciples express great apprehensions lest capital should increase too fast, lest the production of commodities should be too rapid. There is only, say they, a market for a given quantity of commodities, and if you increase the supply beyond that quantity you will be unable to dispose of the surplus.

Yep, that's Keynes and his cohorts all right. All they talk about is gluts, and lack of demand, and excess production.

Now loyal readers of this blog will remember the previous post, where we laid out the parameters of the debate about Say's Law. We explained that everyone is talking about the following case:

1. The manufacturers of all or most industries are making reasonable amounts of product and selling at reasonable prices.
2. For some mysterious reason, the shelves are all full. Nobody is buying.

But the Economistes are pushing the envelope even further. They are discussing a situation where so much money was put into making things that "too much" of everything was created.

Now even they don't mean that so much was made of everything that there is literally nothing to do but throw it all into the sea. No economy has ever succeeded in doing that. If the products are going to be given away free, there would be plenty of takers for all of it.

What the Economistes are talking about is that everything that was made people would like to have. The problem, think the Economistes, is that no one can pay for it. When they say "you will be unable to dispose of the surplus," they mean "you will be unable to sell the surplus at a profit, because people just don't have the money."

What is James Mill's reply? I'll use a story to explain it. Imagine all the manufacturers coming to a common market place with their surplus wares. Each is standing there in the open air next to a huge pile of goodies that he made and nobody can afford. The market place is really crowded, because the Economistes are saying the whole country has produced too much, not just an isolated factory or industry here and there.

Steve Jobs is standing around next to his stack of Ipods that nobody can afford. He smells the delicious aroma of some Starbucks coffee in the tent next to his, and his mouth starts watering. "Anybody buying that coffee?" he asks Mr Starbucks.

"Nope. I can't sell it for less than $10 a cup, and nobody can afford it. Including you, Mr Jobs. I already sold to whomever can afford this fine coffee, and this is my surplus. Since you didn't buy it yet, you are one of those who couldn't afford it."

Jobs notices Mr Starbucks staring at the Ipods, intrigued. Mr Starbucks expresses an interest in buying one.
"Sorry, you can't afford my Ipod. It's $500, and I already sold to everyone who could afford one."

What is going to happen? Obviously, they are going to make a trade, 50 cups of coffee for an Ipod. Each of them has something they want, and something they can offer in exchange. The same will happen thousands of times at that market place, each person trading some of his supposed surplus for part of somebody elses supposed surplus.

Will one person be left holding the bag, with everyone having got rid of their surplus but him? Maybe. But that's a whole 'nother story than saying the whole country has produced a glut of products that can't be sold.

To spare you the need for scouring the Internet, here's one place where Mill's Page 81 is open to the public: http://mises.org/resources/3051. [Look for the word Economistes and you'll get right to page 81].

Does this mean there is no such thing as a recession? Of course there can be a recession. We are living through one right now. But recessions are not caused by making too much of everything, for there is no such thing as too much of everything, as we have explained. They are caused by making too much of the wrong thing [=what people don't want] and too little of the right thing [=what they want].

In our quaint marketplace example, a recession would happen if, before the market even opened, Steve Jobs had hired all of Mr Starbucks workers and bought all his factories to make Ipods, when people didn't want Ipods that badly, and would have preferred more coffee to drink. Then Mr Jobs will come to the market to sell his surplus Ipods and will find no customers. He will have to fire some of his workers and sell some of his factories. Mr Starbucks, if he is a good entrepeneur, will hire the workers right back and buy the factory back, and start making coffee. The recession is that temporary process where things are reallocated back to where they should have been in the first place. Obviously it is a painful process, with people getting fired and Mr Jobs losing money. But it cannot be avoided. Any attempt to help Mr Jobs keep on making Ipods that nobody wants is not going to get anywhere. Ask Mr Obama, it's what he's doing right now, as Mr Bush tried before him .

And what of LK? He thinks Mill's argument depends on a few other assumptions, all of which are wrong, and that Mill too is therefore wrong. We will examine that idea in future blogs, when we discuss the other layers of Sowell's six layer cake.

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