Re: Keynes On Say's Law

["Gunnar Tomasson" <tomasson@xxxxxxxx>]

Dear Per:

Thank you for your message.

After a quick glance through it, I will now re-read it and insert comments
as and where they occur to me.

Gunnar


----- Original Message -----
From: Per Gunnar Berglund <BergP867@xxxxxxxxxxxxx>
To: <tomasson@xxxxxxxx>
Sent: Saturday, May 06, 2000 3:48 PM
Subject: Re: Keynes On Say's Law


> Dear Gunnar Tomasson,
>
> Thanks for your e-mail. I wish you would be more specific, though. It
> is hard to me to relate to your very general points. I will give it a
> try, hoping that the below points will be useful to you.

**********
In the "first round" of my exchanges with Ryan, I had made some very
strong - and purposely provocative - statements on Say's Law on the basis
of - for the most part implicit - epistemological considerations that
provided a common point of departure for classical economists of "first
rank".

That is, Quesnay, Smith, Say, Bentham, John Stuart Mill before mid-19th
century, with Schumpeter and the pre-General Theory Keynes regarded as 20th
century representatives of the classical tradition.

The epistemological pre-suppositions of the classical tradition so defined
were never clearly spelled out and  were effectively removed from the modern
economics research agenda after Samuelson's 'Foundations' had established
the primacy of neo-classical (mathematical) alternative to the classical
approach.

In the circumstances, I thought that a brief re-statement of the classical
viewpoint might, as it were, "shock" PKT Forum participants into recognizing
that Keynes effectively snookered his contemporaries as well as mainstream
and monetarist scholars in the second half of the 20th century into
misconstruing Say's Law.

**********
> The Smith passage strikes me as interesting, particularly the statement
> that money forms part of the capital of a nation. This view was
> subsequently replaced by the view that money, being a financial asset
> and therefore also a financial liability, 'cancels out' in the
> aggregate, leaving 'real capital' as the only true wealth of nations.
> Keynes clearly endorsed the 'old' Smithian view.
>
> Now, if it is true that money forms part of the net wealth of a nation,
> then it seems logical to treat money, like any other capital object, as
> a 'factor of production' (vide Keynes GT chapter 23 on Mercantilism,
> particularly the Heckscher quote on p.341). As a factor of production,
> an increase in the quantity of money would tend to increase the
> aggregate *supply* of output.

**********
In the context, Adam Smith analytical point equates "money" with "free
goods" - air, water, sunshine - which are equally essential for the
production process.

In other words - and this is a point which Gang8 regards as self-evident -
in the context of an analytical view of the production process, "money"
reduces to IOUs issued by "entrepreneurs" to suppliers of Factor Services at
one end of the process to be redeemed in Final Output at the other end.

As for the alternative - illogical - view of "money" as factor of
production, Samuelson arrived at the following conclusion in his analysis of
the "Keynesian system" in 'Foundations':

"...the only theorem which remains true under all circumstances is that AN
INCREASE IN THE AMOUNT OF MONEY MUST LOWER INTEREST RATES IF THE EQUILIBRIUM
IS STABLE."  (p. 283)

Earlier, Samuelson wrote as follows with respect to related issues:

"In this study I attempt to show that there do exist meaningful theorems in
diverse fields of economic affairs.  They are not deduced from thin air or
from a priori propositions of universal truth and vacuous applicability.
They proceed almost wholly from two types of very general hypotheses.  The
first is that the conditions of equilibrium are equivalent to the
maximization (minimization) of some magnitude.  Part I deals with this phase
of the subject in a reasonably exhaustive fashion.

"However, when we leave single economic units, the determination of unknowns
is found to be unrelated to an extremum position.  In even the simplest
business cycle theories there is lacking symmetry in the conditions of
equilibrium so that there is no possibility of directly reducing the problem
to that of a maximum or minimum.  Instead the dynamical properties of the
system are specified, AND THE HYPOTHESIS IS MADE THAT THE SYSTEM IS IN
"STABLE" EQUILIBRIUM OR MOTION.  By means of what I have called the
Correspondence Principle between comparative statics and dynamics, definite
operationally meaningful theorems can be derived from so simple a
hypothesis."  (p. 5)

It was with this "simple hypothesis" in mind that I observed in my recent
message on Stock Market Bubbles that they represent "reality mocking
mainstream and monetarist teaching that money is a factor of production" -
for, IF Samuelson's Nobel Prize-winning Correspondence Principle were worth
a nickle, THEN (a) an increase in the supply of "money" factor services
through the Stock Market SHOULD cause "lower" returns to investors, or (b)
"the hypothesis...that the system is in "stable" equilibrium or motion" is
"deduced from thin air."

**********
>
> With regard to this point, you might want to consider the definition in
> Keynes GT chapter 3 of 'effective demand' (p.25). Effective demand is
> really rather misleading a labelling, for on a close reading it turns
> out that 'effective demand' resides in the minds of the entrepreneurs,
> and that it characterises the considerations behind the decisions to
> employ a certain amount of productive resources. Now, the actual outcome
> of those employment decisions will generate a certain amount of output,
> which is thrown on the market. It is this output, I think, which is
> ordinarily considered as the 'aggregate supply' when talking about Say's
> Law. Clearly Keynes thought that the whole of this 'aggregate supply'
> would also be absorbed by the purchasing power generated by that
> employment (given that short-term expectations were right, which Keynes
> assumed, vide chapter 5 of the GT, p.47).

**********
It is fair surmise - or am I mistaken? - that the following, if submitted as
serious economics by a modern Ph. D. student - would be red-penciled and
returned for revision by his/her thesis advisor Anno 2000:

"...in a given situation of technique, resources and factor cost per unit of
employment, the amount of employment both in each individual firm and
industry and in the aggregate, depends on the amount of the proceeds which
the entrepreneurs expect to receive from the CORRESPONDING OUTPUT.  For
entrepreneurs will endeavour to fix the amount of employment at the level
which they THEY EXPECT TO MAXIMIZE THE EXCESS OF THE PROCEEDS OVER THE
FACTOR COST."

Not to put too fine a point on it, this strikes me as sheer gibberish!

For how can RATIONAL entrepreneurs "expect" that, "in the aggregate", some
GIVEN OUTPUT whose Factor Cost and "corresponding" Factor Income is X may,
perchance, yield Final Sale Proceeds of X + Y?

Samuelson, after pondering the question, finessed it in his Harvard Ph. D.
thesis as follows:

"It is quite clear that in the real world net revenue is NOT ZERO for all
firms, nor is it tending towards zero.  This is true under pure competition
as well as impure competition.  It is clear that THIS RESIDUUM MUST BE "DUE"
TO SOMETHING, and it may be labeled by any name we please (rent to
institutional advantage, etc.)." (p. 87)

Compare Schumpeter:

"I have not been able to convince myself, for example, that such questions
as the source of interest are either unimportant or uninteresting.  They
could be made so, at all events, only by the fault of the author."

I must leave at this for the time being.

Gunnar

**********
>
> What I am trying to say is that Keynes' rejection of Say's Law operates
> on a different level than Say's Law itself. 'Supply' in the immediate
> sense of throwing newly produced output on the market will surely
> 'create its own demand'. But the volume of output so thrown on the
> market is dependent on the state of the entrepreneurs' expectations.
>
> Next step must be to ask whether these expectations are correct or not
> (I don't want to say 'rational'!). In Keynes' GT (as distinct from e.g.
> the Stockholm School) they certainly are, per assumption, as far as
> output is concerned. But how about the factor markets?
>
> This, I think, is where the big quibbles appear: Some people would
> argue that the labour market does not 'clear' in Keynes. This gives rise
> to the obvious question why money wages do not collapse in the face of
> such imbalances? Here comes a host of arguments ranging from
> inflexibility due to tradition, fairness, trade unions, staggered
> contracts, 'money illusion', government regulation, etc. You have surely
> heard them all.
>
> These arguments have in common the weakness that they depart from the
> flexible free-market assumption of the classical theory. I feel
> uncomfortable with that. For if Keynes' message was that employment can
> and does fluctuate because money wages are inflexible, then he was
> surely 'saying nothing new' (GT, Preface, p.xxi). I think he was trying
> to say something else.
>
> My own opinion is that Keynes' assumed that the labour market does
> clear, and that 'clearing' is a prerequisite for 'equilibrium'.
> (Davidson thinks otherwise but I will let him speak for himself.)
>
> Keynes did a rather poor job in expressing this clearly, and the reason
> why it came out so muddled appears in GT, chapter 17, p.226, when Keynes
> defines the liquidity premium: 'There is, so to speak, nothing to show
> for this at the end of the period IN THE SHAPE OF OUTPUT'. This
> demonstrates that Keynes excluded the flow of (convenience) services
> from liquid assets, the 'liquidity services', if you wish, from his
> concept of output.
>
> Now, if one would re-define 'output' such as to include these
> intangible liquidity services, then money would contribute to output
> just like any other tangible asset; it would become a 'factor of
> production'. These liquidity services should also enter into the factor
> remunerations as the liquidity premium times the stock of money.
>
> All of a sudden the whole system 'adds up'. There is no need for any
> non-clearing of the labour market. One can indeed cast the whole thing
> in a general-equilibrium framework but still obtain fully 'Keynesian'
> results. Involuntary unemployment would have nothing to do with any
> inflexibilities or 'irrationalities' on the part of workers -- it would
> be an outcome of the fact that the money stock is too small.
>
> Full Employment would obtain when the money stock has reached the point
> of saturation, so that the 'marginal productivity (or efficiency) of
> money' has reached the zero level, at which point 'output as a whole'
> would reach the maximum attainable level given the endowments of real
> and human capital.
>
> Hope this makes sense!
>
> Best,
> Per