On Say's Law [Was: Re: Outsourcing a plus for the US economy.?

[Gunnar Tómasson <gunnar.tomasson@xxxxxxxxxxx>]

Paul:

Re.. the following:

> This assertion that additional supply always creates its own additional
market
> demand is known as Say's Law which, as the famous economist John Maynard
> Keynes noted, assumes "that there is no obstacle to full employment".
Keynes
> demonstrated that Say's Law could not be applied  to money-using
> entrepreneurial economies and that full employment was not an automatic
> outcome
> of free market competition. Consequently, if there is anything  economists
> should have learned since Keynes, it is that one cannot prove that there
will
> be gains from free trade to be shared by all trading economies unless one
can
> be assured that there is full employment in all nations - before and after
> trade.

Comment:

The proposition that Say's Law implies "that there is no obstacle to full
employment" is rooted in the general-equilibrium construction of Say's Law
which appeared on the scene several decades after Say himself had struggled
to give it clear and coherent formulation.

The closest Say came to success in this respect was with a statement to the
effect that the fruits of production did not become "commodities" in his
sense of the term until they had been actually sold in the market.

In his survey article of the many (eight?) versions of Say's Law, Baumol hit
the nail on the head by commenting that with this reduced Say's Law to
"tautology".

As such, Say's Law is an ANALYTICAL proposition, whose REAL-world
applicability cannot in principle be decided on a priori grounds.

In his 1922 definition of "The Theory of Economics" which I have cited on
earlier occasions, Keynes (following in the footsteps of John Stuart Mill)
underscored this aspect of ALL such "theory".

In this respect, Keynes did ALL that was needed insofar as the question of
the real-world applicability and/or full-employment implications of Say's
Law was concerned with his advice of December 9, 1934 to Hicks that, in his
view, "Walras's theory and all others along those lines are little better
than NONSENSE."  (Skidelsky, 'The Economist as Savior', p. 615)

Why, then, did Keynes write in the General Theory AS IF the nonsense aspect
was insufficient to invalidate the general-equilbrium construction of Say's
Law?

The only plausible explanation that occurs to me is that Keynes was anxious
NOT to infuriate his general-equilibrium-practicing peers by dismissing
their stuff as "little better than nonsense".

Alas, Keynes did not live long enough to disabuse them and their successors
of the notion that denying the real-world applicability of Say's Law was
predicated on the use of money in entrepreneurial economies - that, given
the NONSENSE grounds for the contrary supposition in the first place, the
money aspect was besides the point.

Gunnar


----- Original Message -----
From: "pdavidso" <pdavidso@xxxxxxx>
To: <pkt@xxxxxxxxxxxxxxxx>
Sent: Thursday, February 26, 2004 8:22 AM
Subject: Outsourcing a plus for the US economy.?


> &#65279;Will Free Trade and Outsourcing of US Jobs Inevitably Increase the
> Wealth of All Nations?
>
>               Paul Davidson, Editor, Journal of Post Keynesian Economics
>
> Will outsourcing and the loss of US jobs ultimately lead to the benefit of
all
> nations as President Bush's economic advisor, N. G. Mankiw has declared?
> Mankiw is merely expressing the mainstream  economic theory that claims
that,
> over the long run, free trade in goods and services (including labor
services)
> results in more income and wealth for all nations. Even former US
President
> Bill Clinton at the recent Davos economic conference expressed this belief
> when he stated that anti globalization activists want to "take us back to
a
> time that never was, on a journey that cannot be effective.
>
> The economic theory basis for statements such as Clinton's and Mankiw's is
> what economists call "the law of comparative advantage". But what if this
> comparative advantage theory that  a completely free trade global economy
> results in income gains for all nations require logical conditions that
makes
> it inapplicable to the economic world in which we live?  It can be shown
> that this law of comparative advantage theory has  severe logical
weaknesses
> that makes applying policies based on it misleading and dangerous to the
US
> economy.
>
> A conventional textbook example will make the comparative advantage
argument
> readily comprehensible to the reader. In this example there are two
economies,
> the East [i.e., cheap labor countries like India and China] and the West [
> high cost labor countries such as  the United States]. Assume there are a
> million workers in the East and a hundred thousand workers in the West.
Each
> economy produces  two possible tradeable products - say bicycles (which
uses
> cheap unskilled labor) and computers (which requires skilled labor).  In
the
> absence of trade,  the global total of 1,100,000 workers  produce (and
> presumably their employers could profitably  sell) a global total of
375,000
> bicycles and 55,000 computers. After trade  each country specialises  in
> producing the products it has a comparative advantage, and the result it
is
> assumed is that globally the 1,100,000 workers would  produce 400,000
bicycles
> and 70,000 computers.
>
> It therefore follows that while employing the same number of workers
globally,
> as a result of free trade, the world has gained a total of 25,000
additional
> bicycles and 15,000 additional computers (even if the East has an absolute
> advantage in having an almost unlimited inexpensive supply of both the
> unskilled and skilled labor necessary for  producing bicycles and
computers).
> Consequently, the theory of comparative advantage "proves" that the real
> income of the global economy has increased, thereby providing more
potential
> income for every person in both East and West economies. In the face of
this
> textbook comparative advantage "proof the anti-globalization advocates and
> those who want the Bush Administration to take positive action against the
> outsourcing of jobs to China and India appear to be either the roar of
> ignorant fools who do not understand simple economics, or the voice of a
> coddled, protected (from competition) unionized Western labor force.
>
>  Unfortunately this comparative advantage analysis is based on unrealistic
> assumptions, e.g., under free trade, the hypothesized additional supply of
> 25,000 bicycles and 55,000 computers automatically creates its own
additional
> demand. (Wouldn't the multinational auto companies be glad to know that if
> they increase global productive capacity by siting plants in countries
that
> have comparative advantage in auto assemblies, then they will sell (at a
> profit) all the cars they can produce? There can never be surplus
capacity--as
> there seems to be today.)
>
> This assertion that additional supply always creates its own additional
market
> demand is known as Say's Law which, as the famous economist John Maynard
> Keynes noted, assumes "that there is no obstacle to full employment".
Keynes
> demonstrated that Say's Law could not be applied  to money-using
> entrepreneurial economies and that full employment was not an automatic
> outcome
> of free market competition. Consequently, if there is anything  economists
> should have learned since Keynes, it is that one cannot prove that there
will
> be gains from free trade to be shared by all trading economies unless one
can
> be assured that there is full employment in all nations - before and after
> trade.
>
>  That brings us to a second problem with applying this law of comparative
> advantage to today's global economy. Economic theory assumes that the
gains
> from trade due to comparative advantage occur only if neither capital nor
> labour are mobile across national boundaries. If capital is
internationally
> mobile - as is necessary if one is going to have business firms free to
> produce
> overseas (outsourcing) --, then the proof that  this "law of comparative
> advantage" assures there are gains from trade for all nations does not
> logically follow.  If  capital is freely mobile, marketable goods and
services
> will be produced wherever geographically it is most profitable, i.e.,
> where unit labour costs are lowest for producing bicycles and computers.
In
> such a world if foreigners have an ample supply of both unskilled and
skilled
> workers, outsourcing of all production of tradeable goods will be a
readily
> observable phenomenon.
>
> For example, if  the East has an absolute advantage in that it possesses
> unskilled and skilled workers whose unit labour costs are significantly
lower
> than labor costs of similar workers in the West, while the East has an
ample
> supply of workers to produce all  of the bicycles and computers that
global
> markets can absorb, then the East will attract sufficient foreign capital
from
> the West to hire domestic workers to produce all  the bicycles and
computers
> to meet demand in the global market. As a result, the East will experience
a
> tremendous surge in its growth in GDP. Production and employment in the
West
> will decline (or at best stagnate) and the West's labor force will become
> impoverished as either unemployment rates in the West rise dramatically,
or
> the
> West's workers are forced to accept a real wage that is competitive to
wages
> being paid to the abundant supply of unskilled and skilled workers in the
> East.
>
> Surely, politicians in the West should be more aware of what they are
> advocating for their domestic labor force before blindly accepting the
Clinton
> 's "inevitable journey" into an outsourcing free trade world. Instead
these
> politicians must recognize that indiscriminate application of the law of
> comparative advantage can be dangerous to the health of the West and
> perhaps even the global economy.
>
> Paul Davidson
> Editor, Journal of Post Keynesian Economics
> University of Tennessee
> SMC 503
> Knoxville, Tennessee 37996-0550
> office phone #;(865)974-3303; office fax#(865)974-4601
> home phone and fax # (561)369-1951
> email pdavidson@xxxxxxx
> http://econ.bus.utk.edu/Davidson.html
>