John Stuart Mill on Say’s Law

One of the most important and controversial principles originating from classical economics is the principle known as “Say’s Law,” or the fundamental law of markets. Although this economic principle can trace its roots back to Adam Smith, as its namesake suggests, it is generally credited to the political economist Jean Baptiste Say, who first stated this principle in his classic book, entitled A Treatise on Political Economy; or the Production, Distribution, and Consumption of Wealth ([1803] 1971). 

Stated briefly, Say’s Law postulates that the production of particular goods or services by one group of individuals (or firms) is the source of demand for other goods produced by other individuals (or firms). Therefore, there can be no inherent tendency in the market process toward a general “glut” or an economy-wide overproduction of all goods and services.Since the Great Depression, one of the greatest fears of capitalism is the prospect of mass unemployment due to the economy-wide oversupply of resources. For this reason, John Maynard Keynes centered his book around a frontal assault directed at Say’s Law, incorrectly stated in the following terms: “supply creates its own demand” (emphasis added; [1936] 1964: 19). So important was Keynes’s refutation of Say’s Law that, as he claims, the whole of classical economic theory “would collapse without it” ([1936] 1964: 19). 

 Given, however, that Keynes’s effort to discredit Say’s Law was centered more directly around John Stuart Mill’s account of Say’s Law quoted from Mill’s Principles of Political Economy, it is relevant here to clarify what was wrong about Keynes’s rendition of Say’s Law by clarifying what was right in Mill’s rendering of Say’s Law. Keynes quotes from Chapter IV, “Of Excess of Supply”, to suggest that Mill was arguing that markets instantaneously clear: 

While this is certainly a valid statement of the outcome that follows from Say’s Law, it implies that markets automatically clear based upon fully flexible and instantaneous price adjustment, or so Keynes claims Mill to have understood. However, this places Mill’s argument out of context by misdirecting attention away from the process by which markets tend to clear and eliminate economy-wide overproduction of all goods and services. Say’s Law, as Mill and the classic economists understood it, refers only to a general tendency in the market process that suppliers produce goods and services on the expectation that there will be a demand for their goods and services by suppliers other than themselves, and vice-versa. Stated differently, Mill was not arguing that supply creates its own demand in the sense that “supply of shoes creates demand for shoes. It means that supply of shoes creates demand for everything other than shoes” (emphasis original; White 2012: 144-145). The fact that suppliers produce based on expectations implies they could be in error that there will be a demand for their products, and Mill admits this much. If a supplier “has produced a thing not wanted, instead of what was wanted; and” if “he himself, perhaps, is not the kind of producer who is wanted,” then “there is no over-production; production is not excessive, but merely ill sorted” (emphasis added Mill 1848 [2006]: 573). 

What Keynes’s targeted passage from Mill also takes out of context is the role that money plays in Say’s Law for generating market-clearing tendencies. Say’s Law, according to Mill, does not preclude disequilibrium in markets, meaning an excess supply for some commodities and an excess demand for other commodities. But disequilibrium is not synonymous with general oversupply of all goods and services, once we account the fact that “money is a commodity” (Mill [1848] 2006: 572). “A general over-supply, or excess of all commodities above the demand,” according to Mill, “so far as demand consists in means of payment, is thus shown to be an impossibility” (emphasis added; [1848] 2006: 574). Thus, once we take into account that money is a commodity in demand like any other good or service, then we can understand that the source of “commercial crisis” (Mill [1848] 2006: 574) such as the Great Depression, was not a result of a general glut of resources, but an excess demand of money preceded by an unsustainable boom. As Mill states, “it is a great error to suppose…that commercial crisis is the effect of a general excess of production. It is simply the consequence of an excess of speculative purchases. It is not a gradual advent of low prices, but a sudden recoil from prices extravagantly high: its immediate cause is a contraction of credit, and the remedy is, not a diminution of supply, but the restoration of confidence” (Mill [1848] 2006: 574).