The previous installment of “Economics for English Majors,” on the subject of comparative advantage and its role in producing gains from trade, emphasized the cooperative nature of the market economy: Cooperation in the form of specialization and the division of labor produces wealth and abundance beyond what each of us could do on our own, while an ethos of narrow self-sufficiency produces poverty and shortages. If you want to make a ham sandwich with no help from anybody else, be prepared to wait a long time for your croque-monsieur—turning seed grain into bread takes a long time—and be prepared for it to be the most expensive sandwich you’ve ever heard of.
In reality, even the most ruthlessly competitive capitalist is entirely dependent upon partners who produce the raw materials and tools he needs to do his work—and they, in turn, are dependent upon him for whatever it is he produces. Looked at with the right kind of eyes, capitalism is the opposite of the cartoon Social Darwinism of the anti-capitalist imagination—it is based on an understanding that we are, after all, in this together.
“That sounds a little too close to, ‘You didn’t build that!’” some of you protested. But if my presentation of comparative advantage sounded like goo-goo socialist horse pucky to you, wait until you hear about this week’s subject: Say’s Law, sometimes summarized (clumsily, in my view) as the principle that “supply creates its own demand.”
Like comparative advantage, Say’s Law is often misunderstood, and at times it is intentionally misrepresented by those who do not like its implications. Whether Say’s Law is coherent as a technical economic matter is, in fact, a lively issue, one that typically breaks down along tribal cleavages: Free-market types tend to be better disposed toward it, while capitalism-skeptical would-be social engineers reject it in part because it complicates their political ambition to follow a policy of “fine tuning” the economy, particularly through neo-Keynesian monkeying around with “aggregate demand.”
That kind of macroeconomic management is a tricky business: Our Federal Reserve is, for all of its many faults, one of the better central banks, and it has been generally effective in its responses to challenges such as the 2007-08 financial crisis (two cheers for the creature from Jekyll Island!). But even with its great expertise and genuine autonomy, it is a blunt instrument, one that is, for example, almost certainly about to push the country into a painful recession in order to counteract the current destructive inflation that is in part a result of earlier Fed intervention. Say’s Law implies that what really drives the economy is the supply side rather than the demand side—demand just sort of comes along for the ride.
What does it mean to claim that “supply creates its own demand”? What it doesn’t mean—though the misapprehension apparently is common—is that firms have the ability to simply exnihilate demand for their products into existence just by putting them on the market, possibly with the help of a crafty advertising campaign. If that were the case, there would be no failed products or failed companies, but products fail all the time: We Generation Xers remember the trauma of New Coke like it was our own D-Day. I’ll leave it to you younger readers to dig into the history of Clairol’s Touch of Yogurt Shampoo—and let’s just go ahead and meditate on the juxtaposition of “yogurt” with “shampoo” for a second here—for yourselves. (There are lots of examples: Business genius Ray Kroc thought McDonald’s needed a meatless burger to sell to Catholics during Lent—those were more observant times—and his first effort was the “Hula Burger,” which was a thick slice of pineapple and two slices of cheese on a hamburger bun.A local franchisee in Cincinnati had the better idea: the Filet-O-Fish, which even sounds Catholic.) Companies fail, too: In David Foster Wallace’s futurist novel Infinite Jest, Wayne Huizenga is still a Very Big Deal in the business world—but many of you readers will know his most famous endeavor, Blockbuster Video, only as a 1990s nostalgia totem.
Say’s Law doesn’t say anything about demand for specific products. What it says, rather, is that because human wants and desires become economic demand once you add income to them—once your desire for x is complemented by something you can trade for x—supply creates demand in the economic sense because production creates income. If you produce a widget, then you have created not only a widget but economic demand that is equal to the market price of the widget. You don’t do $500 worth of lawn work because you wish to create $500 worth of landscaping services but because you want to consume $500 worth of other stuff. Bob’s Tire Factory doesn’t produce tires because Bob wants tires—it produces tires because Bob wants a yacht.
As Thomas Sowell put it in his short book on Say’s Law:
The basic idea behind Say’s Law is both simple and important. The production of goods (including services) causes incomes to be paid to suppliers of the factors (labor, capital, land, etc.) used in producing the goods. The total price of the goods is the sum of these payments for wages, profits, rent, etc.—which is to say that the income generated during the production of a given output is equal to the value of that output. An increased supply of output means an increase in the income necessary to create a demand for that output.
It is an aggregate issue: If you create $1,000 worth of widgets, then you create $1,000 worth of income and, hence, $1,000 worth of demand in the economy. How that shakes out as a matter of large-scale economics and national economic policy is, as you might imagine, up for debate. Policymakers used to worry a lot about “general gluts,” meaning an oversupply of goods and services in the economy—too much stuff and not enough demand for that stuff. Say’s Law, the critics say, implies that a general glut is impossible, but such gluts have been (the same critics insist) observed. Again, much of the conversation ends up taking on a tribal quality: Some free-market true believers insist that any unhappy economic outcome must be the result of government intervention rather than the result of markets at work (this is the No True Scotsman Theory of Markets), while some market skeptics insist that “unfettered capitalism” (hooray for fetters?) must always produce disaster and catastrophe. One gets the distinct impression that the animating force in much of that discourse is not economics.
From my point of view, the interesting thing about Say’s Law is not what it tells us about central-bank policy or anything like that (these particular and complex policy concerns are far removed from the gorgeous certitude of anything that could be called a “law”) but the human side of the observation—that we produce in order to consume. Say’s Law is a variation on Adam Smith’s theme: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.” In an economy based on pillage, it pays to be strong; in an economy based on state control, it pays to be good at politics—sneaky, duplicitous, a flatterer. But in an economy based on free exchange, the only thing that pays is doing something for others. Economies based on free exchange (free trade is a subset of free exchange) force us to be, as Adam Smith observed, other-directed. A free-exchange economy forces us to take an interest in other people’s interests: in their desires, their needs, their priorities, their ambitions, even their moral and cultural aspirations.
That doesn’t always produce results that are good in the most meaningful sense. Yes, we probably have enough varieties of Oreos. There’s a great deal of effort being spent trying to figure out how to shove 800 grams of sugar into a 400-gram can of soda—real mission-to-Mars-level innovation and intensity—and there is plenty of market demand for products that are straight-up malum in se: We aren’t going to legalize child prostitution on the theory that Mr. Market is never wrong. The arguments against allowing certain kinds of goods or services into the marketplace aren’t usually economic arguments, or aren’t usually generally applicable economic arguments. (Some of those parochial economic arguments are less persuasive than they seem at first: You might think that having a strip club or a gigantic pornography emporium next door to your fancy shopping center would be bad for business, but it seemed to work just fine in Houston, where the zoning laws are about as assertive as my hairline.) And that’s fine—economic analysis is great for answering economic questions, but it isn’t the only kind of analysis, because those aren’t the only kind of questions. There is a world of difference between arguing that we shouldn’t have regular trade relations with the People’s Republic of China because it is governed by a brutal junta and arguing that we need 25 percent tariffs on Chinese-made tires because American consumers simply must be protected from the bane of low prices and choice.
Of course we draw moral lines, and other kinds of lines, too, related to prudence and order and other concerns. Those moral principles can be distorted, too: In my Texas hometown, the powers that be once used the local law governing sexually oriented businesses (meaning strip clubs and what we stupidly call “adult” bookstores and theaters) to stop a Hooters from opening in a location where some politically influential people just happened to not want to see a restaurant opened. But we should take some time to appreciate the moral consequences and moral character of a free-exchange economy, too: It directs our efforts, however imperfectly, away from force and guile and toward service, toward finding out what it is that other people need and want and trying to supply those needs and wants. That is in and of itself a powerful force for social harmony, a very important community good that is not generally well served by command-and-control economics and other arrangements based, however obliquely or politely, on domination.
An early biographer of the Puritan preacher Jonathan Edwards (famous for his “Sinners in the Hands of an Angry God” sermon) described him as having led a “holy and useful” life. The Puritans were big on being useful and were repulsed by idleness. But how should we proceed to follow that example? Holiness is beyond my remit here, but price signals are an excellent way of understanding precisely what it is other people value and to what extent they value it, showing us how to be useful to others in a practical way. Of course we labor in our own interest—the genius of a free-exchange economy is that it binds our interests to the interests of others. It is what makes us workers, traders, and entrepreneurs rather than pillagers, pirates, or commissars. We work for others even—especially—when we are working for ourselves.