The Law

The first of the aggregates, growth, is the economy's long upward trend; the cycle is the deviation from it — the recurring lurch between boom and idleness that the trend's smooth ascent conceals. And the central scandal of the cycle, the thing a theory of it exists to explain, is involuntary unemployment: willing workers, ready to labor at the going wage, who cannot find work. To understand how this can happen, one must begin with the orthodoxy that held, for over a century, that it could not — the classical doctrine known as Say's Law, which taught that the economy can never suffer a general deficiency of demand, and so can never leave its willing workers idle for long. The cycle is the story of how that doctrine was overturned; and the doctrine must be understood before its overturning can be.

Say's Law is often compressed into a phrase: supply creates its own demand. The thought behind it is that production and the power to buy are two sides of one coin. When a thing is made, the making of it pays out income — wages to the workers, profit to the owner, rent and interest to the rest — exactly equal to the value of the thing produced; and that income is the power to buy. A man produces, in the end, in order to consume, whether the thing he makes or something else he will trade it for; so every act of supplying a good is, at bottom, the expression of a demand for some other good. It follows that the total demand in an economy must always match the total supply, for they are generated by the same act. There can be a glut of one good and a shortage of another — too many hats, too few shoes, a matter of proportion that prices will correct — but there cannot be a general glut, too much of everything at once, a want of buyers for goods in general. The economy, in the aggregate, cannot lack the means to buy what it has made, because making and the means to buy are the same thing.¹

From this premise flow the conclusions that made the cycle, and involuntary unemployment, seem impossible. If demand cannot fail in the aggregate, then output is limited only by the economy's capacity to produce, and the economy tends naturally toward full employment of its resources, labor included. Saving poses no threat to this, for saving does not destroy demand but merely redirects it: the income saved is lent out and spent on investment goods, the rate of interest adjusting to channel every dollar saved into a dollar invested, so that what is not spent on consumption is spent on capital, and total demand is undiminished. And unemployment, in such a world, can only be voluntary or frictional. If there were a surplus of workers — more hands seeking work than jobs to be had — the wage would fall, as the price of anything in surplus falls, making labor cheaper until employers found it worthwhile to hire the surplus, and the labor market cleared at full employment. A worker who remained idle, then, must be choosing leisure over the going wage, or briefly between jobs. Persistent, mass, involuntary unemployment — willing workers unable to find work at the prevailing wage, year upon year — was ruled out by the theory, as surely as a persistent surplus of any good whose price is free to fall.²

The policy that followed from Say's Law was laissez-faire, and in a slump, patience. If the economy is self-correcting — if it returns to full employment of its own accord whenever it is disturbed — then there is little for government to do, and little it can do, to manage the level of activity. In a downturn, the prescription was to wait for wages and prices to fall, which would restore the demand for labor and clear the market; to balance the budget and keep the currency sound; and above all not to meddle. Government spending to revive a slump was thought futile or worse, on the reasoning later called the Treasury view: that the funds for any public project must be borrowed from a fixed pool of national saving, so that every dollar the government spends is a dollar taken from private hands that would have spent or invested it — public spending merely crowding out private, with no net gain in demand or employment. This was the orthodoxy that governed economic policy as the world slid into the Great Depression: the conviction that the slump would cure itself, and that the worst thing to do was to try to cure it.³

Say's Law did not go wholly unchallenged. In the early nineteenth century, Thomas Malthus argued against David Ricardo that a general glut was possible after all — that demand could fall short of what the economy produced, that goods could go unsold for a want of buyers in the aggregate, and that an economy could sink into a prolonged state of gluttted markets and idle resources, its productive power running ahead of the demand to absorb its output. Ricardo and the weight of the profession dismissed him; Say's Law carried the day, and Malthus's dissent was treated as a confusion for more than a century. Yet Keynes, when he came to overturn the orthodoxy, would reach back and single out Malthus as the one classical economist who had seen the truth — who had grasped that demand might fail — and would lament that economics had followed Ricardo into a long detour, building an elegant theory of a world that could not slump upon a premise that the slumps of the real world refuted. The general-glut debate, seemingly settled in Say's favor, was only waiting for the event that would reopen it.⁴

The trouble, in the end, was the world. Economies did lurch into slumps; unemployment did rise to depths that no account of voluntary leisure or brief job-search could explain; and the slumps did persist, sometimes for years, without the self-correction the orthodoxy promised. The Great Depression brought the contradiction to a head: roughly a quarter of the workforce in the worst-hit countries was idle, men and women desperate for work at any wage, for year after year, and no recovery came. Say's Law said this was impossible — that the willing unemployed would price themselves back into work, that demand could not be deficient, that the market would clear. And yet there stood the breadlines, the shuttered factories, the willing and idle millions, in flat defiance of the theory. The doctrine that the economy could not suffer a general failure of demand had collided with a decade of exactly that. The cycle was the anomaly the orthodoxy could not contain, and explaining it would require dismantling Say's Law and building, in its place, a theory in which demand can fail and willing workers can stay idle. The next plate takes the first step, with the mechanism that gives demand its power over output: the multiplier.⁵

Say's Law was the orthodoxy the cycle had to overcome: supply creates its own demand, a general glut is impossible, the economy self-corrects to full employment, and involuntary unemployment cannot persist, for falling wages would always clear the labor market. From this followed laissez-faire and the futility of any attempt to spend a slump away. The doctrine reigned for over a century, dismissing Malthus's lonely dissent that demand might fail. But the cycle, and above all the Great Depression, was the anomaly it could not explain — willing workers idle for years, an economy stalled below its capacity with no self-correction in sight. The volume to come is the story of how economics learned to understand the cycle by abandoning Say's Law: by discovering that the economy as a whole can suffer a deficiency of demand, and can come to rest, indefinitely, with willing hands idle. The next plate is the multiplier.