Say’s Law, Government, and Unemployment

“Supply creates its own demand,” or so goes the popular interpretation of Say’s law. (More about that, below.) But if what you have on offer is not in demand by others, you are out of luck.

That is the point of Megan McArdle’s post, “The New New New Economy.” McArdle writes:

One of my first jobs out of school, way back in 1994, was as a secretary.  I’d be shocked to find that any of the executives at that organization still have secretaries–maybe the executive director, but maybe not even him.  Already at the time there wasn’t really enough for me to do; my boss had a secretary because, well, people in his position did.  That’s not because the work was being outsourced to Bangalore, but because computers and the internet were eliminating much of the coolie labor that secretaries used to take care of.  And of course, the recession is accelerating the pace of change–and leaving the people who are displaced fewer options to transition.

Government interventions that destroy jobs — the minimum wage, capital gains taxes, progressive taxation, etc. — exacerbate the problem because they prevent low-skilled workers (teenagers, mainly) from stepping onto the bottom rung of the employment ladder and eventually acquiring skills (or the money with which to acquire skills) that enable them to compete in an increasingly cyber-mated economy.

Which brings me back to Say’s law, explained succinctly by Steven Horwitz in “Understanding Say’s Law of Markets“:

Say was making the claim that production is the source of demand. One’s ability to demand goods and services from others derives from the income produced by one’s own acts of production. Wealth is created by production not by consumption. My ability to demand food, clothing, and shelter derives from the productivity of my labor or my nonlabor assets. The higher (lower) that productivity, the higher (lower) is my power to demand.

When a firm adopts a more productive technology — one that enables it to reduce the price of a product or service and/or offer a better product or service for the same price — the firm benefits and its customers and potential customers benefit. The firm can reap higher profits (if it is in a competitive position to do so) by “sharing” the productivity gains with customers through its pricing strategy. Customers and potential customers, by the same token reap the benefit of a better and/or less expensive product or service.

Who is made worse off? The workers whose skills are such that they cannot produce things that are valued by consumers. Or, if they can produce them, they cannot produce them as cheaply as, say, an automated system. And that system may well have been introduced because government policies of the kind mentioned above make it less profitable for firms to employ labor.

Whose “fault” is that? In a free-market economy, it would be no one’s fault; it would be what it is: an unfortunate subset of the populace lacking the wherewithal to produce what others want. It follows that governmental interventions have created a large (and growing) additional subset of the populace who could — and should — blame their fate upon the minimum wage; capital gains taxes; progressive taxation; regulations that restrict inputs, processes, and outputs; and all other government policies that discourage employment, saving, capital formation, and business expansion.

Related posts:
The Causes of Economic Growth
Economic Growth since WWII
A Short Course in Economics
Addendum to a Short Course in Economics
The Price of Government
Gains from Trade
Does the Minimum Wage Increase Unemployment?
The Commandeered Economy
The Price of Government Redux
The Mega-Depression
The Real Burden of Government
Toward a Risk-Free Economy
The Rahn Curve at Work
The Illusion of Prosperity and Stability
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
Competition Shouldn’t Be a Dirty Word
The Stagnation Thesis
America’s Financial Crisis Is Now
Money, Credit, and Economic Fluctuations
A Keynesian Fantasy Land
The Keynesian Fallacy and Regime Uncertainty
Creative Destruction, Reification, and Social Welfare
Why the “Stimulus” Failed to Stimulate
The “Jobs Speech” That Obama Should Have Given

2 thoughts on “Say’s Law, Government, and Unemployment

  1. Say’s Law is useful as far as it goes, but it certainty has limitations when apply to short-run fluctuations because it assumes a frictionless economy with no precautionary motive for money holding (alternatively, it assumes a frictionless barter economy). There are well documented frictions that can prevent a perfectly laissez-faire economy from behaving like a Say’s Law economy. I think we have good reason to believe these are important. I think it’s pretty obvious that there is an excess supply of workers, thus there must exist some friction that prevents Say’s Law from going through.

    In fact, your own argument is a bit strange if you buy into Say’s Law – as in Say’s Law world you would measure unemployment as zero. Regulations and taxes can’t cause persistent unemployment in Say’s Law world since employers could just reduce real wages (though they can reduce output), you have to assume some type of friction that prevents a large fall in real wages – in which case, we are outside Say’s world. I guess you can try to argue minimum wages create a legally mandated friction in the form of a wage rigidity, but this seems implausible given what a small fraction of the population is actually exposed to minimum wages.

    Anyway, to sum up, in order to have positive unemployment in equilibrium you have to have some frictions and Say’s Law assumes an explicitly frictionless world.


  2. I am relying on Horwitz’s interpretation of Say’s law, which strikes me as correct and not dependent on the assumption of frictionlessness. It seems to me that even with friction the value of a resource always depends on the value to consumers of the output of that resource. If the output loses value (perhaps going to zero) because the resource owner cannot adapt (e.g., acquire skills to restore the value of his labor to its former level) is that “friction” or the nature of the resource? I would say it’s the latter.

    In any event, my main point was that the kind of labor unemployment which results from Say’s law, as interpreted by Horwitz, is exacerbated by governmental interventions that render valueless (or depreciate) the otherwise valuable products of labor. I listed several legally mandated frictions — the minimum wage being the least of them — that cause underemployment and unemployment of labor and other resources. When government restricts inputs, processes, and outputs in real ways — as it does through regulation and taxation — it creates legally mandated forms of rigidity that effectively reduce the value of many resources (not just labor) because those resources cannot produce to their full potential.


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