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Say and Keynes compared.

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I’ve written many a post on Say’s Law, and on Keynes. [A search for those names here will give you the sources for what follows]. This time, we will compare Say’s explanation of a recession with Keynes’s version.

Let’s begin with a simple semi imaginary story.We assume an economy that is humming along happily. Everyone has a job, all factories are selling all their products, life is good. Then the very first problem shows up.

GM makes many many Chevy Volts, cars that have been reported to burst into flames while sitting in ones garage. People are not buying Volts, and GM is stuck with them.

We ask two economists, J.B. Say and J. M. Keynes, why nobody is buying the Volts.

“Because they don’t want to. Those cars have something wrong with them,” says Say.

“Because people are so rich they have more money than they can spend,” says Keynes. “They were thus certain not to buy something or other that was produced. Poor GM is an innocent victim of a deep flaw of Capitalism, that it makes people rich.”

Notice a key difference between these two explanations. Say thinks that if something is not selling, when everything else is doing just fine, that the reason lies in making something people dislike. Maybe it is of poor design. Maybe it is overpriced. Maybe people decided they just don’t need it anymore, like the end of a hula hoop craze. Maybe the manufacturer thought people would like it, but they don’t. [This last is related to the Austrian Business Cycle Theory, which explains why manufacturers would make such mistakes on a scale large enough to start a depression. But we digress.]

Keynes, on the other hand, thinks that if something is not selling, the problem is overproduction, or what is the same thing, not enough people buying a perfectly good thing at a perfectly good price, simply because people won’t buy everything when too much is being made.

Note that the disagreement between Say and Keynes is in the cause of the very first glitch. They agree on what will happen afterwards. GM workers will be laid off, so they won’t be able to afford that new stove, say, that they were going to buy, so stove makers will fire workers, meaning more unemployed leading to still more unemployed. In other words, a recession.

And when will this downward spiral of recession and unemployment finally stop?

According to Say, when the guys making things people don’t like find new jobs and start making things people do like. Absent govt meddling in the economy, this should happen relatively quickly.

According to Keynes, since the problem was too much wealth, the problem will end when enough people are poor. If we have enough permanent unemployment, then just enough stuff will be made that people can afford to buy it all. The economy will be humming, in the sense that everything made will be bought, but at a human price of massive permanent unemployment.

Of course, anyone with a heart would find the situation Keynes describes as unacceptable. Something must be done to find everyone jobs. And increasing production, so that these people will have jobs making the new stuff, is not the answer, because that will only start the problem of overproduction right back again.

Keynes’ solution was to hire everyone at a lower wage, thus making sure the economy as a whole stays poor, but everyone has a [low paying] job. He assumed that workers would resist a lowering of wages, so he recommended tricking them by causing inflation, which would reduce their purchasing power but not the dollar amount of their wages, thus keeping them poor without them noticing.

So far, we have pointed out the difference between Say and Keynes in two matters, how recessions start, and how they end. Now we’ll talk about what a concerned citizen should do when the country is in the midst of a recession.

According to Say, he should do all he can to increase production, so that the unemployed will get jobs producing. Since increased production requires something to work with, raw materials and so forth, he should do his part to not waste resources. In other words, he should consume less. He should also take the money saved by underconsumption and lend it to a businessman, who will use it to increase production.

According to Keynes, since the problem is underconsumption, he should consume more. He should spend as much money as possible, to make sure all those perfectly good things that were overproduced will get bought.

What applies to the citizenry applies to the govt as well. According to Say, the govt should do all it can to increase production. According to Keynes, they should do exactly the opposite, increase consumption.

In other words, we have two opposite visions of what should be done. Whichever choice we make, save or spend, one of these two economists will think we are doing exactly the right thing, and the other that we are making a bad situation worse.

Obama and Bernanke are betting that Keynes is right. They have been doing that for four years, losing all the time, and have just upped the ante. Now they are all in on the entire US economy. Good luck with that.


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