The cornerstone of Supply Side economic theory is Say’s Law. The commonly used shorthand for it is that “supply creates its own demand,” which encapsulates the primary notions of what we know of supply side economics today in a few words.
The problem is, the encapsulation above ISN’T what Say’s law says at all, and further, what Say actually says has been grossly misunderstood by proponents of supply side economics, which has perpetuated a series of myths and fantasies about economics that persist to this day.
I’ll deconstruct what’s wrong the shorthand interpretation of Say’s Law first, then move to what’s wrong with supply siders’ interpretations of what Say said, then finally move into what Say actually said and what it means.
My major hope in doing all of the above is that I don’t muddy the waters further, but we’ll see how it goes.
First, let’s take a look at the shorthand phrase above (“Supply creates its own demand,”) and compare that to what Say actually said:
He said that “…products are paid for with products.” and “…a glut can take place only when there are too many means of production applied to one type of product, and not enough to another.”
That’s a fairly different thing than “supply creates its own demand,” because the products used to pay for other products don’t have to have anything to do with one another, whereas in a supply/demand relationship, there is…well, a relationship. A connection. If the thing supplied doesn’t meet the demand that has become known, then there IS no economic activity in the latter case.
If I need shoes, and you’re selling lighter fluid, we don’t have a match, and my need for shoes isn’t going to make me magically more likely to buy your lighter fluid.
On the other hand, if I work at a factory making, say, tennis rackets, and someone, somewhere out in the world is buying them then I’ll have the money to buy shoes, and maybe lighter fluid too, if I need some for a cookout or something. Indirectly then, the tennis rackets I’m making are buying the shoes I need. And lighter fluid, and whatever else.
That’s what Say is actually saying.
People make stuff, in order to get money (the intermediate step, converting the stuff I make into a common medium of exchange) to buy the stuff they need. Given today’s more service oriented economy, we can safely swap “People make stuff,” with the more inclusive “People contribute something that has perceived value,” to better capture how Say’s Law works in a modern economy. Thus, a person who gets money by blogging would still be included in the definition, whereas he would be excluded for lack of producing a tangible end product, in Say’s original phrasing.
That’s both very true and fairly self-evident. On its face, there’s nothing radical or alarming about Say’s Law. What is radical and alarming is how proponents of “supply side economic theory” have interpreted the key components of what the man said.
The reason the shorthand phrase I mentioned above “works” in terms of encapsulating Say’s law isn’t because it accurately portrays what the man said, but rather, because it accurately captures how the supply siders have chosen to interpret what the man said.
To listen to a supply sider ramble on about his pet “theory,” supply is the Master of the Economic Universe. A virtual “build-it-and-they-will-come” paradise.
The way out of any economic tailspin, they say, is simple.
Ramp up production, and demand will surely follow.
This is the reason for the insistence on tax cuts for the “job creators.”
It supposedly frees up capital that they will then use to increase supply, which in turn, will automagically increase demand, which will shake the economy out of its doldrums.
If this strikes you as just a shade absurd, that’s because it is.
If economics were as simple as increasing supply at every turn, and this was the magic bullet that led to increased demand, there would be no need for marketing, except as a function of letting the public know where certain goods could be located (Newsflash! A new shipment of patio furniture has arrived at the WalMart Superstore on Highway 8!). “Brand” would be utterly without meaning or purpose.
For that matter, the particulars of the product would be irrelevant as well. I could, for example, invent a recipe for cat vomit cookies (I have two cats with temperamental digestive tracts to help with my initial supply). Assuming my management team was competent, in a supply side universe, there’s no reason to think I would not sell all I could manufacture. Ramp up my production to ten thousand a day, and the demand will materialize.
Expand it to a hundred million a day, and demand follows suit.
Get all kinds of crazy and expand production until I’m making two and a half quadrillion cat vomit cookies per day, and…you guessed it. Demand would obediently follow suit (note that two quadrillion cat vomit cookies per day is probably sufficient to cover the entire earth’s surface, using a 3″ diameter cookie cutter like the one I have in the kitchen).
The trouble is (obviously), cat vomit cookies probably don’t taste all that good. So why would anyone buy them at all, much less buy two quadrillion of them?
And the answer is (also obviously) that they wouldn’t.
In thinking further about supply side nuttery, it becomes obvious though, that in a supply side world, the only possible reason that a business can fail is if the management team is incompetent. Since the product does not matter, the only variable left to chance is the quality of the management team. If they can’t motivate their employees, and handle the supply chain appropriately, then of course, there will be problems. The question is, does anybody actually think this tracks even remotely closely to reality?
I’m not sure how anyone could, which leads me to believe that what we really have are a lot of people with a tenuous grasp of economics, repeating talking points they’ve heard from trusted sources, without actually thinking them through, because the moment you point out stuff like the above to a supply sider, they are aghast and start sputtering that the above isn’t “really” what they mean when they say they’re supply siders (but also, they struggle mightily to explain what they do “really mean,” and universally, in my experience, give up trying in frustration).
So let’s return to what say actually said, and see where the supply siders went astray.
“…products are paid for with products.”
That’s certainly true, and implicit in that relationship is the primacy of demand, not supply.
What I mean is this. The products you make in order to buy the stuff you want and need that other folks make….in order for you to sell them, it is understood that there must be demand for whatever it is you’re making.
Otherwise, you wouldn’t stay in business for very long making them, and this unspoken portion of Say’s Law is the part that today’s supply siders miss.
Far from announcing the supremacy of supply in the economic equation, Say merely reinforces supply’s dependency on demand.
In order for you to get the products you want and need, you have to produce products yourself. But it does you no good to produce mud pies in your back yard (or cat vomit cookies) if nobody wants (demands) what you are making.
Thus, even according to the Godfather of Supply Side “theory” (and I use the term loosely), demand still reins supreme.
Very sad how such simple words have been corrupted, and their meaning so badly mangled.
This is the first part of a two part article series. In the next installment, I’ll outline the specific instances that supply side theory can (and does) make sense. Within the context I’ll outline in the next article, supply side theory certainly works. This does not, however, mean that it is scalable to the economy as a whole, as I’ll demonstrate.