Say's Law or Keynes'?

If we can peel away the political posturing, there is an important argument in the issue of how best to generate a recovery in our country’s economy. Put simply, the question is whether producers (employers) are the answer and we should do everything we can to encourage them, or whether we should do something to encourage demand for their products.

Jean-Baptiste Say gets naming rights for the law that says that production will encourage demand and thus more production. Proponents of Say’s Law argue that producers can ramp up production which will in turn foster demand for those products, and that demand will flow to greater production elsewhere. The law assumes that business will not hoard capital funds, but will invest them in greater production. In today’s dialogue, when we hear calls to reduce business taxes or relieve business of the uncertainty or burden of government regulation, it is the ghost of Say who is speaking. This position holds that unfettered business will invest in more production and growth, and that will, in turn, generate new jobs and economic opportunity. It is roughly accurate to put the label of supply side economics with this group.

In the other corner is John Maynard Keynes. Keynes argued that the economy depends on the demand for goods and services, and that when necessary the government should encourage that demand through added spending or tax cuts. Keynes felt that encouraging demand, by placing more money in the hands of consumers, would stimulate businesses to ramp up production, which in turn increases employment. Today, Keynesian proponents argue for more government spending, and broad based tax cuts (not the kind of cuts targeted only at businesses).

Both approaches have some grounding in economic theory. The Keynesian approach has a better track record in real life, and there are signs in our current, sluggish recovery, that business is not following the assumptions built into Say’s Law. When President Hoover was faced with the early years of the Great Depression, his advisers followed the main stream economic thinking of the time, which was Say’s Law. In addition, main stream economic thought in the late 1920s/early 1930s felt that the economy was naturally cyclical and would eventually mend itself. Hoover pressed his political base, the producers and manufacturers, to ramp up production. They would have none of it.   President Roosevelt took his cue from Keynes’, adding government spending and employment to Federal policy, as a way to pump money into the hands of consumers, which then increased demand for goods and services. For the Great Depression, the Keynesian approach seemed effective while the Say’s approach was not.

Today, many commentators note that corporate America is sitting on large cash reserves, and that they are waiting for consumer demand to strengthen before investing in more production or growth. If that is the case, then more business tax cuts or incentive programs are not likely to speed up the recovery.

As students and citizens, we will do well to consider the conflicting economic theories at work here, and ignore the emotional baggage that hinders civil dialogue.

For my students, see how many of today’s economic issues you can find in this video and compare them to our look at the Great Depression.

Suddenly, everything old is New Deal again. Reagan is out; F.D.R. is in. Still, how much guidance does the Roosevelt era really offer for today’s world? The answer is, a lot. But Barack Obama should learn from F.D.R.’s failures as well as from his achievements: the truth is that the New Deal wasn’t as successful in the short run as it was in the long run. And the reason for F.D.R.’s limited short-run success, which almost undid his whole program, was the fact that his economic policies were too cautious.

In our macroeconomics class today we’ll be looking at FDR actions in response to the Great Depression. The president earned wide spread admiration for taking bold action to reverse the effects of the depression, yet the country stumbled in and out of recovery for 6-8 years afterwards. Krugman argues that FDR didn’t spend enough. This is a worthwhile read but not the full story.

But when Olivier Blanchard, the I.M.F.’s chief economist, was asked about the possibility of the world sinking into another Great Depression, he reassuringly replied that the chance was “nearly nil.” He added, “We’ve learned a few things in 80 years.”

Yes, we have. But have we learned what caused the Depression of the 1930s? Most important, have we learned enough to avoid doing the same thing again?

In a week or so we’ll look at the Great Depression in my Principles of Macroeconomics class. Just as geologists study earthquakes, economists and policy makers need to understand the Depression.

Mankiw places more emphasis on Roosevelt’s regulation of markets as a force that turned an ordinary recession into a depression. Bernanke points to the collapse of the banking system and the sharp reduction in money as the main culprit. Either way, these discussions are instructive.