Econ 307
Lecture Seven - The French Liberal School: Say and Bastiat
Jean-Baptiste Say (1767-1832)
Life: Born in Lyons, France to middle-class parents – during his lifetime he was a journal editor (of La Decade Philosophique - a pro free-market publication), operated a cotton factory, and was a politician. He was the first to teach a course on political economy in France and continued his stay in academics at the Conservatoire des Arts et Metiers, and then at the College de France in Paris. Both Malthus and Ricardo were his friends. Died in Paris.
Most famous work: Treatise on Political Economy: or the Production, Distribution and Consumption of Wealth (1803) – also interesting were his letters to Malthus. All of the quotations below are from his Treatise.
He has been overlooked (as we have said about other French men) – but was extremely important. As part of the French liberal school – he was devoted to laissez-faire principles all of his life.
Classical School and Smith: Although Say is known as one of the Classical economists – as following Smith – he did disagree with Smith on a number of important points. Instead of thinking of Say as a variation on Smith – we should probably think of him as going down a different path in classical economics than Smith did.
As we discussed before Smith leads one to David Ricardo, John Stuart Mill, Alfred Marshall, Irving Fisher, John Maynard Keynes, and Milton Friedman.
Say leads from A.R.J. Turgot and Richard Cantillon to Frederic Bastiat, Nassau Senior, Carl Menger, Ludwig von Mises and F. A. Hayek.
Money:
Double Coincidence of Wants: Say recognized the "double coincidence of wants" problem and how a medium of exchange solves it:
Spontaneous Evolution: Say’s explanation of how one highly demanded commodity spontaneously evolves into an accepted exchange medium is reminiscent of Carl Menger's more famous treatment (which we will discuss later) of the same issue, although it predates Menger by almost seventy years.
"[C]ustom, therefore, and not the mandate of authority, designates the specific product that shall pass exclusively as money."
He then reviews a list of five properties a medium of exchange should (ideally) possess:
1.
2.
3.
4.
5.
He then concludes that the precious metals (gold and silver) are excellent choices as monetary substances. In other words, if individuals are left free to choose, it is highly likely that they will choose a commodity money (specie).
According to Say, the only justifiable intervention by the state into monetary matters is the minting of coins. Money is ruled by supply and demand, just like all commodities. Money's purchasing power "rises and falls in proportion to the relative demand and supply."
As you saw in your reading: it is not the scarcity of money that causes problems in an economy -- it is the lack of productivity. Money is only a medium of exchange, it is not the object of exchange per se.
"For, after all, money is but the agent of the transfer of values. Its whole utility has consisted in conveying to your hands the value of the commodities, which your customer has sold, for the purpose of buying again from you; and the very next purchase you make, it will again convey to a third person the value of the products you may have sold to others."
Division and specialization, money and growth: Say emphasizes that as the division of labor extends ever farther than Smith recognized, horizontally and vertically, through the society, that is, as individuals specialize ever more, the number and the importance of exchanges will increase. And this requires an identifiable medium of exchange. Therefore, money is an integral part of the rise of modern civilization.
Horizontally: More competitors (more specialization at the same level of the production process) -
Vertically (now called vertical disintegration): Spin off or increase specialization in the same line of production -
Banking: Say distinguishes between "banks of deposit" and "banks of circulation," but treats them both as legitimate institutions.
Bank of deposit:
Bank of circulation:
Say’s Law of Markets
The one thing for which Say is best known is "Say's Law," also referred to as his theory of markets (la theorie des debouches) or law of markets (loi des debouches).
In many ways – it can be seen as essential to any defense of markets – so those who support Say’s Law (some version of it) typically support free markets. But also can be seen as the way to really understand how markets or the economy actually works.
Believing that Say's analysis was correct vs. Keynesian economics can be seen as the largest divide among economists.
Most textbooks truncate Say's Law into the phrase "supply creates its own demand" (which was actually first termed by James Mill, not Say).
Perhaps a better way to state it is: "aggregate supply creates its own aggregate demand," because the claim is not that the production of commodity X necessarily results in an equivalent demand for X, but that the production of X leads to demand for commodities A, B, C, and so forth. The production, or supply, of commodities (and complementary services) in general leads to the consumption of, or demand for, commodities (and complementary services) in general.
People really trade production for production. One must produce first in order to have the means to buy someone else's production -- whose production enables them to have the same means.
Be careful -- for someone to have an actual demand for a good one must have both the want and the ability to buy. To Say, the want gives value to certain goods - but one can value something but not have the means to buy it. Productivity gives people that means.
So there is a difference between wants and demand.
It is certainly possible for there to exist either a shortage or a surplus of any particular commodity, but general overproduction or general underproduction can only exist in the short run (at least that is how he has been interpreted by some).
"I answer that the glut of a particular commodity arises from its having outrun the total demand for it in one or two ways; either because it has been produced in excessive abundance, or because the production of other commodities has fallen short.
If it is due to excessive abundance - Say explains that the price will fall to correct this glut in the market. This is a market correction. How long it will take is not clear.
On the other hand, if it is because the production of other commodities has fallen short -- this is Say's law -- it is because there hasn't been enough productivity to generate the means to buy.
In the long run -- if there is imbalance that persists, it is due to something outside of the market -- government or a natural disaster of some kind.
"It is because the production of some commodities has declined, that all other commodities are superabundant," and such maladjusted production results from "some violent means . . . a political or natural convulsion."
It is important to note that one can have a general agreement with Say’s Law – but not agree with the “equilibrium” aspect that many have attributed to it.
So remember, the "equilibrium version" via our old friend the circular flow diagram:
Say identifies two means by which the corrective process operates if demand is less than supply.
1. Savings and Investment:
Each market will adjust accordingly. Those markets that are profitable will see an increase in investment. Those that are not, will see a decrease. Savings will lead to more investment, more productivity and then more demand. He was micro oriented - although is not often given that credit.
2. General Fall In Prices:
Prices will simply fall in order to increase demand. S = D
Not only does this circumstance (more production relative to demand) indicate, contrary to popular belief, "that a country is rich and plentiful," but also that "products formerly within reach of the rich alone have been made accessible to almost every class of society."
Again, productivity is the key to a prosperous economy -- and the way to increase the standard of living for the relatively poor.
Even if one hoards money or buries it, "the ultimate object is always to employ it in a purchase of some kind," so there still cannot be deficient demand as long as real economic values are being produced. In order for consumers to exist, there must first be producers.
On the Entrepreneur
Some say that Adam Smith made the entrepreneur invisible (the invisible hand theory was too macro or general), while J.B. Say brought him or her back to life and even to the center of market theory. Of course - as we know - the entrepreneur was alive and well in both Turgot and Cantillon.
Say’s entrepreneur uses their “industry” (Say used this term instead of labor - as did Turgot) to organize and direct the factors of production so as to achieve the "satisfaction of human wants."
But they are not merely managers of resources. They are:
1. He agreed with Cantillon and Turgot:
2.
3.
Out of their own financial capital, or that borrowed from someone else, they advance funds to the owners of labor, natural resources ("land"), and machinery ("tools"). These payments, or "rents," are recouped only if the entrepreneurs succeed in selling the product to consumers.
Entrepreneurial success is not only sought after by the individual, but also essential to the society as a whole.
"[A] country well stocked with intelligent merchants, manufacturers, and agriculturists has more powerful means of attaining prosperity, than one devoted chiefly to the pursuit of the arts and sciences."
Capital and Interest
Say's use of the word "capital" can be confusing, because it is used to mean, as the context requires, either
(a) capital goods -
when combined with the industry of the entrepreneur - generates profit or loss.
(b) financial capital -
result of saving some portion of the income from the past productive activity and generates interest.
Interest: Say’s analysis of interest rates is very perceptive. He speaks of what we now call the real rate of interest -
First: Say realizes that the interest rate is not the price of money, but the price of credit, or "capital lent." Therefore, what does the lender lose by not using the money himself? So he does have a vague notion of opportunity cost here -- but not really of time preferences. This is the price of credit.
Therefore, it is false that "the abundance or scarcity of money regulates the rate of interest." Of course, Say is thinking of the real rate of interest, not the nominal, or market, rate. So he doesn't think interest comes from a simple loanable funds theory.
Remember: the real rate of interest + the expected rate of inflation = nominal rate of interest. The amount of money in the economy will affect the nominal rate, but the not the real rate.
Second: He also clearly sees that interest rates will include some risk premium as a sort of insurance to protect against loss due to default. Such a risk premium will become very large when, for example, laws are imposed so that creditors have no legal recourse against a debtor who defaults.
Third: Say identifies the fact that there are "political risk" differentials between nations that lead to an international array of nominal interest rates – and differences in investment across countries.
So his policy on interest rates: the same stance with regard to credit markets that he exhibits elsewhere: the government should not get involved.
The "rate of interest ought no more to be restricted, or determined by law, than . . . the price of wine, linen, or any other commodity."
The Labor Theory of Value
For Say, the foundation of value is utility or the capacity of a good or service to satisfy some human desire.
Those desires and the preferences, expectations, and customs that lie behind them must be taken as givens, as data, by the analyst.
Say is most emphatic in denying the claims of Adam Smith, David Ricardo, and others that the basis for value is labor. According to Say, economists who subscribe to a labor theory of value have the theory exactly backwards.
"[I]t is the ability to create the utility . . . that gives value to productive agency." (the derived demand theory). Wants give value to goods.
To Say, the two categories of value are:
1. exchange-value
. . . "[t]he only fair criterion of the value of an object is, the quantity of other commodities at large, that can be readily obtained for it in exchange."
Those things which possess exchange-value would today be called "economic goods," or scarce goods but Say calls them "social wealth."
2. use-value
These are now known as "free goods," or non-scarce goods but Say labels them "natural wealth."
Equal Values? Here we go again!!
Unfortunately, Say plunges into what most economists today would consider an error. He concludes that since the measure of a good's economic value is literally and precisely its market price, then all market transactions must involve the exchange of equal values. This, of course, must imply that neither buyer nor seller gains. Or, in other words, all market transactions are a "zero-sum game."
"When Spanish wine is bought at Paris, equal value is really given for equal value: the silver paid, and the wine received, are worth one the other."
Say believed that self-interest and the search for profits will push entrepreneurs toward satisfying consumer demand (here is where he agreed with Smith).
"[T]he nature of the products is always regulated by the wants of society," therefore "legislative interference is superfluous altogether."
On monopoly privileges that some want on the grounds of “national security” : Say answers that this is so only if "it is an advantage to one nation to domineer over others. . . . The love of domination never attains more than a factitious elevation, that is sure to make enemies of all its neighbors. It is this that engenders national debt, internal abuse, tyranny and revolution; while the sense of mutual interest begets international kindness, extends the sphere of useful intercourse, and leads to a prosperity, permanent, because it is natural."
Does Say's insight hold today?
This quotation reveals how well Say believed in the proposition that free trade and peace go hand in hand.
As for taxation, Say divides it into two types:
1. Direct:
2. Indirect:
Regardless of its specific form or method of collection, "all taxation may be said to injure reproduction, inasmuch as it prevents the accumulation of productive capital."
Therefore, according to Say, "[i]t is a glaring absurdity to pretend, that taxation . . . enriches the nation by consuming part of its wealth."
But what about: from a statistical standpoint, prosperity and taxation may be positively correlated.
Say explains that such assertions commit the error of reversing cause and effect.
That is, "[a] man is not rich, because he pays largely; but he is able to pay largely, because he is rich." In other words, Say believed that prosperous nations, if they remain prosperous, do so despite heavy tax burdens, not because of them.
If you read Say's Treatise you will notice that the discussion of taxes and government appears in the section headed "consumption." This is because Say identifies government spending as "unproductive consumption." And "[e]xcessive taxation is a kind of suicide."
In Summary:
Say should be known for a lot more than his law of markets. But that theory does set economists apart even today. I would say it is THE major distinction between economists -- productivity drives an economy vs. demand!
Frederic Bastiat (1801-1850)
The Setting: The so-called Laissez-faire school in France during the nineteenth century was very dominant and influential. It even permeated the popular culture - finding its way into novels and plays. The ideas of the harmony of interests, trade being mutually beneficial and that free markets brought general prosperity were all popular. These were basically writings by workers on how the free market benefited them.
One of the most influential of his time was Claude Frederic Bastiat. Although forgotten by much of mainstream economics, he was a lucid and brilliant writer. His influence eventually spread beyond France.
Bastiat's Life: Bastiat was orphaned at age ten, and was raised and educated by his paternal grandparents. When his grandfather died, Bastiat, at age twenty-five, inherited the family estate, which enabled him to live the life of a farmer and scholar for the next twenty years (mostly scholar). He was fluent in English, Italian and Spanish (besides French).
His publications: Economic Sophisms (1845) a collection of witty essays on protectionism and government controls, sold out quickly, going into several editions, and was swiftly translated into English, Spanish, Italian and German.
Also, his Selected Essays on Political Economy - including the most popular essays, "The Law" and "What is Seen and What is Not Seen" (1848), and of course Economic Harmonies (1850) - his two volume theoretical magnum opus, only partially published upon his early death - but was published posthumously.
He was an avid reader and was most heavily influenced by Say, partially by Smith, by Destutt de Tracy, and a libertarian Charles Comte (A Treatise on Legislation, 1827).
Bastiat's first published article appeared in April of 1834. It was a response to a petition by the merchants of Bordeaux, Le Havre, and Lyons to eliminate tariffs on agricultural products but to maintain them on manufacturing goods.
Bastiat praised the merchants for their position on agricultural products, but criticized them for their hypocrisy in wanting protectionism for themselves.
"You demand privilege for a few, whereas I demand liberty for all."
He then explained why all tariffs should be abolished completely.
Bastiat continued to hone his arguments in favor of economic freedom in most of his essays. Although he is not credited by many historians of thought as adding any original theory to our body of knowledge (although some disagree) – he is credited for having put certain theories in understandable language – as well making economics fun to read.
Bastiat's Ideas
Economic Harmonies
While Bastiat was writing in France, Karl Marx was writing Das Kapital, and the socialist notion of "class conflict" that the economic gains of capitalists necessarily came at the expense of workers was becoming popular.
Bastiat's Economic Harmonies explained why the opposite is true - that the interests of mankind are essentially harmonious if they can be cultivated in a free society where government confines its responsibilities to suppressing thieves, murderers, and special-interest groups who seek to use the state as a means of plundering their fellow citizens. In this way, he was also a leader in the ideas of Public Choice theory.
His Main Contributions:
Wants Drive Economic Activity - Not Production:
He built upon Say's insistence that all market resources were "productive", and that income to productive factors were payments for that productivity. Therefore, Bastiat said that "value is measured by services rendered, and that products exchange according to the quality of services stored in them." Here, talking about subjective value as being the reason that people trade and where the value of resources comes from -- the consumer.
He continually emphasized that consumption was the goal of economic activity. His often repeated triad was:
Wants -
Efforts -
Satisfactions.
Wants are the goal of economic activity, giving rise to efforts, and eventually yielding satisfactions. Furthermore, he noted that human wants are unlimited, and hierarchically ordered by individuals in their scales of value.
So he said, "it is necessary to view economics from the viewpoint of the consumer. . . . All economic phenomena . . . must be judged by the advantages and disadvantages they bring to the consumer."
So his focus on exchange, instead of simply production, was itself a contribution.
Capital Theory (going along with Economic Harmonies - that markets and capital accumulation are good for everyone, including workers!)
Bastiat contributed to capital theory by explaining:
1. How the accumulation of capital results in the betterment of the workers:
2. How the accumulation of capital results in cheaper and better quality consumer goods:
3. How the interest on capital declines as it becomes more plentiful:
Thus, the interests of capitalists and labor are harmonious, not antagonistic, and government interventions into capital markets will impoverish the workers as well as the owners of capital.
Bastiat also explained why in a free market no one can accumulate capital unless he uses it in a way that benefits others, i.e., consumers.
Subjective Cost and Revealed Preference Theory
Bastiat viewed economics as "the Theory of Exchange" where the desires of market participants "cannot be weighed or measured. . . . Exchange is necessary in order to determine value." Thus, to Bastiat, value is subjective, and the only way of knowing how people value things is through their demonstrated preferences as revealed in market exchanges.
Voluntary exchange, therefore, is necessarily mutually advantageous.
So to many, this was an important theoretical innovation in the history of economic theory - the understanding that value is created by voluntary exchange, when so many others before him (Smith, etc.) and Marx during his time harped on the labor theory of value
The Broken Window (opportunity cost analysis)
Bastiat's greatest contribution to subjective value theory was how he applied the theory in his essay, "What is Seen and What is Not Seen." Where he pointed out that there are unseen parties and both short and long term effects of government policy (and other economic happenings). A good economist – to Basitat – is one that can point to these unseen parties and to the long term effects of things.
Have you ever been witness to the fury of that solid citizen, James Goodfellow,*1 when his incorrigible son has happened to break a pane of glass? If you have been present at this spectacle, certainly you must also have observed that the onlookers, even if there are as many as thirty of them, seem with one accord to offer the unfortunate owner the selfsame consolation: "It's an ill wind that blows nobody some good. Such accidents keep industry going. Everybody has to make a living. What would become of the glaziers if no one ever broke a window?"
Basically he had three levels of economic analysis:
1. First-level - common sense. The destruction of property in breaking the window is not good. So people have sympathy for the store owner.
2. Second-level - sophisticated analyst or what Rothbard calls a "proto-Keynesian" analysis. Destruction of property, by compelling spending, therefore stimulates the economy and has an invigorating "multiplier effect" on production and employment.
3. Third-level - the economist. Vindicates common sense and refutes the theory of the sophisticated analyst. Here is where he considers what is seen and what is not seen!
It is basically the best application of opportunity cost analysis that one can provide.
In that essay, Bastiat, by relentlessly focusing on the hidden opportunity costs of resource allocation, criticized the idea that government spending can create jobs and wealth, war is good for the economy, technology destroys jobs, protectionism is good for the economy, etc..
Political Economy - Government
Bastiat is perhaps best known for his work in the field of political economy - the study of the interaction between the economy and the state as opposed to pure economic theory.
"The state is the great fictitious entity by which everyone seeks to live at the expense of everyone else." "The Law"
While establishing the inherent harmony of voluntary trade, Bastiat thought that governmental resource allocation is necessarily antagonistic and destructive of the free market’s natural harmony. Since government produces no wealth of its own, it must necessarily take from some to give to others – this is the essence of government to Bastiat.
Also, as special-interest groups seek more and more of other people’s money through the state, they undermine the productive capacities of the free market by engaging in politics rather than in productive behavior (again the unseen losses).
Majority Vote and Morality:
Government was necessary, according to Bastiat, but only if restricted to its "essential" functions (protecting life, liberty and property).
“No society can exist unless the laws are respected to a certain degree," but at the same time that could only occur if the laws themselves were respectable.
Majority vote (or a law decided on this basis) cannot be justified on moral grounds -- because "since no individual has the right to enslave another individual, then no group of individuals can possibly have such a right."
All income redistribution through majoritarian democracy is therefore "legal plunder" and is, by definition, immoral.
Following Say - The slogan, "if goods don’t cross borders, armies will," is often attributed to Bastiat because he so forcefully made the case that free trade was perhaps the surest route to peace as well as prosperity.
He understood that throughout history, tariffs had been a major cause of war.
Free Trade and Peace
In Economic Sophisms, Bastiat created the most complete case for free trade ever constructed up to that time, which applied such economic concepts as:
1. the mutual advantage of voluntary trade,
2. the law of comparative advantage (which we will go over under Ricardo),
3. the benefits of competition to the producer (and worker) as well as the consumer,
4. and the historical link between trade barriers and war.
Free trade, Bastiat explained, would mean "an abundance of goods and services at lower prices; more jobs for more people at higher real wages; more profits for manufacturers; a higher level of living for farmers; more income to the state in the form of taxes at the customary or lower levels; the most productive use of capital, labor, and natural resources; the end of the "class struggle" that . . . was based primarily on such economic injustices as tariffs, monopolies, and other legal distortions of the market; the end of the "suicidal policy" of colonialism; the abolition of war as a national policy; and the best possible education, housing, and medical care for all the people."
Bastiat was a genius at explaining all these economic principles and outcomes by the use of satire and parables, the most famous of which is "The Petition," where he very cleverly asked the government to prohibit the sun because it was unfair competition to those who make lights.
Another of Bastiat's most memorable satires is his criticism of the protectionist argument that a "balance of trade" is necessarily desirable.
A French merchant is said to have shipped $50,000 worth of goods to the U.S., sold them for a $17,000 profit, and purchased $67,000 worth of U.S. cotton, which he then imported into France. Since France had therefore imported more than it exported, it "suffered" an "unfavorable" balance of trade. A more "favorable" situation would have been one where the merchant attempted a second transaction in the U.S., but had his ship sunk by a storm as it left the harbor. The customs house at the harbor would therefore have recorded more exports than imports, creating a very "favorable" balance of trade. But since storms are undependable, Bastiat reasoned, the "best" policy would be to have the government throw all the merchants goods into the sea - thereby guaranteeing a "favorable balance of trade.”
Bastiat's Legacy:
At his time he was extremely influential across Europe. He formed a free trade association and because of his ideas, free trade associations rapidly established themselves in various countries in Europe. Examples include Belgium (follower Charles de Brouckere), Italy (Francesco Ferrara - a professor of political economy at the University of Turin) and Sweden (Johan August Gripenstedt and G. KI. Hamilton, professor of economics at the University of Lund - even named his son "Bastiat"!).
Today, Bastiat's legacy is still carried forward in some circles (mostly Austrian economics circles), not mainstream economics.
Deb's Commentary: I think it is sad that many contemporary economists seem to believe that the act of communicating economic ideas -- especially economic policy ideas --to the general public in the style that Bastiat did is somehow unworthy of a practitioner of "economic science." In other words – if you don’t add in some graphs and equations – nobody will listen to what you have to say or think it is important. This is why Bastiat is often over-looked in the history of economic ideas. Too bad. Perhaps we need another Bastiat today more than ever.