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Function assignment options - Part 1

Hector McNeill1

I recently read a piece listing over 10 reasons why Say's Law doesn't stand up and in particular doesn't apply to today's economy. Most of the criticisms were attributed to Keynes.

However, I also noticed that as economic policy priorities shifted through time Say's Law, which was essentially minding its own business, was attacked even more vehemently to justify why the latest mode of economic "thinking", which has moved us into highly precarious territory, on an incremental basis, has been a quantum, but irrational, leap in economic logic. In following this trail of criticism it occurred to me that what is a general principle, Say's Law, was being attacked on the basis of altering Function Assignment Options. It is very easy to attack any general principle, especially those that apply to the whole economy, but such criticisms usually don't detract from the value of the general principle but rather expose the motivations of those on the attack.

I don't have time to deal with all of the criticisms but I cover two in this article. The others can be dismissed but in any case are covered in other articles on this site. However, the emerging lessons don't only apply to Say's Law but they expose an illogical pursuit of policies based on exogenous money. This is what caused the 1929 Crash and Great Depression.

This note provides some observations on this matter.

Function assignment options

A Function Assignment Option is a choice made from many existing options, open to a company or individual, on how a commodity or money will be used. So on receiving £100 a person can use this gamble, to place in a savings account, purchase a share or two or buy essential needs such as food and to pay rent. So although we might assume money is spent on the purchase of goods, obviously this is not always the case. On the other hand, in terms of the circulation of money, the general principle is best understood by looking at the barter economy where all exchanges are physical products or services of people provided to others. So Say's Law deals with endogenous money, that is, money generated within the system by the supply side. Each decision on function assignment is accompanied by an opportunity cost. So this establishes the principle that in a cash economy money used for consumption comes from people being paid for producing goods and services elsewhere in the economy.

Endogenous and Exogenous money

To understand this issues it is important to recognize the existence of two different functional assignments for money which are confused by money being assumed to be simply a means of exchange. However, money's role, that is where it ends up in the short, medium to longer terms is important. Endogenous money is the money flowing from productive efforts through those employed in such activities being used to consume the output of all of the productive units cross an economy. Endogenous money includes cash, savings and investment by producers in their own activities and the production of capital goods and equipment used by investments, its life cycle, in terms of circulation is short to medium term. Say's Law is essentially concerned with endogenous money.

Exogenous money is additional money from lending based on fractional reserve banking and reloans based on open money market transactions. Exogenous money is associated with "leverage" and the risks of borrowed money not producing the payback assumed leading to loss of collateral, such as land and housing paid for by endogenous money. As a result exogenous money carries with it risks to the flow of endogenous funds. However, exogenous money also tend to flow into assets whose life cycle can be long term.

Criticism 1: Effective demand deficiencies

A criticism of Say's Law is that it states that, under normal circumstances, there cannot be over supply. But the criticism is that this is not true because income can be spent on either investment (I) or consumption (C), thus income (Y) is equal to (C + I). As services expand to provide opportunities for investment it is self-evident that funds diverted into investment rather than short term needed consumption is because short term needs are satisfied and there is an opportunity for a new productive activity requiring investment. So the acceptance of more function assignment options simply means productive activities have been extended into investment activities. It should be added that Say had included the production and purchase of capital goods such as equipment for industry, is included in his model. Under normal circumstances investment funds come from savings of endogenous supply side issued money. The money flowing from investment activities will flow back through those employed by the sector. On the other hand, some investments are not really investments in the productive sense but are purchases made to store value, or assets (A). So Y becomes (A + C + I). For example, assets include land, real estate, gold and durable commodities. Here the payback or expected income is deferred, sometimes well into the long term. Since it is this money that is essentially withdrawn from circulation, this result sin falling demand on the production side. The services and mechanisms which administer and benefit from land, real estate, gold and durable commodity transactions gain a commission but the product, sometimes an expected windfall gain on sale becomes indeterminate.


Whereas, in general, companies produce goods and services, the opportunities to purchase a house, land, to save or buy gold are all transactions that individuals with enough income can participate and as a result the productive sector is atomized into as many decision making centres as there are constituents. If these decisions on function assignment options do not in fact reduce the consumption needs for basic goods and services, then Say's Law holds, but its operational base in terms of "production" broadens to include the new forms of money assignment, some of which ends up in non-circulating assets. This undermines demand and the stability arising from Say's Law is undermined.

Criticism 2: Depressions

The experience associated with the 1929 Crash led to producers not being able to sell their produce and a downwards spiral in prices, not related to increased productivity, but by a drop in purchasing power of the currency and people being made jobless. The cause of this depression was an imbalance caused by too much money flowing into assets in the form of stocks and shares (A) not using money earned from production, but rather money obtained through debt (loans) which exogenous to the supply side, using other assets as collateral, such as houses.

This drove an inflationary spiral which possessed no fundamental justification in terms of production and company prospects. Therefore when this bubble burst through lack of confidence, unemployment was imposed on a large segment of the population and a result of inability of many companies and individuals to repay their loans and losing their collateral. This led to a drastic loss in purchasing power and a retraction in the value, even of essential goods and services. This was the result of loans made on the basis of exogenous money, essentially money that did not come from the supply side, failing in its intended purpose and removing many assets built up from endogenous funds from the supply side, usually based on savings, being removed from people's asset holdings. As a result of the speed of this diversion of funds from the productive economy and lack of policy oversight and controls, was considered to be a reason to by some to consider Say's Law to have "failed". However, this failure was not a deficit in it value and general principle involved but was rather a deficit in the rational and decisions of people in pursuing function assignment options which risked collapsing the economy, which was what happened. Because of the extreme irresponsibility of such actions it is reasonable that Say's Law and any other economic principles were not designed to build in such irrationality. This is why financial regulations were introduced post-1929 to prevent this from happening again.

The blame game

Say's Law became a useful basis upon which to criticise the futility of economic models but it is interesting that the change in financial regulations post-1929 created a situation that to some extent returned the economy to the Say's Law equilibrium and between 1945 through the 1970s there was essentially a boom in economic growth. In the UK, this boom was not related to Keynesian policies which between 1945 and 1965 were not applied. The boom was the result of production growing in a rough balance with increasing incomes, made possible through a steadily rising level of productivity.

The rise in policy-making that promotes growth in exogenous money

Following the collapse of the Gold Standard in the 1970s and the failure of Keynesianism and monetarism to offer effective policy instruments to resolve slumpflation crisis governments came under pressure. The response of the economics profession was lamentable and an inexplicable pressure, headed by people like Milton Friedman, resulted in monetarism winning the day with governments who did not seem to know any better. As a result financialization took off associated with a constant stream of financial services deregulation of those stabilizing regulations introduced post-1929. This expanded the range of function assignment options for "money" which took on the descriptive form of "financial engineering". The underlying principle was to apply increasing amounts of exogenous money to the operation of macroeconomic policies while ignoring the fact that this had been the cause of the 1929 Crash and Great Depression. The inevitable result was the financial crisis in 2008. Another collapse as a result of monetary management moving, yet again, beyond the bounds of endogenous money circulation contained by Say's Law. Unbelievably, the post-2008 policy "solution" was quantitative easing, again based on yet more exogenous money, which has further undermined the value of money and depressed the goods and services consumption sectors and their ability to pay decent wages.

It is notable that today, when Say's Law is mentioned, the reaction is even more dismissive, banal and in some cases emotive. But such criticism comes from those who still promote highly risky macroeconomic policies based on exogenous money flows in collaboration with central banks. Such people earn their money promoting such ideas. The latest wave includes the Modern Monetary Theory addicts who are promoting more of the same.

As always it is to be noted that the damage wrought by exogenous money growth is under governments who have permitted the banks and financial intermediaries to have most say over policy while the constituents who live in a world largely based on Say's Law are suffering. This is proof, if any is needed, that economic policies, in terms of public choice and constitutional economics are not serving the needs of the population. Even more troubling it that this fiasco deepens because governments are not allowing the constituents to have any say over monetary policy while this continues to be directed by politicians guided by monetarists and where so-called central bank "independence" is a myth.

1 Hector McNeill is the Director of SEEL-Systems Engineering Economics Lab.

Updated for clarity: 26th July, 2020.

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