Say’s Law works: Supply does create its own demand
PremiumEconomics is a contextual study and Say’s proposition that supply creates its own demand must be examined as an underlying principle in a nuanced way and not as an absolute result.
John M. Keynes, while writing his seminal work, The General Theory of Employment, Interest and Money, comprehensively refuted, in the context of the Great Depression, what he termed “Say’s Law", usually nutshelled as “supply creates its own demand". According to Keynes, this was the only major tenet of classical economics. Nonetheless, classical economists did not deny the occurrence of economic recessions, even though their reasons were different from what Keynes was pointing to, and their analysis is arguably in consonance with modern business-cycle theories.
For long, there have been academic attempts to establish the provenance of Say’s Law and espouse its true meaning. In fact, rejoinders are still being exchanged in this debate, even as little effort has been made to comprehend it in the context of an evolving world economy and its relevance to public policy. Economics is a contextual study and Say’s Law should be examined as an underlying principle in a nuanced way, instead of being treated as an absolute result. As a discipline, economics is full of debates, but good ideas eventually prevail. The triumph of behavioural economics in recent years against the prevailing orthodoxy of rational-actor-based modelling is an example of this. In a similar way, the essential insight behind Say’s Law needs to be identified amid the cacophony of contestation. This could offer a valuable perspective on the empirical world, inform academia and soften rigidities in the adoption of various ideas.
Governments, especially of developing countries, in choosing between competing uses of limited fiscal resources, have tried to optimize state expenditure with the aim of maximizing its beneficial impact across sectors. Allocations, however, require more deliberation. Infrastructure spending is one such lever that can have advantageous ripple effects on the rest of the economy. A 2019 Reserve Bank of India report found that ‘Central Capex’ has a multiplier ratio of 3.25, which Indian policymakers have intuitively grasped since the heydey of central planning. Infrastructure received attention for the first time in the Sixth Five-Year Plan (1980-85) and continued to be a crucial component of all further plans and budgets. Its share has only increased since, both in terms of budget allocation and our policy focus, in myriad ways. The definition of infrastructure keeps expanding, which provides projects included in it access to easier bank loans and attractive tax benefits. The government has made huge financial commitments through production-linked incentive (PLI) schemes as well as the “Panchamrit Commitments" made at CoP-21, which aim at developing a cutting-edge and adaptive infrastructure base to rev up India’s growth engine, while coping with climate change. This indicates its salience even in times of economic disruption and transition imperatives.
In 2019, India had announced an ambitious investment agenda called the National Infrastructure Pipeline (NIP) for a six-year period ending 2024-25 of ₹111 trillion (or $1.5 trillion). This story is true for other countries as well. For instance, China spent a whopping $8 trillion in 2020 and the US is in the process of getting approval for its Build Back Better bill, which aims for investment of $1 trillion in both traditional and advanced infrastructure. Today’s policy landscape speaks of the importance and prevalence of such state-directed interventions that have stood the test of time and space. Developing and developed countries alike are taking the same fiscal path of supply-based expansion to meet their economic aspirations.
Infrastructure spending is not just useful in helping a fast-growing nation achieve its ambitions, it also has an important role to play in times of an economic crisis as a policy option. A calibrated approach to develop a broad enabling base for the economy has been at the core of our strategy, rather than just digging and filling up pits (which is the usual caricature of what Keynesian stimulus policies entails). As Crisil recently reported, India’s central capex grew 31% over the last fiscal year, despite the government’s tight fiscal position. If this trend is maintained, it is set to overshoot by 12% the pre-pandemic trend level.
It’s not extraordinary that China has resorted to investing in infrastructure to revive its economy every time it has shown signs of a slowdown.The US infrastructure plan has a geo-strategic element to it, but its timing soon after its covid economic crisis indicates a similar fiscal stance.
The broad objective has been to push the economy into a virtuous cycle of mutually-reinforcing supply and demand by nudging supply ahead in ways that generate jobs, boost incomes and beget demand, resulting in the attainment of a higher growth trajectory. The subtlety of this argument lies in rejecting a long-term dichotomy between demand and supply. Any investment that ups production capacity is a supply-side phenomenon that can stoke demand.
The importance of an initial supply push cannot be overstated, but the size of its snowball impact warrants a detailed scrutiny of data. But we should acknowledge that supply and demand move in an interlinked cycle, one pushing the other forth, and this should underpin our policy responses.
Broadly speaking, front-loaded supply-based interventions are a popular public-policy choice for a reason: Supply expansion can increase demand and thereby have a lasting positive impact on our economy.
Monika is an assistant director at the ministry of rural development, Government of India
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