By Frank Shostak*
Following the ideas of John Maynard Keynes and Milton Friedman, many commentators associate economic growth with increases in the demand for goods and services.
Both Keynes and Friedman held that the Great Depression of the 1930s was due to an insufficiency of aggregate demand and that thus the way to fix the problem was to boost aggregate demand.
For Keynes, this could be achieved by having the federal government borrow more money and spend it when the private sector would not. Friedman advocated that the Federal Reserve pump more money to revive demand.
But there is never such a thing as insufficient demand. An individual’s demand is constrained by his ability to produce goods. The more goods that an individual can produce, the more goods he can demand, i.e., acquire.
Note that the production of one individual enables him to pay for the production of the other individual. (The more goods an individual produces, the more of other goods he can secure for himself. An individual’s demand therefore is constrained by his production of goods.)
In this sense, producers and not consumers are the engine of economic growth. Obviously, if he wants to succeed, a producer must produce goods and services in line with what other producers require.
According to James Mill,
When goods are carried to market what is wanted is somebody to buy. But to buy, one must have the wherewithal to pay. It is obviously therefore the collective means of payment which exist in the whole nation that constitute the entire market of the nation. But wherein consist the collective means of payment of the whole nation? Do they not consist in its annual produce, in the annual revenue of the general mass of inhabitants? But if a nation’s power of purchasing is exactly measured by its annual produce, as it undoubtedly is; the more you increase the annual produce, the more by that very act you extend the national market, the power of purchasing and the actual purchases of the nation….Thus it appears that the demand of a nation is always equal to the produce of a nation. This indeed must be so; for what is the demand of a nation? The demand of a nation is exactly its power of purchasing. But what is its power of purchasing? The extent undoubtedly of its annual produce. The extent of its demand therefore and the extent of its supply are always exactly commensurate.1
If a population of five individuals produces ten potatoes and five tomatoes—this is all that they can demand and consume.
No government and central bank tricks can make it possible to increase their effective demand. The only way to raise the ability to consume is to raise the ability to produce.
The dependence of demand on the production of goods cannot be removed by means of monetary pumping and government spending.
Loose fiscal and monetary policies will only impoverish real wealth generators and weaken their ability to produce goods and services—they will weaken the effective demand.
Since government does not produce any real wealth, the real savings will have to be diverted from wealth-generating activities. This however, is going to undermine wealth generators and is going to weaken the real wealth generation process. The following simple example encapsulates the situation.
In an economy which is comprised of a baker, a shoemaker, and a tomato grower, another individual enters the scene. This individual is an enforcer who is exercising his demand for goods by means of force.
Can such demand give rise to more output as the popular thinking has it? On the contrary, it will impoverish the producers.
The baker, the shoemaker, and the farmer will be forced to part with their product in an exchange for nothing and this in turn will weaken the production of final consumer goods.
Therefore, what is then required to revive the economy is not boosting aggregate demand but sealing off all the loopholes for the creation of money out of thin air and curbing government spending.
This will enable true wealth generators to revive the economy by allowing them to move ahead with the business of wealth generation.
We can conclude that by strengthening the economy’s ability to produce goods and services we are in fact strengthening the so-called aggregate demand and promoting real economic growth.
- 1.James Mill, On the Overproduction and Underconsumption Fallacies, ed. George Reisman (Laguna Hills, CA: Jefferson School of philosophy, Economics, and Psychology, 2006).
Source: This article was published by the MISES Institute