To Most of the Classical Economists, the Theory of General Over-production Was a Heresy

It is one thing to deny the existence of demand deficiency and another to provide a theory of the cycle. Classical economists, because of their acceptance of the law of markets, had to do both. Those who accepted the validity of the law of markets had to explain the fact of recession without reference to demand deficiency or over-production. This was done by explaining recessions as resulting from misdirected production or other factors which drove demand and supply out of alignment.¹ This theory of recession must be seen as an integral part of the matrix of ideas associated with the law of markets since it was this which explained the existence of recession while denying the possibility of deficient demand or overproduction. The two concepts, in fact, evolved together and are part of a unified conception of the operation of an economy.

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¹ Cf. Wesley Mitchell (1927: 8) who wrote, ‘to most of the classical economists, the theory of general over-production was a heresy, which they sought to extirpate by demonstrating that the supply of goods of one sort necessarily constitutes demand for goods of other sorts. But maladjusted production they allowed to be possible, and their brief references to crises usually aimed to show how production becomes maladjusted through the sinking of capital in unremunerative investments.’

—Steven Kates, Say's Law and the Keynesian Revolution: How Macroeconomic Theory Lost its Way (Cheltenham, UK: Edward Elgar Publishing, 2009), 75, 75n.

Industry Is Limited by Capital, BUT There Is NO Upper Limit to Production Imposed on the Demand Side

In Chapter V, Mill provides four propositions with regard to capital which are in his view fundamental for anyone wishing to understand the workings of an economy. The first proposition is that ‘industry is limited by capital’ (John Stuart Mill's Principles of Political Economy, 63), of which he wrote:

While, on the one hand, industry is limited by capital, so on the other, every increase of capital gives, or is capable of giving, additional employment to industry; and this without assignable limit. (Ibid.: 66)

In other words, there is no upper limit to production imposed on the demand side. This was the fundamental issue in question during the debates over the validity of the law of markets, and it was to this section of the chapter (pp. 66-8) that Mill referred during his more comprehensive discussion in Book III, Chapter XIV. Mill contrasts this view with the views held by others:

There is not an opinion more general among mankind than this, that the unproductive expenditure of the rich is necessary to the employment of the poor. Before Adam Smith, the doctrine had hardly been questioned; and even since his time, authors of the highest name and great merit have contended, that if consumers were to save and convert into capital more than a limited portion of their income, and were not to devote to unproductive consumption an amount of means bearing a certain ratio to the capital of the country, the extra accumulation would be merely so much waste, since there would be no market for the commodities which the capital so created would produce. (Ibid.: 66-7)

That is, if unproductive consumers decided to invest instead, and therefore used their capital productively rather than merely consuming it, beyond some upper limit the additional output produced would fail to find buyers. Production, on this view, can therefore rise faster than demand, a situation which only an increase in unproductive spending can forestall. It is this proposition which the law of markets was designed to refute.

—Steven Kates, Say's Law and the Keynesian Revolution: How Macroeconomic Theory Lost its Way (Cheltenham, UK: Edward Elgar Publishing, 2009), 69.

The Meaning of the Law of Markets Can Be Understood ONLY through Mill's Definition of Capital

But to understand Mill's meaning with regard to Say's Law fully, it is necessary to turn to Book I, Chapter V, Mill's famous chapter on ‘Fundamental Propositions Respecting Capital.’ Indeed, the appropriate place to start is the discussion on the meaning of capital in the previous chapter (Book I, Chapter IV) because, as with the essay, it is only through following Mill's definition of capital that the meaning of the law of markets can be understood. Capital, according to Mill, is everything and anything an entrepreneur intends to utilise to earn income. There is nothing intrinsic in an item which makes it capital, but only the intention of its owner. Capital includes not only all tangible goods, but also money and available lines of credit:

The distinction, then, between Capital and Not-capital, does not lie in the kind of commodities, but in the mind of the capitalist — in his will to employ them for one purpose rather than another; and all property, however ill adapted in itself for the use of labourers, is a part of capital so soon as it, or the value to be received from it, is set apart for productive reinvestment. The sum of the values so destined by their respective possessors, composes the capital of the country.

In Chapter V, Mill provides four propositions with regard to capital which are in his view fundamental for anyone wishing to understand the workings of an economy.

—Steven Kates, Say's Law and the Keynesian Revolution: How Macroeconomic Theory Lost its Way (Cheltenham, UK: Edward Elgar Publishing, 2009), 68-69.