(1) World GDP (2007):What is significant about this?
US $65.61 trillion
(2) Global annual value of major financial asset market transactions (2007):
US $900 trillion*
* This includes foreign exchange turnover and stock market trading (excluding bonds and other over-the-counter transactions).
The significance is that global GDP is dwarfed by the value of major financial asset market transactions. A vast amount of spending that occurs every year is on secondary financial markets, including markets where foreign exchange, stocks, and shares are sold.
I assume that some of this $900 trillion involves foreign exchange transactions for international trade and so on (that is, for purchases of goods and services), but it is estimated that over 90% of foreign exchange transactions are speculative. At any rate, the total value of world trade (merchandise exports plus commercial services) was about $16.9 trillion in 2007, but not all of this required foreign exchange transactions (e.g., trade between nations in the Eurozone involves countries using the same currency, the Euro). Moreover, given that over-the-counter transactions and bond trading is excluded from the estimate above, it is obviously an underestimate of the real global aggregate value of such trading.
Any economic theory that ignores this type of spending and its sector of the economy (i.e., the secondary financial asset markets) is deeply flawed and liable to be missing something fundamental about modern market economies. In any one year, money can get sucked into this world of financial asset market transactions and essentially trapped there for a significant period of time as it is used to buy and sell assets over and over again.
Spending on the secondary financial asset markets is essentially a type of transaction that does not induce employment in the way that spending on final goods and services does. Most financial assets are non-reproducible, in the sense that businesses do not hire a significant number of workers or factor inputs when demand for these assets rises (Davidson 2002: 44), for they already exist in vast quantities in many different countries.
This type of spending is also a fundamental reason why Say’s law is one of the most ridiculous ideas ever formulated by economists.
The late Frank H. Hahn pointed out why:
“there are ... resting places for saving other than reproducible assets [i.e., final goods and services – LK]. In our model this is money. But land, as Keynes to his credit understood, would have just the same consequences and so would Old Masters. It is therefore not money which is required to do away with a Say’s Law-like proposition that the supply of labour is the demand for goods produced by labour. Any non-reproducible asset will do. When Say’s law is correctly formulated for an economy with non-reproducible goods it does not yield the conclusions to be found in textbooks. As I have already noted Keynes was fully aware of this and that is why he devoted so much space to the theory of choice amongst alternative stores of value.” (Hahn 1977: 31).As individuals become richer and richer, the less likely it is that their income will be spent on final goods and services. That is to say, the wealthy have a lower marginal propensity to consume than poor classes of people.
So what do the rich and ultra-rich mostly spend their money on? The answer is: mostly assets on secondary financial markets (either directly or, more likely, indirectly via financial institutions). This is why there is no necessary reason for Say’s law to hold true in any modern capitalist economy.
The stupidity of the assumptions behind Say’s law goes right back to Jean Baptiste Say (1767–1832) himself:
“Every producer [= capitalist] asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product; for we do not consume money, and it is not sought after in ordinary cases to conceal it: thus, when a producer desires to exchange his product for money, he may be considered as already asking for the merchandise which he proposes to buy with this money. It is thus that the producers, though they have all of them the air of demanding money for their goods, do in reality demand merchandise for their merchandise.” (Say 1816: 103–105).When you believe (like Say) that capitalists only ever spend their money on goods and services (whether consumption goods or factor inputs for further production), it is a recipe for disastrous economic theory.
It occurs to me that I should have mentioned another source of non-employment inducing demand: spending on real assets with low or relatively low elasticities of production (e.g., gold).
As one moves to real assets with moderate to high elasticities of production, the story is different, of course.
Furthermore, one might reply with the question: why is it that during asset bubbles, economies tend to have booms? But the booms associated with asset bubbles tend to be driven by the modern financial system and its creation of credit to fuel asset bubbles, consumption and investment, with a positive wealth effect amongst owners of the assets whose price is rising (either more consumption out of income or credit). Capitalists are caught up in the boom via their optimistic expectations.
If in a recession demand to hold money increases and demand to hold non-reproducible financial assets also rises (by using money to buy them), we have in the latter case exactly what can be called non-employment inducing demand.
Davidson, P. 2002. Financial Markets, Money, and the Real World. Edward Elgar, Cheltenham.
Hahn, F. H. 1977. “Keynesian Economics and General Equilibrium Theory: Reflections on Some Current Debates,” in G. C. Harcourt (ed.), The Microeconomic Foundations of Macroeconomics Macmillan, London. 25–40.
Say, J. B. 1816. Catechism of Political Economy, or, Familiar conversations on the manner in which wealth is produced, distributed, and consumed in society (trans. J. Richter). Sherwood, Neely, and Jones, London.