How important is land speculation in today's economy? You be the judge. Here we see one of the aces that Donald Trump held during his financial slump of the 1990s: the old Penn Central rail yards, 52 acres on the west side of Manhattan. This photo actually appeared in a late 80s advertisement for the planned "Trump City." Trump held the site, looking just like this, for about fifteen years. Finally, after many rounds of taxpayer-funded offerings -- including the re-routing of the West Side Highway -- the site was developed, into upscale housing.

A theory of economic boom and crash is one of Henry George's two great purposes in Progress and Poverty. What is the root cause of the "paroxysms of industrial depression"?

The root cause, says Henry George, is the speculative rise of land prices, which cuts into the earnings of labor and capital. Land rents and prices rise at a faster rate than general economic growth, because of two unavoidable facts:

  1. Land is fixed in supply.
  2. Land is needed for all production.

When sufficient numbers of workers and capitalists cannot afford to produce at the higher rents brought about by growth and speculation, production begins to stop.

Let us examine some of the implications of this fact for modern economies:

New Construction is Limited. If builders must pay too much for building sites, it takes from their profit by raising their costs. Their profit on investing in the building itself is what stimulates investing, which in turn is what makes jobs and incomes.

Business Costs Go Up. Businesses that rent their premises also get squeezed by rising rents. Here's an example: A merchant goes into a new shopping center with a long term lease. His rent is often too high, but he pays it to hold his position for the later term when he hopes the rent will be a bargain. Landlords writing long-term leases get used to this, and hold out for high rentals.

Nonproductive Investments Become More Profitable than Productive Ones. Let’s say that you own some land, which you might decide to improve. But, you have the option of selling the land to a speculator. Why improve the land if the profits on your improvements would yield little more than merely collecting the speculation-hyped value of the vacant site? Landowners will "site-sit" and wait, if they believe future development will be much more gainful than development for the current market. When the workaday facts of today begin looking dull and prosaic next to the gleaming expectations of tomorrow, look out.

Banking and Credit is Destabilized. Builders needing land borrow to buy it, even though the price is too high, gambling that future rises in rents will let them repay the loan. If these rent rises fail to happen, they go bankrupt. Their buildings are not destroyed, but the capital they used to build on them was misdirected, so much of it is economically lost: the buildings lose their market value.

Parking lots next to skyscrapers... boarded-up buildings (used as billboards!) on busy corners... blocks upon blocks of abandoned buildings... everywhere you look, you see evidence of backwards, wasteful, counterproductive incentives to hold as much of the best land out of use, for as long as possible. The consequences of this are not just economic. The syndrome of urban blight/suburban sprawl is propelled by the underlying force of land speculation. Center-cities spiral downward, as suburban flight lowers revenues. Meanwhile, suburban sprawl exacts a terrible, unsustainable cost in energy and resources, even as development passes over land that is ideally suited for urban use.

Unlike items of wealth, which are priced according to their cost of reproduction at the present time, land is not produced -- so it has no cost of production. Yet it is bought and sold, like articles of wealth. The selling price of land is determined by comparing its income potential with that of an equivalent value of wealth, through a process called capitalization. Here's how that works. However, the capitalization of current rent is only the beginning. With land, there is nearly always an added premium reflecting expected price increases in the future.

Speculation raises land prices beyond the sites' current use values. Credit is extended farther in order to accommodate this. That is, banks lend on overpriced land, counting on a further rise. When the rise slows, they extend the loans, sometimes even granting new loans for paying interest on old loans. They use political pressure to get governmental agencies (e.g. the World Bank) to extend or underwrite these risky loans (e.g. in Latin America). When the bubble bursts, the loans are not repaid. This destroys capital. The Savings & Loan fiasco of the 1980s is a case in point, but the basic dynamics are there in every recession.

This is not a new phenomenon. John Stuart Mill had written (before Henry George) of a tendency of lenders, when legitimate demand for loans dries up, to "lower the quality of credit" by accepting high-risk loans they would have spurned before. Because land value is such a large part of collateral on loans, and land values fluctuate wildly in business cycles, the tendency toward these volatile, high-risk lending practices is very strong.

Why don't capitalists needing land simply join in the speculative game? Couldn't they buy land at speculative prices and use it while it continues to rise in value? Actually, that's what they all do. No one can justify buying and holding land at today's prices without counting the future advance in price or rent as part of his or her gain. Thus everyone is hooked, forced by the market to participate in the speculative game, once it gets started. All become implicated and habituated, emotionally and politically, whether they like the principle or not. Eventually people forget that there could be any other way of doing business.

How do labor and capital resist advances in land value, when they must have land in order to produce? By ceasing production. What does this mean in real life? Labor and capital decline to buy or rent land at the high asking prices. Some will rent or buy less land, and use it more intensively. Some will sleep on the street, or sell from the sidewalk. Some will retreat to little patches of marginal land. Some will buy as much land as ever, but thus use up funds they otherwise would have used to improve it, becoming withholders themselves. Some will organize and pass counterproductive rent-control laws. The economy-wide net result will be less production, more unemployment.

The question that many modern-day economists fail to ask is this: How do investors react to a set of incentives where expected changes in land value are made part of the overall return on investment -- and land price is part of the investment on which return is figured?

This has several results:

  1. Many are screened out by the increased need for credit.
  2. Rising land value becomes part of the incentive to build. It can't go up forever. When it levels off at a high level, it becomes a serious drag. When it starts falling, it is worse.
  3. Land value becomes collateral; its wild swings destabilize credit and money.
  4. A lot of land is unused, (or run down in its present use), as the holder waits for a possible higher use that never materializes. In and after a crash, bid prices for land fall, but asking prices stay high, so sales drop like a stone. This behavior is inconsistent with the premises of the "rational expectations" theorists, but is good history: it has been extensively documented, over several giant cycles of boom and crash.

Land
Speculation
and Inflation?

There are as many different theories of the basic cause of inflation as there are for depressions. But since today's business cycle seems to involve a constant tension between periods of inflation and periods of unemployment/recession, the two phenomena clearly are linked.

George said almost nothing in Progress and Poverty about inflation; in his day industrial depression was a much more serious problem. However, inflation was not unheard-of in those days, and a strong connection is implied in George's reasoning. Consider the following statement regarding George's remedy (which this course is soon to consider): "Taxes may be imposed upon the value of land until all rent is taken by the state, without reducing the wages of labor or the reward of capital one iota; without increasing the price of a single commodity, or making production in any way more difficult."

What has this to do with inflation? George identifies land rent as an income that does not come from production; it is, in effect, a tax on production, the burden of which increases as production increases -- due to rising demand for the fixed supply of land. The tendency of this process is, as we have seen, to raise land rents beyond the marginal ability of labor and capital to pay them -- and depression is the result.

This process can be forestalled, temporarily at least, by increasing the money supply. Remember, the income of landowners increases as overall production increases, even though landowners make no contribution to production! The buying power that landowners gain, laborers and capitalists lose. But the effect of this can be blunted by increasing the money supply. When then supply of money increases faster than the supply of actual wealth, that's called inflation. An increase in the money supply can stimulate demand for goods, for a while -- if people have a certain amount of money to spend, they will try to spend it before it loses its value. Thus, an increase in the money supply, via lowered interest rates, can keep a period of economic growth alive -- at least until after the next election. Eventually, though, increased rents will consume the extra money. Then, one of two things must happen: either the money supply must be increased further, risking runaway inflation -- or there must be a recession.

Is Full Employment Possible?

After the Great Depression of the 30s, governments began to use Keynesian fine-tuning of government spending and interest rate levels to blunt the impact of the boom-bust cycle. Since then, "capitalist" economies have teeter-tottered between periods of inflation and unemployment. It seemed that one came at the expense of the other. Thus, employment surged until inflation started to heat up, then monetary brakes were applied, inflation slowed down, and unemployment started to rise. It became a truism that universal employment was not possible, in a modern market economy, without creating unacceptably high inflation.

Then, beginning in the 1970s, the phenomenon of "stagflation" -- a period of simultaneous high inflation and unemployment -- began to rear its ugly head. The power of governments to contain these bad economic effects seemed to have diminished, and we were forced to accept higher residual levels of unemployment.

Today, economists define a "full employment" point which is the highest level of employment that can be achieved without an unacceptably high level of inflation (the point is usually reached at an unemployment level of four to six per cent).

Why would this be so?

Economists recognize two major types of inflation. Demand-pull inflation occurs in a growing economy in which increased demand for goods and services leads producers to raise prices faster than the overall growth in output. Cost-push inflation occurs when a "supply shock" -- a rise in the cost of some vital material or resource -- raises the cost of production, and hence the market prices, of goods whether demand is increasing of not. It's easy to see that a combination of the two could result in stagflation.

This is not a new idea. I fact, it's exactly what Henry George is describing in his theory of booms and busts. In a growing economy, land rents increase faster than overall growth. This creates an incentive for more land speculation, further increasing land rents and prices. Higher rents are passed on into consumer prices: a "supply shock" which grows more severe as the economy increases its output!

Although modern macroeconomic tinkering with the money supply was unheard-of in George's day, we can use his reasoning to show that inflation and recession actually spring from the same cource. Land speculation does two things to create inflationary pressures: 1) It increases the volatility of the economy, creating more severe swings and a sharper demand- pull climate when things are moving upward. 2) It creates a growing cost-push effect by creating a general increase in the cost of land, exacerbated by unproductive land-hoarding. Thus we are led to suspect that if we could rid our economy of land speculation, we could erase the tendency for economic growth to lead to high inflation.

In this case, economic theory does a good job of explaining the uncannily good effects of Denmark's land tax reform in the late 1950s. When Denmark's legislature promised, in 1957, to issue a law to implement the taxation of increases in land value, land speculation ceased, and Danish inflation fell to below 1% -- even though employment and wages remained high! A new government overturned the land tax initiative in 1960, and land speculation started up again - as did inflation.

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