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Who or what to blame?

Who or what is to blame for the present economic crisis? How about sloppy thinking? Such as using the phrase “Capitalist System” without being precisely clear what the terms Capital and Capitalism mean.

So in a sense, we have nobody to blame but ourselves. Most supporters of the movement for land value taxation – I will call it the “Single Tax movement” as shorthand – are 50+. They learnt their economics whilst in their twenties, at institutions such as the School of Economic Science or the Henry George School of Economics in the years after World War II. In the 1970s, for instance, the Henry George School started two of its twelve-week classes three times a year at its premises in Vauxhall Bridge Road, with fifteen or so students in each class, whilst students thronged to the SES courses. What happened? Interest died out during the Thatcher years, when young people were encouraged to go out and make money and that there was no such thing as society. But was that the reason or is it just that people got into the habit of staying at home with their computers? The result is that the Single Tax movement has a demographic problem.

There is a a huge volume of debate on the net, in blogs and in the comment pages of newspapers. Land value tax and the theories that underpin it receive hardly a mention. Today I had the opportunity to post a response to one of the Guardian journalists, and it went like this…

There are three factors of production. Land, Labour and Capital. Land is the surface of the earth and resources in their natural state eg minerals in the ground, fish in the sea. Labour is human effort. Wealth production takes place through the application of human labour to land. Simple, isn’t it? Capital is wealth set aside for assistance in wealth creation, plus goods in course of production. A fisherman uses a boat and nets (capital) to catch fish in the sea (“land”). Once the fish are in the net they become capital. Further work is carried out on the fish to get them into the hands of the final consumer, at which point they are no longer part of the economic process.

Land is not “capital”. Nor is land “wealth”, though the general view is that land is wealth, a misapprehension which has a direct bearing on the present troubles. Nor is money wealth or capital. Money is nothing more than a medium of exchange. The holder of money or any other financial instrument is merely the holder of a claim on wealth now or at some future date. Others will normaly honour that claim, but in some circumstances they will not.

The supply of capital can be increased. The supply of land is fixed. Every site is unique. It the best possible site for an activity is not available, then an inferior site must be used. The holder of the better site then has an advantage, giving rise to a rental value. This is the principle behind David Ricardo’s Law of Rent. Every street busker and Big Issue seller is aware of it, but the theory is now regarded by economists as an interesting historical curiousity, of no importance today. So modern economic theory  lumps together land and capital, thereby depriving itself of the ability to analyse how the land market operates and the problems that can arise, such as the present meltdown of the banking system.

What is special about the land market? The supply of produce can be increased in response to increased demand, as signalled by higher prices. The free market works perfectly well. But higher prices for land can not call forth increased supply. The price just rises more. There is a positive feedback loop in the market system which gives rise to these periodic booms and busts. This has been recognised for over a century and the cause explained but this knowledge has been forgotten or perhaps deliberately suppressed through obfuscation and ridicule.

How does the land market work? First, it is essential to understand that the value of land it not its price but its annual rental value. The price is what the market will pay for the rental income stream. Think of it as the purchase of an annuity. The catch is that it is subject to cyclic movements. At the bottom of a cycle, the price of land is such that the same amount invested in a bank deposit would yield the same in interest as the rental income from the land. But with prospects of rising rents, the expectations gradually get built into the price, and so the dircet rental return on investment in land is soon less than prevailing interest rates. As the market sees the price of land rising, land then starts to be traded as a commodity whose price can only keep on going up. The next phase is that money is lent for land purchase on the security of a rising price. The willingness of lenders to lend money for land purchase has the effect of pumping up the price further. The cycle is now entering the bubble phase. Panic buying takes place. But in the meantime, rental values may have risen due to improved conditions in the economy, but to nothing like the same extent as prices. Eventually, considering the rental income that can be achieved, land prices are absurdly more than could be earned by putting the same amount in a deposit account. The system is primed for a collapse. All that is needed is a trigger.

I have referred to rental value. Mortage repayments are closely tied to rental values as people will not purchase if rental costs are significantly lower – a few canny individuals will not ruin themselves to jump on the bandwagon, and these are key to what happens in the market.

What can be done about it? Nothing, because of vested interests. Expect another crash around 2026 and a mass of political and social unrest in the meantime. But something could be done about it, as this site and others like it show.