Thought for the day: why didn’t we look under the streetlamp
from Merijn Knibbe
There is a famous joke about the drunk who, at night, lost his watch and started to search under the streetlamp, not because he lost it there but because he could see something. But economists did not even bother to look under the lamppost. Dean Baker complains about the inability of economists to spot the housing bubble. He’s right. Economists did not only fail to construct a ‘bubble indicator’ (see Shiller and Baker, however), they did not even bother to look at available information. Let’s take a look at the next data, freely available at Eurostat, not really the most obscure of all statistical agencies: the household investment rate (mainly investements in houses). I compare the countries with the biggest bubbletrouble with Germany, which thanks to good rules did not have a bubble:
Household investment rate, 2000, peak (2006 or 2007) and 2009 (% of disposable income)
Germany 10,8-9,2-8,8
Ireland 17,0-27,4-7,7
Spain 10,9-15,1-9,2
Other countries with deflating bubbles (with different timing): The Netherlands, Estonia, Finland, Denmark. In all these cases, the investment rate increased to a level above 10%. In all these cases, the problem appeared at the latest in 2006, sometimes much earlier (Ireland, Spain, The Netherlands). I did not check it, but I do dare to take a bet (100,– in Euro) that in all these cases deregulation and globalisation of the mortgage market aggravated and even caused the problems.
Is it a surprise to anybody that Dutch economists (CPB, Nyffer, Francke) still deny that there has been any bubble? Recently, The Dutch RABO bank seriously proposed that we should tear down houses, to protect prices – let’s destroy real capital to protect balance sheets… But this bank at least understands what has happened.
http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&language=en&pcode=tec00098&plugin=1
By the way: Colander made extensive use of this joke when he testified before the USA congres on DSGE models and it is starting to catch on:http://economistsview.typepad.com/economistsview/2010/10/is-macroeconomics-just-looking-under-the-streetlamp.html#comment-6a00d83451b33869e20133f51f6bdb970b
“Economists did not only fail to construct a ‘bubble indicator’ (see Shiller and Baker, however)”
So are Shiller and Baker economists or are they not?
I’m not so sure about Spain. By entering the EuroZone Spanish mortgage interest rates fell from 11% in 1995 to to 3.5% in 2003-2005 — rates which were often negative after discounting inflation. Also the purchase of properties by families not living in Spain (UK, Germany) has increased substantially. And Spain has very conservative banking rules and practices. Banks are required to have high capital provisions and demand various proofs and securities from intending borrowers.
The basic principle is that there needs to be a balance between money in circulation and goods and services being exchanged in order to have relative
financial stability. It ain’t rocket science. You don’t need a degree in economics, or anything else, to understand it.
A financial bubble means that too much credit money has been created in relation to real goods and services.
In a “normal” situation the excess money would have expanded to supply of goods and services to restore the balance. However, in the present situation this money has been used to buy phony “financial products” that are not worth the chip space they occupy in computers. Even so, in relation to the credit money created to buy this crap, the debt obligation exists legally.
So now the real economy is being starved of money to fuel it, because that money is going into the fixing of wounded balance sheets.
Who’s at fault? Speculators on all levels of society with the big financial institutions leading the way.
Stephan, I probably owe you. First I’ll delve a little deeper in the Spanish situation.
Merijn, for me the main culprit in regard to Spain and Portugal is the common currency. The Euro mess ;-) Milton Friedman was wrong about almost anything but in regard to the Euro he was on the point.
Our monetary dictators are only looking on EuroZone aggregates. This is akin to assessing the economy of the Korean peninsular by aggregating North- and South-Korea. Interest rates in Spain were inappropriate to put it mildly.
The Germans are complaining about all these irresponsible idiots in the South and then turn around to export like crazies to them. Germans only know the current account and never have heard about the capital account.
Foreign investment went to a large extend into housing. Of course there are also local problems. The construction sector in Spain accounts for 13.3% of employment compared to 6.7% in Germany.
What were all these people doing? Building a lot of houses of course. All this economic activity produced a vicious cycle filled further by artificial low mortgage rates and traditionally long running (30 to 40 years) mortgages.
Housing is a land issue. Land is in fixed supply, bricks and mortar are not. True land/house values represent the capitalisation of a rental stream. Rental values are relatively stable. It is quite obvious then when house prices are inflated above their true value. You can’t ‘cure’ this by raising interest rates because that would kill off the productive sector. The correct instrument is a full land value tax – on all land. Land rent is totally unearned so is ripe for extraction for public benefit.
Dear Carol,
Thank you for your reply. But I do have a question.
I do agree with you that land is different. I even completely agree with you that Georgism has been dismissed far too easy.
The first why I agree has to do with its historical influence that. Sicco Mansholt, one of the most important politicians ever in the Netherlands and also one of the, if not THE main architect of the common agricultural policy of the EU, was heavily influenced by Georgism. ‘For instance’: there were more such politicians in the Netherlands, back then. It has only been very recently (two years ago) that land rent policies in the Netherlands have been changed in a (there it is again) neo liberal fashion. To understand post war economic policy of the Netherlands, you have to know about Georgism.
The second is that Georgism has something to offer to understand ‘today’. Take the Dutch housing markt. Since about october 2008, things are nog what they used to be anymore. The number of sales has dropped 30%. (Inventory of houses for sale/monthly sales) has increased to 48 for the most expensive class of houses (i.e.: 4 years…). This, of course, follows a price bubble. House prices are however remarkably stikcy. Guess what – when I read something of Mason Gaffney, this stickyness turned out to be part and parcel of the Georgist housing markte bubble model http://www.masongaffney.org/essays/Great_Crash_of_2008.pdf. I did not read him (as yet), but Fred Foldvary seems to have been the first one to predict (with a variant of this model) the 2008 housing crash.
But: what’s land? The Netherlands are a drained swamp. The Inuit are supposed to have quite some wors for different kinds of snow – well, the Dutch language has quite some words for all kinds of mud. Dykes were made and improved, drainage canals were dug and (much more important ) maintained, layers and layers of peat were excavated, fertilizer was used, land was parcelled. Land is not in fixed supply. It’s man made, at least at some places (also in England: http://en.wikipedia.org/wiki/The_Wash).
I do think that Georgism has a lot to offer. Since about 1995, the housing market in The Netherlands has gone astray. A Land Value Tax on rentier land income (in combination with better mortgage market rules!). One of the consequences of the bubble prizes was a very lare increase in the prices of land (with building permit). At this moment, economists have advised the government to increase house rents (to be precise: to give house owners the right to increase rent faster while also taxing away monopoly profits of house owners with ownng older houses) as prices of land have inreased so much. I think that a bit of Georgism (in fact: more than a bit) would have been in place. On the other side: land has a cost of production too… What’s your view on this.
(On the historical development of land rents in the Netherland and agricultural productivity: Knibbe, M. ‘Lokkich Fryslan. Landpachten, arbeidsloon en productiviteit in de Friese landbouw, 1511-1830′. Groningen, 2006.)
P.S. – I have a nice table of years with major floods and years when the rules on the height and width and financing of dykes were tightened. Guess what….
My 1997 article predicting and explaining the 2008 crash is at: “The Business Cycle: A Georgist-Austrian Synthesis.” American Journal of Economics and Sociology 56 (4) (October 1997): 521-41.
Apologies if this gets repeated. I tried to send by email but don’t think it worked.
I would like to point out that it was in fact Fred Harrison who precisely predicted the ‘crash’ in his 2005 ‘Boom Bust, House Prices, Banking and the Depression of 2010 – as he did the previous house price crash.
Also, I would like to explain that the Dutch polders are capital, because they are man-made and thus need a constant application of labour to retain their value. But they are built on land (the surface of the planet) which is not man-made and has a separate rental value which should be collected for public benefit.
Hope that answers your question, Merijn.
I would suggest that “land” is just as “man made” as any other commodity because what is traded is the title (right to use) a piece of land, which is a human made product.
There is a nearly unlimited supply of land, for which title can be created at the whim of a government or its agencies.
So putting land in a special category, for the purpose of taxation, makes no sense to me. That is not to say that it should be used as a speculative commodity.
The underlying problem is the speculative mentality and a lack of regulation thereof.
Helge, I’m afraid you are letting your landowner status cloud your judgment. A title is not the actual thing. Every single plot of land is unique and the owner of it holds a monopoly. You seem to be implying that all land has equal value which you must surely know is wrong. Producing worthless titles to worthless land is a solution to nothing. Land is our common inheritance – it was recognised as common land until it was enclosed and often then held by force. Collecting the rent for everyone’s benefit is the only just, effective and efficient solution to the dysfunctional land market, which does not allocate to best use. For paying the rent you get exclusive use, which is all anyone could want. Anything which is produced using labour and land is capital. Land just is – it is location, pure and simple – geography.
Control of land used to be the key to position and power in medieval society.
Today, the control capital has supplanted the control of land in this regard.
I think it is counter productive to simply focus on one thing, land, and believe that government taxation of same is going to solve a lot of societal problems, while letting capital have free reign.
Capital movements, increases and decreases, have a lot more to to with societal well being than land titles, which are only a small piece of the pie in contemporary society.
Helge, I do not advocate focussing on land alone (supporters of land value tax do not pay enough attention to the expropriation of surplus labour by the owners of capital, in my opinion), but ignoring the land issue is a serious impediment to economic analysis. It does seem that once land is built upon it becomes invisible. In the UK in particular an overwhelming proportion of the value of residential and commercial property is actually land value. Location matters – and that is largely what land is.
Carol, the Dutch CBS have done an excellent job this year, by calculating national Dutch wealth (part of the national accounts). They splitted the value of land and the value of buildings. That yielded the next results:
Table 1. Non-financial wealth in the Netherlands, 1996 and 2009 (billions of euros)
1996 2008
Buildings, roads, etc. 1052 1951
Inventories 55 85
Land 264 1145
Natural resources 68 173
Consumer durables 98 156
Total 1537 3510
Well, I tried if I could copy an Excel tabel into the blog but it did not work out. The whole thing: the value of land was about one sixth of total wealth in 1996 but about one third in 2008. Almost all of this rise was due to increasing land prices.
http://www.cbs.nl/nl-NL/menu/themas/macro-economie/publicaties/publicaties/archief/2010/2010-p19-pub.htm
Thank you so much for these data, Merijn. If only the UK govt would do this kind of exercise I am sure that we would see the same pattern. But the UK has lost, more than any other state, the concept of land as distinct from capital. We never consider separating land and buildings values and our property taxes are paid by occupiers rather than owners. Is this unique in the world?
Land is not wealth. The ownership of a land title is a claim on that stream of wealth that constitutes economic rent of land. It is essential to understand this distinction.
The price of a land title is the capitalisation of that stream of rental income that remains with the holder of the land title, adjusted for future expectations.
Helge, I do not know what definition of capital you are working to, but no capital can be put to work unless there is suitable land upon which to locate it. Land is as important as it ever was, in fact, land in commercial use is orders of magnitude more valuable than land in agricultural use. And its value arises from the presence and activities of the community, in particular, the value of infrastructure provided at the taxpayers’ expense. That is just one of many reasons why the rental value of land should be a particular object for taxation.
It is also the case that titles are issued, protected and defended by the civil government and it is only reasonable that the beneficiaries of this service should pay for the benefit they receive.