Here We Go Again

by Nicholas Rosen

Not only does the economy seem to be headed into recession again -- but most economists, once again, don't know what to do to fix the problem. This is sadly confirmed by an article in the Washington Post (Sunday, November 11, 2001, page B1) by Joseph Stiglitz, the most recent Nobel laureate in economics.

Professor Stiglitz, who, I do not doubt, sincerely cares and wishes to help, tells us that the Federal Reserve Board isn't going to solve all the economy's problems by cutting interest rates. For one thing, it can't really cut all interest rates, just short term interest rates, and doing so raises expectations that an increase in the money supply (inflation in the original meaning of the term) will lead to price inflation, and those expectations may actually raise long term interest rates. After all, if you think that dollars will buy a lot less in five or ten years than they do now, you'll be tempted to use your dollars to buy gold to put under your mattress, or to invest in more insulation to cut your fuel bills, but not to lend out unless a high interest rate makes it worth your while.

Makes sense so far. But Professor Stiglitz has more to say. He criticizes the Bush tax cut, saying that a lot of those $600 checks went into savings accounts instead of being spent. Is this bad? One would think that a boost in savings would make more available to invest, letting worthy ventures be funded, and driving down real interest rates, even long term interest rates. He criticizes the Senate Republican bill for offering benefits mainly to the rich, instead of putting money into the hands of those who would spend it. I approve of his humanitarian desire to give benefits to the poor and middle class as well as to the rich, but I can't endorse his economic analysis. First, the rich do spend money as well as save it, and tax breaks for millionaires may lead to increased employment in the yacht manufacturing industry, to take one example. Secondly, saving is not an evil. Saved money is not usually hidden under mattresses; it is invested, and used to hire people to build new factories, or build machines to put in those factories; it is lent to people who want mortgages, and used to finance the construction of new homes; it is lent to entrepreneurs who hire people for their new or existing businesses.

Stiglitz goes on to suggest that the U.S. has one of the worst unemployment insurance systems in the industrial world. He says that if we give money to people who have lost their jobs in this recession, it will be quickly spent. What he doesn't seem to realize, however, is that it will largely be spent, one way or another, even if we don't give it to people who have lost their jobs. If the government raises taxes to give more money to the unemployed, then the taxpayers have less to spend. If the government borrows the money, then less money will be available for productive investments. If the government prints the money, then inflation will erode the value of everyone's dollars, and they will not be able to buy as much. Giving money to the unemployed may be a compassionate measure, but it won't fix the economy.

Secondly, Professor Stiglitz suggests temporary investment tax credits to induce firms to invest now, when the economy needs it. Does this mean that investment is a good thing after all? I thought that Professor Stiglitz was saying that spending was good, and investment, bad. Oh, wait, he didn't say that investment was bad, he only implied that saving wouldn't help the economy, so he must be in favor of investment without saving (or merely against savings without investment). But how do banks get the money to pay interest on people's savings accounts, if not by making profitable investments? If my only knowledge of economics came from the college texts I've read on the subject, I would either put myself under a psychiatrist's care until my head stopped spinning, or conclude that I was too hopelessly dull-witted to understand the subject, and leave the certified experts to give advice to the politicians and the public. Fortunately, I've read Henry George, so I can see what the Keynesians -- and most of the other heirs of neo-classical economics -- don't. In case you haven't, Gentle Reader, be patient; all will be explained.

Stiglitz points out that in a recession, state and local government revenues suffer, forcing spending to be cut, which further exacerbates the downturn. He says that a revenue-sharing program with the states would preserve vitally needed public services, and, he implies, stimulate the economy. This has the same basic problem as raising unemployment benefits, with a few twists of its own. The basic problem is that the revenue which the federal government shares with the states has to come from somewhere -- leaving whoever it came from with less to spend. Furthermore, if local politicians get to spend federal grants, they'll have less need to justify their spending to the local voters, so we're likely to see more state and local spending on such vitally-needed public services as subsidies for sports stadiums. And even further more: federal revenue sharing funds do not come from property taxes, but local revenues do. What's wrong with reducing reliance on property taxes? Read on, Gentle Reader, read on.

By no means would all mainstream economists agree with Professor Stiglitz. His right wing counterparts would likely try to stimulate the economy by cutting taxes, not so much to give people more to spend, as to give people an incentive to earn more from their labor and capital. The supply siders' position is less incoherent than the Keynesian theory, but it offers no adequate explanation for why there were high unemployment rates and periodic panics (as depressions used to be called, long before they were renamed recessions) back in the Good Old Days when taxes were much lower than they are now, with no federal income tax at all.

The favorite economists of the conventional right and the conventional left are like blind men groping at different sections of the elephant. Their big problem is that they fail to distinguish between land and capital, as the classical political economists did. Capital is produced by human effort; land isn't. That makes a profound difference. If you tax labor, people will tend to work less, at least aboveboard. If you tax capital, people won't bother so much to accumulate and use capital, at least not where the tax collectors can see and grab it. If you tax land, there's no decrease in the production of land -- and no landowner rolls up his acreage and carries it to a jurisdiction with lower taxes.

Remember what I said about savings being invested and used productively? That was a half-truth. Some savings are invested and used productively, but some aren't. The problem isn't that unproductive savings are hoarded under mattresses rather than spent (an impression you might get from reading Keynesians); the problem is that some savings are spent buying land, bidding up the price of land, and speculating in land.

Suppose someone who has managed to save $100,000 invests it in a new house. He spends $40,000 to buy a plot of land, and $60,000 to have a house built on it. The $60,000 creates jobs for construction workers, and also for lumberjacks and brickmakers and manufacturers of plumbing fixtures, but the $40,000 spent on the land does not create any jobs for landmakers; it's merely transferred from the account of the new landowner to that of the former landowner.

That isn't actively harmful, but what really hurts is if someone else sees how land prices are booming, and reacts accordingly. "I'd be a fool to sell my lot to some would-be homeowner for just $40,000," he says. "The way prices are rising, it should be worth $55,000 or $60,000 in just a couple of years, and I'm only paying a smidgen in taxes on it, so I won't part with it now for less than $50,000."

The next would-be homeowner who has $100,000 saved can't buy a lot and have enough left to build an adequate house. Maybe he can borrow an extra $10,000, but the people who don't have much in the way of savings, and have just enough income to qualify for a $100,000 mortgage, are now priced out of the market. As a result, construction workers and others don't get jobs.

It's not just homeowners who need land (and it's not just farmers, although some people only think of agriculture when the topic of land is brought up). Factories need to be built on land. Shops and offices are located on land. When land speculation makes land unaffordable, businesses can't expand, or can't be started in the first place. That means fewer jobs and lower wages for everyone from microchip designers to sales clerks to janitors.

Imagine that we cut marginal income tax rates on those in the upper brackets, and reduced the tax on capital gains. George Gilder and the editors of The Wall Street Journal would doubtless applaud. They would say -- and be partly right -- that such a measure would encourage people to work harder, earn more, and invest their earnings productively. They would say that venture capitalists would have more money to invest in promising enterprises. They would say that the tax cuts would boost the stock market. What they would mostly fail to say is that the tax cuts would also boost the land market, or if they said it, they would treat the boom in real estate prices as a good thing, just like a boom in production. The trouble is that more money available for "investment" in land won't stimulate the production of land, but only increase the price of existing land. Entrepreneurs who found it easy to find more money for their businesses would also find it necessary to spend much of that money on buying land or leasing space, leaving less available to buy equipment, erect buildings, and hire workers.

If you've followed this far, you may be able to see what it would take to give the economy a real boost. We should cut taxes on earned income, cut sales taxes and tariffs, cut property taxes on buildings, but raise property taxes on land. The tax cuts would give people more incentive to work, to build, and to invest, while the tax increase would deal a blow to land speculation, and cause vacant lots to be made available. The owner of the unused land next to a plot which had sold for $40,000 would no longer be able to demand $50,000 for permission to let someone build a house; instead, he'd look at his tax bill, and decide that if he wasn't about to use the land, he'd better sell it quickly. He would soon be glad to accept a mere $30,000 or $20,000 to have someone take the land off his hands, and a house or a shop would be built. Architects, carpenters, and plumbers would find more work, and as the supply of shop and office and factory space went up, so would sales clerks, janitors, machinists, auto mechanics, advertising executives, webmasters, and solid state physicists.

The greatest obstacle to accomplishing this is ignorance: simple ignorance among most of the population, and an ignorance which does not know itself to be ignorant among those whose profession is to know better. Most Americans today do not think of land as being different, in an economic sense, from things created by human labor. Most economists today do not concern themselves with the distinction between land and capital. Land is treated as capital, just like a factory building, a lathe, personal skills and training (human capital), an ingot of gold, a government bond, a freight ship, or a share of stock. They could all be converted to one another by trade, proclaimed the neo-classical economists of the late nineteenth and early twentieth centuries, and they could to various degrees substitute for each other, so they were all capital.

The trouble, of course, is that some of these forms of "capital" are produced by human effort, and some are not. You can exchange an acre of land for a shop full of machine tools -- but you cannot make more land the way you can make more machine tools. In consequence, taxes on land and taxes on capital (or on labor) have very different effects. All of this, however, is usually either ignored or given just a couple of paragraphs in a thick econ textbook, and few economists talk much or loudly about land value taxation as a way to stimulate the economy.

That is why, despite the genuine advances which mainstream economists have made in some respects over the past century, they have proven incapable of solving some important problems. Having turned their backs on the rhinoceros in the corner of the room, they have to come up with some explanation of why the floor is sagging and creaking, so we hear a lot about the mice of money supply and the rats of aggregate demand. We see countries suffering from inflation after trying Keynesian policies, suffering from depression after imposing IMF austerity plans, suffering from skyrocketing land prices and consequent busts after free market policies have brought some growth and apparent prosperity, or suffering from all of the above. We even see Georgist policies having some limited success where tried to a limited extent, but we don't see the World Bank, of which Professor Stiglitz used to be chief economist, or America's Council of Economic Advisors, of which he used to be chairman, coming out for a free market and a single tax on the value of land. Perhaps we will see such things one day, but for that to happen, we need to replace ignorance with understanding, one pupil at a time, one letter to the editor, one letter to a politician, one presentation to a city council, one study on the effects of land taxation where tried.

It's a big job, but let us hope that it not prove impossible. If it does, then economics is indeed "the dismal science" -- because to bring about prosperity the way Professor Stiglitz recommends is, alas, truly impossible.

November 27, 2001

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