Saturday, February 15, 2020

So Claire Jones, Henry George and Adam Smith Walk Into A Bar...

....and the barkeep says "What is this, some kind of a joke?"

Nah, its economics.

"Every increase in the real wealth of the society, 
every increase in the quantity of useful labour employed within it, 
tends indirectly to raise the real rent of land."
-Adam Smith, "The Wealth Of Nations"
Book I, XI. Of the Rent of Land, Conclusion

That was one of the first things I thought of when I started reading Ms Jones' post at FT Alphaville on Thursday:

As unsafe as houses
Few industries show more visible signs of the extremes of the economic cycle than construction. During the frenzy, skylines are full of cranes. When the bubble bursts, we’re left with ghost estates.
This perception matches reality, according to an IMF research note published Wednesday. Stretching back to the 70s, not only is the construction sector the most prone to booms and busts, according to the data, but also its frothiness on the way up is also a decent predictor of the scale of the impending crash:
We find that the worst booms — that is, the costliest among bad booms in terms of subsequent growth (or lack thereof) — are associated with higher growth in the construction sector during the boom phase. A recession following a bad boom that features fast construction growth is more than 1.4 percentage points worse than one following a bad boom with low construction growth.
The riskiness inherent in construction booms may seem obvious.
Few people borrow several multiples of their income to fund purchases of any other asset than property. Yet the IMF research finds that construction growth in a boom also outperforms metrics such as household debt, via the note:
We find that a significant number of bad booms in emerging markets did not feature any rapid increase in household debt . . . However, almost all the bad booms were accompanied by strong expansion of the construction sector.
(Though credit booms in advanced economies with well developed mortgage markets were a good indicator of subsequent busts.)

So what makes construction booms so likely to lead to spectacular busts, besides simple over-indebtedness? Two things.

The first is that construction produces tangible things which can be used as collateral. If the initial debt to fund the development is partially paid off, or the asset appreciates, equity can be released to raise more funds and increase investment. Lenders – from banks to private equity – are often far more willing to fund real estate investment as a result. This leads to a misallocation of capital, which – due to the social value attached to housing, especially – is politically difficult to curb.
The second is that it tends to skew the labour market....

If interested here's the Harvard Classics 1909 version of Smith's book I, chapter XI, via Bartleby which begins:
RENT, considered as the price paid for the use of land, is naturally the highest which the tenant can afford to pay in the actual circumstances of the land. In adjusting the terms of the lease, the landlord endeavours to leave him no greater share of the produce than what is sufficient to keep up the stock from which he furnishes the seed, pays the labour, and purchases and maintains the cattle and other instruments of husbandry, together with the ordinary profits of farming stock in the neighbourhood. This is evidently the smallest share with which the tenant can content himself without being a loser, and the landlord seldom means to leave him any more....
Smith has some conflicting views on rent and land that he had not worked out by the time the great book was published.
Our last member of the trio did not suffer from Smith's failing. Henry George thought things out.
Unfortunately these days he is remembered, when he is remembered, mostly for his tax proposals.
Here's the introduction to a 2016 post:
Forgetting History: "Nothing Like This Has Ever Happened Before" 
Back in 2012 there occurred one of those eruptions of comment* that seem to happen for no discernible reason other than some combination of network effects and echo chambers.

The eruptions peak and die away as the crowd moves on leaving almost imperceptible ripples where there had been much thunder and fury.

This is a reflection on one of them, Henry George and the land tax, updated for current values and valuations....
Which is a pretty good primer. Alternatively, for a more academic treatment  there is:
The Metropole
The Official Blog of the Urban History Association

But for the closest tie-in to what Claire Jones was highlighting here's economist Mason Gaffney:

Henry George 100 Years Later: The Great Reconciler
M. Mason Gaffney
Prepared for Henry George Centennial, 1997
Henry George (1839-1897) is best known today for Progress and Poverty (1879). Eloquent, timely and challenging, this book soon became and remains the all-time best-seller on economic theory and policy. 
In 1879, George electrified the world by identifying one underlying cause for two great economic plagues: chronic poverty arising from insufficient demand for labor, and cycles of boom and bust. These twin plagues arose from concentrated ownership of land, compounded by land speculation. Large landowners and speculators (often one and the same) held the best land idle or underused, forcing labor onto marginal land and driving down wages. Collapse of speculative land price bubbles caused periodic slumps.

(By "land" George meant exclusive rights to use natural resources in a specified territory. It included mining, water, fishing, and timber rights, road and rail rights-of way, and some patents. George emphasized the high value and productivity of urban land, which facilitated communication and trade. Today, we would add to "land" such items as taxi medallions, telecommunications licenses and pollution "rights".)....
Which leads us back to the Henry George Society and their page on Land Speculation and the Boom/Bust Cycle

That's what I thought of when reading Claire's post.