An 18-year cycle of real estate and land values has been the cause of every major recession, and without a radical shift in taxation structures, the U.S. economy will be in for another shock around 2026.
EarthSharing.org had the opportunity earlier this month to speak with Fred Foldvary, professor of economics at San Jose State University and board member of the Robert Schalkenbach Foundation. Foldvary predicted the last recession in his 2007 book ‘The Depression of 2008’, and said real estate bubbles in general can be predicted using an 18-year cycle model developed by early-20th-century economist Homer Hoyt.
“[Hoyt found that] in Chicago there was an 18-year real estate cycle with very astonishing regularity, and that also coincided with the general business cycle of the United States,” he said.
Foldvary used the same methodology as Hoyt, swapping in the most up-to-date numbers from today’s real estate sector.
“I brought it up to date with current data on both construction and land data… The data is out there for the last 50 years,” Foldvary said.
A combination of low interest rates and high land values was the key warning signal for recession, Foldvary said, a kind of hybrid between the Austrian and Georgist schools of economic thought.
“The major recessions have all been closely related to the real estate cycle,” he said. “In each case the real estate prices and construction peaked shortly before becoming a recession.”
Without any unprecedented changes in government policy, there was no immediate risk of another recession for the next decade, Foldvary said. But the other side of the coin is that, without new ways of thinking about land values and controlling speculation, the U.S. economy should be prepared for another recession in around 2026.
“The federal debt will be that much higher, and if the government is all tapped out and it can’t borrow any more money in the next financial crisis, it could be even worse than 2008,” he said. “The economy has the same structure as it’s had for the last 200 years. The basic problem is massive subsidies to real estate – both fiscal subsidies and monetary subsidies.”
Even newer financial regulations like Dodd-Frank would be ineffective, because they failed to address the core reason for the business cycle, Foldvary said.
“They don’t touch the fact that land values absorb the benefits of progress, and then speculation carries them to a height that makes real estate unaffordable, and then you have the collapse.”
The potential for a system of land value taxation to break this 18-year cycle is enormous. Taxing land and natural resources instead of incomes and investment would act to discourage real estate speculation, keep the market accessible for wage-earners, and stimulate the construction of centrally-located real estate that promised the best value for the public and the greatest amount of space in which to work and live.
There will come a time in the next ten years when we will begin to see the signs of another impending recession in the U.S., one with the potential to be the worst this country has ever seen. Knowing the precipitating factors of a future crisis, and as the economy experiences slow growth, now is the critical time for land value taxation to be seriously considered.
Fred Foldvary is on the board of the Robert Schalkenbach Foundation (RSF), a non-profit organization established in 1925 to spread the ideas of the social and economic philosopher Henry George (1839-1897). Foldvary received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He has taught economics at the Latvian University of Agriculture, Virginia Tech, John F. Kennedy University, California State University East Bay, the University of California at Berkeley Extension, Santa Clara University, and currently teaches at San Jose State University. Foldvary is the author of The Soul of Liberty, Public Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and The Half-Life of Policy Rationales. Foldvary’s areas of research include public finance, governance, ethical philosophy, and land economics.
WKZSU 90.1 FM Stanford University Radio Interviews EarthSharing.org
July 5th, 2016, Edward Miller and Jacob Shwartz-Lucas were invited onto Stanford University Radio to discuss an event they would organize in Oakland a few days later. The event was titled BIL Oakland 2016: The Recession Generation.
The discussion revolved around the event’s aim of helping young adults to navigate the challenges of living in our harsh economic climate and rapid technological disruption.
Jacob and Edward discussed their motivations for putting on the conference. This included explaining their backgrounds, and what changes they want to see in the world.
The lessons of the 2008 financial crisis are quickly being forgotten. That market collapse was precipitated by an extraordinary rise of US land values, which was driven by the emergence of subprime lending on a mass scale.
Prices of residential and commercial real estate are once again on the rise. A major driver of this astounding rebound has been Chinese real estate investment. Chinese investors, seeking promising investments and a way to move their money out of the slowing Chinese economy, have poured $110 billion dollars into US real estate in the past five years. By contrast, the Chinese real estate market, which is putting a drag on the Chinese economy, has been called by many the largest land bubble in history. Chinese investments in the US market are inflating housing prices across the country and placing home ownership further out of reach of many Americans.
Over the past several years, Chinese investment in commercial properties has captured headlines. For example, in 2015, the Anbang Insurance Group purchased the Waldorf Astoria Hotel for $2bn and attempted to purchase Starwood Hotels for $14bn. However, the vast majority of Chinese speculative investment has been in the residential market, to the tune of over $93bn. Cities with the most rapidly rising housing costs–San Francisco, New York, Los Angeles, and Seattle–are popular markets with Chinese buyers. But as housing stock across the country continues to gain value, buyers are now turning their speculative intents to Chicago, Miami, and regions of middle America.
When people speak of rising real estate prices, they certainly aren’t talking about bricks, they are talking about land. As a consequence of all this land speculation, Americans are finding it harder to obtain affordable housing and commercial space, and not only because of rising prices. Close to 70% of Chinese buyers pay cash, which is more appealing to sellers because deals can close much faster. This puts US residential buyers who require a mortgage at a disadvantage. Bidding wars with deep-pocketed foreign speculators also has the effect of pressuring US buyers with more limited liquid assets to sign off on larger mortgages than they can financially handle.
Prospective home buyers are not the only ones feeling the crunch. As homeownership becomes more unaffordable, the number of people in the rental market increases, driving up rents across the country. In 2016, rent increases are expected to outpace wage increases by about one percentage point. Faster than the general rate of inflation.
The periodic bubbles in real estate markets are a symptom of this rush to pocket the rising value of land, whether by foreigners or citizens. So far, the United States is not taking steps to curb either domestic or foreign speculation in real estate. Instead, Congress is going in the opposite direction by encouraging foreign “investment” in US property.
An alternative to such measures, which numerous eminent economists recommend, is a tax on land values. Land value taxation (LVT) is a twist on conventional property taxation, whereby improvements to the land are not taxed, but the land itself is taxed. Proponents argue that we ought to shift as much taxes as possible away from productive activity and onto land values. While other strategies would serve to limit foreign land purchases, taxing land values would actually halt idle landholding in general by making the speculative ownership of raw or underdeveloped real estate unprofitable.
When markets are operating correctly, profits are simply a return for productive activity, not a windfall that is achieved by excluding others as with the landed gentry in the feudal era. With LVT in place, Chinese or other foreign investors who wanted to make money by purchasing land would have to actually develop that land. They would need to attract residential or commercial tenants by providing desirable amenities and reasonable rents, and shouldering the risks involved in any sort of productive activity. This would result in a growth of construction activity and an increase in US housing supply. Increased construction activity and decreased cost for commercial and residential real estate would stimulate the rest of the US economy, simultaneously decreasing unemployment and raising wages. In effect, taxation of land values would convert the current Chinese desire for US land into a sustainablemeans of growth for the US economy.
This weekend, the Paris Climate Summit marked more diplomatic progress on the issue than ever before. China, the United States, and other key nations pledged unanimously to greatly reduce their emissions. Of all the solutions discussed, there really is only one reform that has the chance of being a game-changer, and that’s heavily taxing pollution. Even if you don’t believe in global warming, or whether it is man-made, you can’t deny that pollution is harmful in lots of other ways and that we ought to reduce it. The most common objection to this is that it would somehow hurt the economy. The truth is, a tax on carbon and other pollutants would would actually give the economy a great boost. Just ask the Republicans; taxing carbon was the Bush administration’s official policy.
Whether you’re a conservative or a liberal, for higher taxes or lower taxes, it doesn’t matter. If we collected the same amount of revenue we do now, it would be better if it came from pollution than wages, sales, etc. By removing taxes from hard work and exchange, business would get a boost, and polluting would become expensive. Therefore, people’s behavior and technological innovation would shift to be more in line with the environmental cost of their actions.
President Obama said the following in Paris:
“I have long believed that the most elegant way to drive innovation and to reduce carbon emissions is to put a price on it. This is a classic market failure. If you open up an Econ101 textbook, it will say the market is very good about determining prices and allocating capital towards its most productive use — except there are certain externalities, there are certain things that the market just doesn’t count, it doesn’t price, at least not on its own. Clean air is an example. Clean water — or the converse — dirty water, dirty air.In this case, the carbons that are being sent up that originally we didn’t have the science to fully understand — we do now. And if that’s the case, if you put a price on it, then the entire market would respond.”
The agreement calls for rich countries to invest in clean energy infrastructure in poor areas of Africa and other regions, but who knows whether it will actually be spent well. That doesn’t make it a bad idea per se. One shouldn’t have a zero rule for misappropriation if the overall aim of the spending is achieved and these results are more beneficial than alternative investments. However, it would make more sense to take the pollution tax revenue and just give it to everyone as a global citizen’s dividend, or basic income as some call it, like Alaskan citizens get when companies extract oil from their state.
Government can be effective in the realm of basic research, but when it comes to creating final products that reduce pollution, the private sector is likely to do a better job. I’m not saying this because I’m some kind of crazy Ayn Rand fanatic, I’m just a pragmatic nerd who wants a clean planet with high living standards and lots of technological innovation. We don’t need to depend on government to come up with clean technologies if we simply give businesses the right incentives. There is no way that even the smartest in government can beat out the collective ingenuity of billions of people actively looking for ways to reduce their carbon footprint in avoidance of paying pollution taxes.
Take Tesla Motors for example. They have beautiful, fast, and completely electric cars already on the market. Sure, most people can’t afford a Tesla at present, but Elon Musk’s long term business strategy is to progressively make less and less expensive models at higher sales volumes, once Tesla’s costs are lower that is. If taxes were shifted off of companies like Tesla who make clean cars, and on to big polluters like Ford, it would naturally lead to more demand among consumers for cleaner vehicles, and car manufactures would need to follow suit to remain competitive. If you’re concerned about raising productive employment in the United States, providing such incentives would enable the US to compete with Asian car manufacturers. The problem at present is that not only do we not tax pollution, we actually subsidize a host of industries involved in a supply chain latent with pollution. If we end the subsidies and start taxing pollution, you’ll see lots of clean economic growth. They taxed energy in Denmark, a way to approximate taxing pollution, and the results have been greatly beneficial.
This clip from the Daily Show demonstrates how land owners are able to push taxes onto poor and middle income people via sales taxes. We should do the opposite, end sales and wage taxes and increase the tax on land instead. This would have many positive effects.
How can we reduce pollution globally? It’s important that we not only ask individuals to change their personal behavior but that we also change the incentives under which they operate. We should tax the use and abuse of natural resources. We should make companies pay taxes in proportion to how much they pollute. This would give them not only a moral reason to pollute less but also a financial one.
One of the major causes of pollution is urban sprawl. Sprawl is caused when central locations are not used efficiently and people are forced to outlying areas as a result. The best way to curb sprawl is to tax the value of land so that owners of central locations will use their land efficiently, making the land available for the otherwise would-be sprawlers. To learn more about taxing the value of land, see our illustrated article Visualizing Earth Sharing.
Clickable text version
Pollution is one of the top ten dangers to life.
Table: Risk factor, deaths in millions, percentage of total: 1: Tobacco use: 1.5; 17.9 2: High blood pressure: 1.4; 16.8 3: Overweight and obesity: 0.7; 8.4 4: Physical inactivity: 0.6; 7.7 5: High blood glucose: 0.6; 7.0 6: High cholesterol: 0.5; 5.8 7: Low fruit and vegetable intake: 0.2; 2.5 8: Urban outdoor air pollution: 0.2; 2.5 9: Alcohol use: 0.1; 1.6 10: Occupational risks: 0.1; 1.1
Studies correlate nitrates in bacon, drinking water, etc. (from modern farming practices) with harm to the pancreas, increased risk of diabetes mellitus, as well as Alzheimer’s, Parkinson’s disease, and more. So… Care about what you eat and learn where it comes from. If you can’t afford organic, at least remember that how animals are reared will affect you, and may come at a high price. Source: http://sciencedaily.com/releases/2009/07/090705215239.htm Pollution can make you fat
Studies correlate air pollution with cells being less able to cope with free radicals, causing stress due to generally poorer health . So… Exercise! Walk more! Get fit! Studies also show that physical exercise helps your body fight back, compensating for the damage due to air pollution. Sources: http://sciencedaily.com/releases/2015/03/150324210045.htm Pollution makes it harder to breathe
Studies correlate air pollution with damage to brain cells, leading to increased autism in children, unhappiness in all ages, and anxiety and decreased brain function in middle aged and older people. So… Use your brain while you can! Understand the bigger economic picture: Why are we so messed up that we would poison our own air? And how can we make a better world? Learn the economics of wealth and poverty: http://understandecon.com/igivetest/register.php
Stuart Gaffney and John Lewis spoke at the Council of Georgist Organizations annual conference. Their talk was entitled: Case Study in Building Successful Movements, How the LGBT Community Went from the Margins to Mainstream. They discuss how movements to end poverty and save the environment can benefit from the what they have learned about the LGBT movement.
Stuart Gaffney and his husband John Lewis are leaders in the freedom to marry movement. Together as a couple for 26 years, they were two of the plaintiffs in the historic 2008 lawsuit that held that California’s ban on same-sex marriage violated the state constitution. On June 17, 2008, they married at San Francisco City Hall, surrounded by friends and family.
Stuart and John are leaders in Marriage Equality USA, a national grassroots organization, and API Equality, a coalition targeting outreach and education to the Asian-American community. They have appeared extensively in local, national and international media. The focus of their work has been to foster connection between the general public and the lives of LGBTIQ people.
Stuart is a graduate of Yale University and currently a Policy Analyst at the UCSF Center for AIDS Prevention Studies. [from Huffington Post]
As of Friday, same-sex marriage is now protected in all 50 states under the 14th amendment to the US Constitution. Justice Anthony Kennedy delivered the 5-4 decision:
“It would misunderstand these men and women to say they disrespect the idea of marriage. Their plea is that they do respect it, respect it so deeply that they seek to find its fulfillment for themselves.”
“Their hope is not to be condemned to live in loneliness, excluded from one of civilization’s oldest institutions. They ask for equal dignity in the eyes of the law. The Constitution grants them that right.”
Before today’s decision, same-sex marriage was legal in 36 states, covering 70 percent of the US population. The remaining 14 states included: Alabama, Arkansas, Georgia, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Nebraska, North Dakota, Ohio, South Dakota, Tennessee and Texas.
The Sixth Circuit Court of Appeals in Cincinnati had previously determined that states should define marriage laws, and “to allow change through the customary political processes” instead of the courts. In recent years, public opinion has shifted rapidly. A Gallup poll in 1996 indicated that 27% of people approved of same-sex marriage, up to 60% now. Over the last year and a half, 60 decisions struck down same-sex marriage bans.
Matthew Rognlie’s analysis of Thomas Piketty’s predictions on increasing inequality is on point regarding both the role of housing and the poor substitutability of capital for labor, but it’s blind to the very existence of money and to the role of the interest rate on risk-free bank deposits in determining the costs of real investments.
The returns on capital can only diminish if the interest rate, and thereby discount rates for real investments, falls further. Currently, this cannot happen because the zero lower bound (ZLB) of interest rates acts as a “minimum wage of capital.” No matter how eager people would be to save, the return on monetary savings cannot fall any further (as this article will explain). Hence also the returns required from other assets remains high.
Eliminating the ZLB and implementing a land value tax (LVT) simultaneously would solve the majority of our economic concerns, such as chronic unemployment, heavy taxation of labor, the polarization of income and wealth differences and the growth dependence of our economies, which prevents tackling our environmental threats. It would also be feasible for any first mover nation or monetary region, as it would actually improve its competitiveness over real, productive investments.
Otherwise the “oversupply of capital” in the sense of an oversupply of saving — and hence essentially an oversupply of labor — will just drive the economy into a more severe depression. The unemployment, deflation pressures, and public deficits we are currently seeing in Western economies are the results of the ZLB and the low substitutability that Rognlie emphasizes.
If there is one thing we should’ve learned from the financial crisis, it is the danger of making real-world predictions with economic models that ignore the monetary and financial system .
Apparently we didn’t.
Not only housing, but all real estate — which is unequally distributed
MIT graduate student Matthew Rognlie has received a lot of attention with his criticism of Piketty’s “r>g theory,” which predicts that income and wealth inequality will continue to rise when the rate of economic growth (g) falls below the average return on capital (r). Rognlie’s work sure is admirably thorough.
Before going into the biggest omission both of their analyses, let’s point out that Rognlie is not the first nor the only to notice that most of Piketty’s “increase in the amount of capital” is actually an increase in the value of land (see e.g: Stiglitz, Karl Smith, Galbraith).
Many like to conclude from Rognlie’s analysis that “since the housing ownership is much more evenly spread than productive capital, it may be less worrying for inequality.” (It maybe partly because of this framing that Rognlie’s critique receives so much attention.) However, this is not the case. Homeownership is one of the biggest unearned polarizers of both income and wealth differences; the higher and more reliable your income, the bigger and cheaper a mortgage you can get.
Also, the issue of rising land values does not only apply to housing but to centrally located real estate in general. This includes office buildings in business districts. Overall, the limited resource of land (location) is very unequally distributed. (In fact, the distribution of land ownership was one of the first cases to which Vilfredo Pareto applied his famous 80–20 principle.)
Also, some city planning is very useful and valuable, as all land use has externalities (positive and negative) on the value of adjacent land. Zoning makes these predictable- mitigating windfall gains and losses. The absence of planning would also result in less efficient infrastructure and transit systems, further reducing the availability of locations with good accessibility.
High depreciation rates = low capital intensity of technologies -> low substitutability
Unlike some Chicago economists believe, capital is not some generic “putty clay” that can be applied productively in different quantities at will. The opportunities to increase capital intensity in production are significantly limited by available technologies. If we assume that all capital assets can be produced with labor (i.e. we omit land and natural resources), capital intensity essentially means how much beforehand on average all the work required for producing the end product needs to be done.
As The Economist paraphrases Rognlie’s point on the changing nature of capital:
“Modern forms of capital, such as software, depreciate faster in value than equipment did in the past: a giant metal press might have a working life of decades while a new piece of database-management software will be obsolete in a few years at most.”
This higher rate of depreciation essentially means that new technologies are less capital intensive than earlier ones — even if they increased labor productivity significantly. In other words, even if they allow a more valuable output with the same amount of labor, they don’t need as much work to be done before it’s usable capital. Of course, robots that make, repair, and program themselves could eventually turn this trend on its head. But for now, Rognlie’s arguments for a low substitutability of capital for labor are well grounded. Piketty mistook the rise in land values for a rise in capital intensity.
Also, Piketty seems to imagine that capital can always be accumulated by saving up more money. However, in a closed economy, net savings are limited by profitable real investment opportunities. Rognlie is on the right track in that, theoretically, an increased desire to save should result in the yields of capital falling. According to supply and demand, a factor or resource in abundant supply should fall in market price. This was already pointed out by Banko Milanovic of the World Bank in his 2013 paper:
“But, the reader will ask, if the capital/output ratio increases so much, would not the marginal return to capital diminish? Would not r go down? This is obviously a soft point of Piketty’s machinery.” (Milanovic 2013, p. 9)
“Will the reader be convinced by the argument that the elasticity of substitution between capital and labor is likely to remain high, and that an increase in capital will not drive r down?” (Milanovic 2013, p. 10)
Unfortunately, high substitutability of capital for labor is not the only factor that can maintain high returns on capital. Tragically, the economics discipline is so segregated that capital theorists don’t understand macroeconomics — and neither capital theorists nor macroeconomists (want to) understand money.
“Capital” has two different meanings
Before explaining the role of money and the risk-free interest, it might be useful to avoid a possible source of confusion in terminology.
In economics, “capital” usually refers to real assets that allow easier production or provide some other real benefits in the future. In addition to physical production goods (machines, buildings, tools etc.), this includes for example, technologies and new product designs created by innovation. This was also the meaning used above when discussing “capital intensity.”
In finance and accounting on the other hand, “capital” refers to “financial capital,” which is any property or security that can generate income in the future for its holder. In addition to the ownership of real capital assets (directly or indirectly through shares in companies or funds), this includes all forms of credit (including money), immaterial property rights, and other kinds of privileges that can be owned and traded (e.g. taxi badges and patents).
In the case of a company, real capital assets appear on the “assets” side of the balance sheet (together with any credit and IPRs the company might hold), while “capital” in the financial sense refers to the “liabilities” side of the balance sheet: The capital structure of the company determines how the risks of the company’s assets and business are allocated between shareholders and creditors. (The shares and bonds of the company are of course assets for their owners. One’s liability is another’s asset.)
Rognlie importantly points out that the market value of a company’s shares (its shareholder equity) can diverge significantly from the book value of its assets in excess of debts. (Rognlie 2014 p. 15) Even if a company with a relatively small balance sheet can be valued at billions. This is not only the result of those product designs, human capital, or other immaterial assets that a company cannot capitalize into its balance sheet for accounting reasons, but also any monopoly rents (as explained by Stiglitz) or competitive advantages established through a strong brand or customer relations. Also, the whole is often “more than the sum of its parts” — and so it should be with a company.
This distinction between “real capital assets” and “financial capital” is even more important for what we mean by “the cost/price of capital.” Rognlie writes about “capital” in the first sense, and by the “real price of capital” (Rognlie 2014, e.g. p. 2–3) he means the production or acquisition cost of the assets in question. So to him, a rise in land value is a “rise in the real price of capital.”
However, when we talk about the “cost of capital” in finance, we mean an investor’s profit requirement for an investment or company in question. For credit finance, this is the interest rate on the company’s debt. The cost of shareholder equity is the return that would make an investor deem the investment “profitable,” i.e. worth making. This depends on the interest rate on deposits and the perceived risks involved, as will be explained. For a company’s real investment decisions, it is common to calculate the Weighted Average Cost of Capital (WACC) from credit and equity costs and to use this as a discount rate for expected cash flows. Discounting means that future expected cash flows are “devalued” by the discount rate (i.e. the profit requirement) – the more times the further they occur in the future.
The interest rate determines the returns on producible capital
Rognlie’s analysis is based on an economic model without a monetary system — which is a typical neoclassical approach. This assumes that all savings are automatically turned into real capital investments. Increased saving hence increases the supply of production goods and automatically lowers their net yields.
Moreover, the return yielded by risk-free credit — bank deposits — determines the costs of equity: the profit required of real capital investments.
As long as the risk-free interest rate follows the natural rate of interest — the rate at which overall desires to save are approximately in balance with profitable real investment opportunities — the outcome is pretty much the same as in a model omitting money. However, if the interest rate fails to keep the macroeconomy in balance, the story is very different.
Diminishing returns on capital — or a worse depression? The interest rate decides
Let’s assume we have a closed economy or an externally balanced open one, i.e. one with a balanced current account. This means that the economy is not falling into debt overseas, nor accumulating net foreign financial assets.
If the overall desire to save exceeds the available profitable investment opportunities, this essentially means that not everyone gets to earn and save as much as they would like to (unless the government facilitates this extra private sector monetary saving by going into debt itself, i.e. unless there is continuing fiscal stimulus). In practice, this oversupply means involuntary unemployment and underemployment. In the absence of wage regulations and excessively generous social security, this results in lowering pressures on nominal wages, and hence also prices, i.e. deflation pressures.
This is where the central bank would normally lower interest rates to balance the economy. However, currently many Western economies are stuck at the zero lower bound of interest rates (ZLB). In this situation, the result is not increased investment and lower returns on capital but more unemployment — or a need for the government to accumulate more and more debt (to stimulate the economy fiscally) to keep the economy running .
Quantative easing is mainly an inefficient placebo medicine based on the outdated quantity theory of money. It does not lower discounting rates notably nor reduce people’s desires to save.
Many economists and commentators have noted the possibility that even the long-term natural (or equilibrium) rate of interest might have fallen significantly below zero (see e.g. Summers, Blanchrd et al, Avent, Buiter).
The Remedy: a land value tax + removing the zero lower bound
On the other hand, if the real interest rate did fall to e.g. -5 %, we would see our real estate bubbles explode to unprecedented proportions. Land does not erode (Rognlie 2014, p. 13), is limited in supply, and has few direct substitutes. Therefore, in valuing it, we are essentially discounting an infinite cash flow – a “perpetuity .” When the discount rate approaches the expected growth rate of the cash flow, the net present value approaches infinity.* In other words, if you have an asset that forever gives you more every year compared to the previous year than you require your investments to yield, you should not sell such an asset for any price. With a profit requirement of zero or less, even a fixed (non-growing) perpetuity is infinite in price.
While the ratio of producible capital to income is determined largely by the capital intensity of available technologies, the capitalized value of monopoly resources is strongly dependent on the market interest rate.
However, in the current situation, this effect is much more an opportunity than a threat. The biggest obstacle to implementing a proper land value tax (LVT) is that imposing it suddenly would make real estate prices crash, resulting in a massive, unjust wealth transfer in the real estate market. A mere glance at the situation shows that the dilemmas associated with both LVT and removing the zero lower bound solve each other. We can compensate for the lower costs of capital by raising the LVT rate at the same time with removing the ZLB.
With no lower bound on interest rates, Piketty’s r (the average return on capital) can even drop negative. Good bye r>g dilemma and never-ending accumulation of patrimonial wealth.**
Western countries have a unique opportunity to make a shift towards a more equal and prosperous economy. More over, the move would be extremely competitive for any first mover: A lower interest rate would devalue an area’s currency lowering labor costs, and both LVT and negative interest rates government debt would allow reducing harmful taxes on trade (income tax, VAT, corporate taxes), vastly increasing any area’s competitiveness over productive, risk-bearing real investments. It remains to be seen, which economy first realizes the potential in this superior strategy.
Rognlie’s point about the importance of growing income differences between types of labor is also very relevant. To counter this, we need to maximize mobility between professions by removing artificial rigidities and privileges, ensuring access to education, as well as maximizing competition over employees.
The writer is an author, institutional entrepreneur, and economic engineer-philosopher. He has developed the Root Bug hypothesis that identifies the main flaws in our current economic system and provides fresh solutions for a fair, sustainable, and growth-independent economic system that facilitates all desired growth. Follow the Root Bug on Facebook and Twitter, and subscribe to the YouTube channel and the newsletter (in the right-hand column).
A version of this article has also been published on Medium.
*The valuation formula for a growing perpetuity is V = P0/(r–dP), where P0 is the first year’s expected cash flow, dP is the annual growth rate of the cash flow, and r is the discount rate employed, including risk premiums. In reality, the value won’t turn infinite, as increased volatility raises risk premiums. Instead, real estate prices become extremely speculative with negative real interest rates — in the absence of proper land value taxation.
**If we additionally mitigate risks of long-term unemployment and ensure that people have the realistic alternative to work less in the mid-term (if they so desire), we can make supply meet demand on the individual level regardless of aggregate demand. Then g (the economic growth rate) can be whatever people really want it to be. Economic growth becomes a matter of personal preference, while we can allow productivity to grow (unnecessary work to be destroyed) as much as technology allows.