In August 2005, Fred Harrison warned in MoneyWeek that the house-price bubble would burst in 2008. Here he explains how market dynamics can be stabilised.
As I first predicted in 1997 in my book The Chaos Makers, house prices peaked in 2007. I believe they now won’t stop falling until they reach a cyclical trough in 2010. But why did this happen? Governments blame greedy banks and weak financial-sector regulation, but they are wrong – and this failure to understand the root causes of the problem is why boom and bust will not be abolished.
So what’s behind the instability in the capitalist economy? The explanation must account for similar crises in countries that did not regulate banks (19th-century America) and those which imposed tight regulations on them (the UK over the two cycles between 1956 and 1992). It must be common to land-rich countries (19th-century Australia) and densely populated urbanised societies (17th-century Netherlands). Only one candidate explains boom-and-bust cycles across such diverse societies: the economics of the land market.
Let me explain. Labour and capital are reproducible – if there is a shortage of labour, wages rise and people are drawn to locations and industries where they are needed. If necessary, we can import labour from abroad. So across the economy, over time, wages are equalised and stabilised. The same process applies to the market for capital: it can be imported from anywhere on earth. So the returns on capital investments also tend to equalise over the business cycle.
But we cannot reproduce land in places where people want to live and work. The elevator made it possible to increase densities – but, as the Manhattan skyline shows, upward mobility has limits! So the people who can secure the biggest share of national income for themselves are the landowners. With economic growth, a rising proportion of national income surfaces as increases in the rents that people are willing (or obliged) to pay for the use of land.
This can be seen in the housing market. Over the business cycle, an increasing proportion of the cost of new dwellings is the price of the land they’re built on. Data from Ireland, whose housing boom ended before Britain’s, are given in the table below. In 1994, land amounted to 12% of the cost, rising in 2000 to 28%, and 42% in 2006. The cost of capital and labour to construct the dwellings, over this cycle, rose by a factor of three. But the cost of land jumped 15-fold.
Land values as debt
To gauge the social impact of the land market, we have to realise that rising prices, as a result of buying and selling land, do not mean we are creating wealth. As individuals, we may feel richer. But a land deal merely tells us that a claim on future income has been transferred from the buyer to the seller. The nation has not become wealthier.
So why does land speculation damage the economy? There would be no negative consequences if land values were taxed to fund the public services – such as transport infrastructure – which (in the main) create them. We would all derive a growing portion of our incomes from the “social wage” – the public services that we share in common. But this community-created stream of income is privatised. So governments must fund public services by taxing people’s wages. Those taxes exact what economists call “deadweight losses” – if every extra £1 of your income is taxed, you have less incentive to work harder. I estimate that, during Tony Blair’s ten-year premiership, Britain lost output of wealth and welfare equivalent to a whole year’s national income because of the distortions arising from tax policies.
Incentives to speculate
In the market economy, it’s everyone for himself. So where would you put your money? Obviously, in assets that deliver the highest returns. That means land-based assets. And you don’t have to buy and sell land to get a slice of the windfalls. In the 19th century, the mania for railway shares was driven by the attempt to cash-in on land prices. This time round, 21st-century banks engaged in land speculation, twice or three times removed from the land deals themselves. Mortgages were used to chalk up fat profits as they were traded around the world – ostensibly, a low-risk asset backed by rising land values.
The current economic crisis will be deeper than previous downturns because, as I explained in my 2005 book Boom Bust, for the first time in history national property cycles are synchronised by a globalised property market. From South Korea to China to Spain and on to California, houses became unaffordable. Those who were locked into cripplingly expensive mortgages cut back on spending. As people defaulted (starting with the US in 2006), banks knew there would be huge losses. House building was scaled down, and mass unemployment – and the liquidation of debt – was inevitable.
Tighter regulation of banks will not prevent this process in the next business cycle. There is only one way to stabilise the dynamics of the land market: reform taxation so that rent of land is re-socialised, and wages are re-privatised.
Ireland: value of land in housing 1994-2006
| 1994 | 2000 | 2006 | |
| Average house price € | 72,732 | 169,191 | 305,637 |
| Rebuilding cost | 64,004 | 121,818 | 177,800 |
| Land | 8,728 | 47,373 | 127,837 |
| No. of houses | 26,863 | 49,812 | 88,219 |
| Total land cost €m | 234.5 | 2,359.7 | 11,277.6 |
Source: Building Industry Bulletin,09-2007
• Fred Harrison’s new book, The Renegade Economist (www.renegadeeconomist.com), is out on 3 December, priced £10.