Rethinking the Economics of Land and Housing

Josh Ryan-Collins, Toby Lloyd, Laurie Macfarlane

• Publisher: Zed Books
• Year: 2017
• ISBN:
  9781786991218
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Why are house prices in many advanced economies rising faster than incomes? Why isn't land and location taught or seen as important in modern economics? What is the relationship between the financial system and land? In this accessible but provocative guide to the economics of land and housing, the authors reveal how many of the key challenges facing modern economies - including housing crises, financial instability and growing inequalities - are intimately tied to the land economy. Looking at the ways in which discussions of land have been routinely excluded from both housing policy and economic theory, the authors show that in order to tackle these increasingly pressing issues a major rethink by both politicians and economists is required.

CHAPTER 1

Introduction

Buy land – they’re not making it anymore.

MARK TWAIN (ATTRIBUTED)

Attention salesmen, sales managers: location, location, location, close to Rogers Park.

1926 REAL ESTATE CLASSIFIED AD IN THE CHICAGO TRIBUNE, IN SAFIRE (2009)

This is a book about land and its role in the economy. By land we don’t mean physical earth and rock, we mean locational space. Land plays a central role in the economy but one that is often overlooked and poorly understood. This lack of understanding is a major weakness in much orthodox economic thinking, and helps to explain many of the policy failures and problems that bedevil modern societies. These include the crisis in the affordability of housing (the main use for land in modern economies), rising inequality, financial instability, excessive household debt and falling investment and productivity levels, despite increasing paper wealth.

This book should help the reader understand how these problems came about and provide some clues as to how they might be addressed in the future. The book has two sets of audiences and objectives. Firstly, it is aimed at the interested reader who wishes to better understand some of the challenges facing modern economies and societies. These questions include:

• Why are house prices in advanced economies rising faster than incomes and the growth of the economy? Is it simply a case of building more homes or having fewer people? Why don’t politicians or policy makers want or allow house prices to fall?

• Why is landownership so concentrated and wealth inequality growing so fast?

• Is it desirable for society to aspire to home- and landownership as the best route to wealth?

• What is the relationship between the financial system and land? Why have banks begun to lend more for the purchase of existing property and land than to businesses for investment? Why are household debt levels historically so high?

• What is the cause of the large boom and bust cycles in house prices experienced in the UK and other countries over the last forty-five years?

• How does the value of land relate to the technologies of production, the distribution of wealth and economic inequality over time?

• Why isn’t land and location taught or seen as important in modern economics or integrated into national accounting?

Secondly, this book is aimed at students and academics in the social sciences, including politics, political economy, law, sociology, geography, urban studies and, perhaps most of all, economics, where the topic of land has almost completely disappeared from most textbooks. To understand land properly, we must take a cross-disciplinary approach – we need a bit of history, a bit of economics and a bit about power and the law.

This book is focused on the macroeconomics and political economy of land – in other words, how it impacts on aggregate or national economic phenomena, such as the distribution of wealth and income, changes in asset prices, flows of credit and stocks of debt, and, for the most part, the national rather than international or local/regional policy and political sphere. A particular goal is to help develop a more coherent analysis of the role of ‘economic rent’ in modern economies: that is, the excess returns derived from the ownership of a natural (usually scarce) resource. Land, we believe, is the most important source of such rents in advanced economies and also the most neglected. The book is motivated by the failure of mainstream macroeconomics to develop theories adequate to explaining these dynamics. This has been a long-term problem and we are not the first to tackle it,¹ but it is one that has been brought into particularly sharp definition in the post-financial crisis period since 2007–8.

This book does not examine the economics of cities or urban space more generally, or the role of land in agricultural or development economics settings. These are fields which we felt were already well covered in the existing literatures.² The focus of the book is also primarily on the use of land as housing rather than commercial real estate, although the latter is discussed in a number of places. Similar dynamics apply to both, but there are important differences that space has not allowed us to examine.

The economic story of land is global, and much of the evidence and arguments presented in this book are relevant to advanced economies generally. But the way in which land’s role in the economy has played out in different places depends largely on the laws, institutions and political history of particular nations, and so varies widely. Rather than attempt to comprehensively cover the world – an endeavour that would have required a book six times the length of this one – we mainly focus on the United Kingdom as our case study. The UK is a large and mature economy, and many aspects of its land economy, legal institutions and financial system have been exported around the world (particularly to Anglo-Saxon, common law countries), making it a useful reference point for more generalised discussion of the issues. But throughout the book we also incorporate examples of the role of land in other advanced countries.

1.1 What is land?

In classical political economy (the predecessor to modern economics), land was understood to be one of the three factors of production, along with capital and labour. Any economic activity requires the combination of all three: a farm obviously requires land to produce food, but so too does a factory to produce goods, or a lawyer’s office to provide legal services. Looked at like this, it is clear that land is not simply soil, and its economic uses are not simply agricultural. In fact, land is better understood as space and the occupation of that space over time.³

Throughout most of economic history the primary function of land was for agricultural production. But since the birth of modern, capitalist economies other uses have become predominant: first as the site of industrial production, and later as the site of service provision and domestic housing. Today, it is in the housing market that the economic function of land is most visible, as the value of residential property has overtaken the value of land used for other purposes, as the economist Thomas Piketty (2014) makes clear in his recent book Capital in the Twenty-First Century. For this reason, much of the book focuses on housing as the main economic use of land.

Land has several unique features that differentiate it from the other ‘factors of production’ that form the central focus of the economics discipline: capital and labour. Most obviously land is immobile: you can’t move land from one place to another, because land is the place itself. The supply of land is highly inelastic, if not fixed, because you cannot make any more of it (with the small exception of reclamation from the sea).⁴ To all intents and purposes, land is eternal (with the small exception of coastal erosion), although climate change looks set to lead to a reduction in its habitable surface. Most importantly, land is essential for all economic activity to take place – and indeed for life itself.

These unique features determine much of the special economic functions of land. Notably, they are features that do not fit well into mainstream (neoclassical) economic models where the supply of commodities, labour and capital can easily adjust according to the demand for them and find an equilibrium price and quantity (see Box 1.1). But rather than adjust their models for this reality, economics has neglected land or conflated it with other factors of production, most notably ‘capital’. This failure to distinguish between land and ‘capital’ as factors in the production process, in notions of ‘wealth’ and in national accounting is a major conceptual error in the evolution of economic theory that we explore in this book (Chapters 3 and 5 in particular).

Throughout this book we treat land as the physical space within which economic activity takes place.

Box 1.1 Neoclassical economics

Neoclassical economics is a school of economics with its origins in the late nineteenth century which views the economy as a self-equilibrating system driven by the voluntary exchange of goods and services by individuals and firms in seeking to maximise their utility and profits. Neoclassical economics assumes people and firms are able to make rational preferences between identifiable outcomes and attach value to those outcomes. It also assumes people are able to act independently on the basis of full and relevant information. The interaction between market supply and market demand, which are aggregated across firms and individuals, determines equilibrium output and price.

Within the broad school of neoclassical economics there are a range of different approaches; however they mainly share the above core assumptions and a general requirement that economic theory should be grounded in the actions of individuals – that economics needs ‘micro-foundations’. Neoclassical economics became the dominant school in teaching, research and economic policy making in the 1970s and remains so today, but in recent times it has come under considerable criticism for its failure to help predict and explain the financial crisis of 2007–8 and the slow recovery that has followed it.

Policies influenced by neoclassical economics focus upon removing barriers to the free and independent exchange of goods and services that may temporarily prevent markets achieving equilibrium conditions. The emphasis is on ‘supply-side’ solutions, such as tariffs, labour market regulations and certain taxes.

In this book we will use the terms ‘mainstream’, ‘orthodox’ and ‘neoclassical’ economics interchangeably.

1.2 What is the value of land?

The economic value of any piece of land initially stems from the uses it can be put to – as a field, a factory, an office, a shop or a home. The economic value of these uses will vary not only with the natural features of the land, but with their geographic relationship to the rest of the economy. A fertile field is obviously more valuable than a desert, all else being equal, but fertile ground miles from people to farm, roads to carry or markets to consume its produce is less valuable than one near a city with good transport connections. Estate agents like to say that ‘location, location, location’ is the most important factor in selling a home, because everything else can be changed. What they are referring to is the fundamental locational value of the land itself. This can be seen in the often huge discrepancy between the ‘replacement cost’ of a home calculated for insurance purposes and the actual market price it commands: the difference between the two is essentially the value of the land in that particular place.

Land values in any particular location reflect the level of wider economic activity in that area.⁵ The price of a home in a thriving city can be many times that of an identical home in a remote, depressed region, because of the access to economic opportunities that living in the city brings. Most obviously, investment in infrastructure increases the value of land, by increasing the range and quality of uses it can be put to, and the relative advantages of well-served locations over other places. New transport links, or being in the catchment area of a good school, dramatically affect the market value of homes in that location, because they boost the value of the land underneath those homes.

But the value of land is not only determined by its current use value. Because land is permanent, controlling land is also a means of securing the economic value that holding it will provide in the future. In other words, land is an asset as well as the provider of consumption goods (food, shelter), and land prices will reflect people’s expectations of future economic activity. The permanence and inherent scarcity of land make it a good asset for the storing of value (assuming no major changes to planning regulations). Most capital assets depreciate in value over time due to natural wear and tear but land tends to appreciate. This means people are often keen to convert other forms of wealth into land, including money which, although much more liquid, can lose value rapidly under conditions of consumer or asset price inflation. This dual function makes land challenging to neatly fit into economic theory since at any point in time land can be being used for different purposes.⁶

For similar reasons, land is also an excellent asset to act as security (or ‘collateral’) for extend...