Land Speculation and the Boom/Bust Cycle

A theory of economic boom and crash is one of Henry George’s two great purposes in Progress and Poverty. What causes the recurring “paroxysms of industrial depression”?
Could there be a single, root cause? A variety of events have been associated with the onset of economic crises: natural disasters, sudden increases in oil prices, wars, political instability, etc. In fact, just about anything can seem to cause a recession — just as the back of an overloaded camel can be broken by a pencil, a paperclip or a piece of straw.

Henry George identifies the root cause in the speculative rise of land prices, which cuts into the earnings of labor and capital. Land rents and prices rise at a faster rate than general economic growth, because of two unavoidable facts: 1) Land is not produced; its supply is fixed, and 2) Land is needed for all production. As we have seen, this creates a tendency for land rent to take a greater share of aggregate production whenever the economy is growing.

This tendency places ever-increasing stress on the actual production of goods and services. For an example of how these stresses make themselves felt in modern economies, let’s examine the incentives and costs of creating new buildings.

There exists a current demand for square feet of residential or commercial space, based on population and local economic activity. However, because land values are expected to increase over time, the buyer must pay a speculative premium on the site’s value. To justify building at all, the new building must generate higher returns than the current demand for space at that site! That means a bigger, higher-value building must be built — and more money must be borrowed, both to buy the site and to build the bigger building, which will have that much higher a property tax bill once it is built!

How can this higher demand be created, all of a sudden? It becomes less mysterious when we realize that land and buildings are nearly always bought with borrowed money. In most cases the value of the real estate itself is offered as collateral for the loan used to buy it. The expected increase in land value makes borrowers willing to borrow more, and lenders willing to lend more. With more borrowed money up front, buyers can spring for a more luxurious building.

The effect of all this is that new construction is delayed, pushed upscale, and made riskier. In cities, where land values and speculative premiums are all concentrated, all of these effects are magnified. High-rise luxury condos bloom in the boom, while the call goes up for more “affordable housing” — which the market just doesn’t seem able to provide. This creates political pressure to subsidize housing in various ways — through tax deductibility of mortgage interest, for example, or outright provision of public housing, or rent-control legislation — “market interventions” that create unintended consequences of their own, adding complexities which make the underlying land problem that much harder to see.

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