Why Georgists Correctly Predicted the Crisis

by Polly Cleveland

Land bubbles of varying severity and universality recur roughly every eighteen to twenty years. Like Henry George, modern Georgists attribute recessions and depressions to these bubbles. A huge real estate bubble of the 1920's preceded the Depression of the 1930's. That bubble actually began to burst in 1926, three years before the stock market crash of 1929. So when "house values" exploded around the world during the last decade and then began to decline in 2006, many of us predicted the worst. I even convinced my husband it was time to sell our property--but alas, too late.

A few prominent economists recognized the bubble's threat, notably Karl Case and Robert Shiller of the Case-Shiller Home Price Index. But most economists didn't see the crisis coming until it ran them over. Why couldn't they see what Georgists saw? (Non-economists can skip to the last paragraph.)

1. Like Adam Smith and other classical economists, Georgists assume a three-factor world: land, labor and capital, earning economic rent, wages and interest respectively. But starting in the early 20th century, conventional economics merged land into capital. Land disappeared so completely that Robert Solow could joke in 1955 that "...if God had meant there to be more than two factors of production, He would have made it easier for us to draw three dimensional diagrams."

2. Conventional economics airbrushes out economic rent. The National Income and Product Accounts omit or conceal rent. They exclude even realized capital gains, let alone unrealized gains. They lump rent received by business into profits. When I teach micro I have to explain to students that those cute little triangles we label "consumer surplus" and "producer surplus" are really economic rent.

3. Conventional microeconomics is static. Textbooks incorporate discounted present value poorly, or omit it altogether. In teaching micro, I've had to write a special section on discounting--after all, someday, students will buy houses and take out mortgages. Bubbles are just unrealistic projections of rent, capitalized into the present. Without discounting, how can we understand them? (Mind you, many Georgists don't understand discounting either; they explain bubbles as the work of "speculators." But at least they know bubbles are destructive.)

4. Conventional macroeconomics tosses out the good part of micro, namely, marginal analysis. So in conventional macro, all taxes are alike, all consumer spending is alike, all saving and investment is alike. Economists can truly believe that it's good for the economy now to borrow money (from whom?) and spend it on roads and bridges. How can they understand that overspending on infrastructure stimulates bubbles?

5. Conventional economics disregards a central Georgist assumption: distribution of wealth matters. Moreover, the tax and subsidy system is rigged to drive rent to the top of the heap. This very rigging of the system also encourages bubbles. So the Georgist cure is to reverse the rigging, capture the rent and redistribute it to society either in the form of public goods, or directly as tax credits or grants. That's a dangerously radical idea.

One hundred years ago, Georgists allied with Progressives to form a powerful movement for political and fiscal reform. In The Corruption of Economics, Mason Gaffney argues that neoclassical economics assumed its blinkers precisely to thwart that movement--leaving modern economists helpless.

Labels: economic crisis, financial crisis, Georgists, Henry George, housing bubble, land tax, Polly Cleveland

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3/25/2009 04:01:00 PM