Subscribe to Dollars & Sense magazine. Recent articles related to the financial crisis. Mason Gaffney on the U.S. EconomyThe first part of an interview with Mason Gaffney, who was interviewed by Kevin Press for SunLife Financial's Today's Economy blog. Gaffney is promoting his new book After the Crash: Designing a Depression-Free Economy.November 30, 2009 After the Crash: Designing a Depression-Free Economy, Selected Works of Mason GaffneyAt a time when most everyone has an opinion about the state of the U.S. economy and the quality of decision-making in Washington, D.C., the voice of esteemed economics professor and former TIME magazine journalist Mason Gaffney is an important one. Currently teaching at the University of California, Gaffney has been publishing vital contributions to economics since his PhD dissertation in 1956. Western Canadians will remember him as the founder of the British Columbia Institute for Economic Policy Analysis. I spoke with professor Gaffney last week about what went wrong with the American economy, and what he thinks president Barak Obama should be doing about it. (Hint: the president hasn't got it right.) Today's post sets out Gaffney's description of what's wrong with traditional government stimulus programs and U.S. tax policy. Part 2 will feature Gaffney on the trouble with macroeconomics. He also makes a startling prediction about U.S. unemployment. You write that the state of the U.S. economy is a result of a misallocation of capital. What do you mean? The emphasis here is on the allocation between durable capital, or capital that turns over slowly and working capital. Capital goes into highways, dams and battleships easily, but it doesn't come back out easily. That's where we are today. Any corner bakery or hamburger stand makes more jobs per dollar of capital than the massive public works that we depend on traditionally to fight unemployment. We depend on it, and it doesn't work. Yet we go on depending on it. It's been that way for hundreds of years. One of the worst examples, which sent many of our ancestors over to this country, was the English attempt to solve the potato famine problem in Ireland by putting Irishmen to work building roads. The people were starving to death, quite literally. They needed breakfast for tomorrow morning, and they were being put to work building roads for the next century. That, in an extreme case, is the kind of policy mistake that has been repeated time after time. What they needed was working capital for the private sector. How do you provide capital for the private sector? The private sector generates capital itself. Step one is not to take it away from it. Step two, in our own case, would be to pay down the public debt, because when you pay down the public debt, you put capital in the hands of the bond holders. If you don't give them the alternative of putting their money back into public debt, they invest it in the private sector. There's also a great deal of saving going on in the private sector at all times. It gets aborted by a phenomenon that I'll refer to generically as land speculation. That is what's been happening in the last eight years or so. The value of residences, or at least the land under them, has skyrocketed. The owners have borrowed on that through lines of credit and other means for consumption, with no production corresponding to it. The increase in land value appears to the owner of land as an income, but nothing is produced. So when you consume that, you're eating the seed corn, so to speak. You're consuming capital and not replacing it. I've been living on the old homestead myself for several years and now I'm sorry. Along with millions of other people who ran up debts based on their expectation of rising residential values which have turned negative. It happens wherever there is real estate. What's the answer? Change tax policy, which would dehydrate the unearned increments of land value and keep them from getting started in the first place. If you focus your taxes on the value of land instead of on payrolls, let's say, that nips a land boom in the bud. As the boom gets started, the irrational exuberance would cause the tax levy to rise. That throws cold water on the irrational exuberance as it gets started. It keeps it from going to the extremes that we have just been through...[Currently,] the tendency is to stick with the old values for several years. Tax valuations lag behind market valuations as the latter are rising. That lets the bull get off to a flying start. In California for example, the assessors are forbidden by law from following the market up. They're allowed to raise values by 2% a year at the most, while market values are going up, or were, by 10% a year. It wasn't long before the tax burden became negligible compared to the value of the land. In my own case, my own value went up so high and so fast, that my taxes were less than .2% of the market value at the peak of the boom. They didn't amount to anything; they were less than my fire insurance for heaven's sake. This situation let the boom in California and other extreme areas get completely out of hand, and we're now experiencing those results...They should be revising tax policy in a drastic way, to exact less tax money from honest labour and productive labour and more money from unearned increments – capital gains. By increasing taxes on capital gains, you tamp down market speculation. That's correct. Once the capital gain has occurred, you have this enhanced value which is an excellent tax base. Read the original interview. Labels: Georgists, land tax, Mason Gaffney, tax policy Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). Why Georgists Correctly Predicted the CrisisFor more on the Georgists, Henry George, and the idea of a land tax, see this excellent sidebar D&S co-editor Amy Gluckman wrote to Mason Gaffney's excellent article about how a land tax helped rebuild San Francisco in 1906, and could be used to rebuild New Orleans after Katrina.Why Georgists Correctly Predicted the Crisis, and Why Conventional Economists Couldn't 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 Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). |
