Land Markets and Business Cycles
in the United Kingdom and Australia
TABLE OF CONTENTS
Credit and the economic cycle
The land cycleCredit or land speculation?
- A Georgist Monetarist decides Speculation chips and the "real"
A mechanism for the longer term business cycle:
(1) Demand side distortion
(2) Supply side disruption
[1957/58 LVRG's 1961 booklet is the source for all the
property tax revenues, apart from The mechanism at workLand
prices as a constraint on monetary policy]
Solutions for the UK and Australian business cycle
APPENDIX 1: Estimation Of Australian Land Values EndnotesTable
of Australia land values
APPENDIX 2: Estimates of the public equity in land in
It is ironic that the monetary system of the market economy should be
especially dependent for security on an asset which is particularly
volatile in price, and which lacks both a functional and a moral
justification for its very existence. The asset is private equity in
land. The intimate association between credit creation and land prices
may go a long way towards explaining the erratic, cyclical performance
of market economies.
"Safe as houses" runs the popular refrain. Lenders
certainly put much faith in the idea that real estate is a safe
defence against defaulters. Real property provides the security for
perhaps three-quarters of UK bank lending, which means that changes in
the money supply are closely linked to changes in property prices.
Property is commonly dubbed "bricks and mortar" in the UK.
But around one-half of the price of property reflects the sites under
the bricks and mortar - less in "normal times", but more
near the peak of the property cycle. Peaks of property cycles coincide
with the greatest amount of net lending, which suggests that site
prices may be the most gushing fount of creditworthiness over the long
Yet bad loans written-off against profits, which hit lending
institutions so badly in times of recession, are primarily the result
of declining land prices. The immediate guarantor of debt repayment,
and stimulus to credit creation, becomes the immediate cause of bank
losses, and inhibitor of credit creation. Figure 1 shows just how
cyclical land prices are - at least as cyclical as share prices.
Bricks and mortar are a far more stable form of collateral, as Figure
1] Remember, the house price
data includes land prices. Credit being the lifeblood of the economy,
the inclusion of land prices in the collateral for loans would appear
to be an unhealthy situation. There is an a priori case for
severing this dependency in order to prevent alternating bouts of
fever and anaemia.
If land prices are merely the innocent victim of stops and starts in
the economy, their shere volatility exacerbates swings in the money
supply. If on the other hand they are a prime mover in economic cycles
then the case against them is overwhelming. The practical question of
conquering land price inflation and deflation is a separate issue.
Ultimately, it might involve allocating sites by annual rents alone
and reserving the equity in land for the public domain, while
otherwise retaining full private ownership of land. Current land price
levels might remain as a premium, or "key money".Morally, as
a matter of tailoring reward to contribution, there can be no
objection (it would even seem desirable) to proscribing a right to
income from sites and natural resources, as such, which exist and have
equity value entirely independently of private owners' activities or
willingness to purchase the equity.
The hypothesis that land price inflation is the most important
destabilizing influence on economic growth rates will be elaborated
and tested against UK and Australian evidence. The UK led the world
into the depression of the early 1990s; Australia followed smartly,
and offers valuable additional evidence in the form of relatively well
documented land values.
If the hypothesis is correct, the tight fiscal and monetary
straitjackets by which manic economies are periodically restrained may
be replaced by a surgical removal of land price inflation - the root
cause of economically irrational mass behaviour - that does no damage
to property rights. Improved long term economic performance depends
Credit and the economic cycle
Diagnosing the extreme boom-bust symptoms of the UK economy of the
late 1980s to early 1990s - in terms applying equally to many other
western economies, including Australia - The Economist traced their
fundamental cause to a "surge of credit" inspired by
The Economist's editorial stated: "Just as credit freedom
fuelled much of the spending of the 1980s, so it is prompting much of
today's caution [roller-coaster house prices being a prime symptom]. A
burnt-finger economy is not easy to revive. Yet...[t]he fact that
financial freedom has been abused by some is no reason to take it away
from all. The fault was in the earlier restrictions, not in the
freedom that followed."[
The Economist, therefore, laid the ultimate blame at the door of the
Milkens, the Maxwells, and the Bonds - the high priests of the
borrowing binge of the 1980s, who abused their freedoms, and came so
conspicuously to grief when the party ended. Or was the leader writer
thinking of the equity-withdrawing homeowners who led the consumption
boom, the equity-withdrawing companies which led the investment boom,
and the lending institutions that doled out the low interest credit
that made the demand explosion possible? They over-stretched domestic
suppliers of consumer and capital goods (allowing them to raise their
prices) and sucked in imports - in other words, they created the
inflation and trade deficits that forced interest rates back up and
brought the party to an end.
Or perhaps The Economist's editor was thinking of imprudent
borrowers and lenders only: those who bought houses and businesses in
1988 and 1989, or lent money to them, and were found wanting when
interest rates lept by 50% or more, or their jobs or markets
disappeared - repossessed homeowners, bankrupt businesses and bad
The Economist refrained from mentioning, in this leader at
least, the the loosening of monetary policy presided over by the
Chancellor of the Exchequer, Nigel Lawson, between 1985 and 1988,
which pushed down real interest rates and earned the accompanying
spending explosion the epiphet "the Lawson Boom". In
hindsight, even Mr Lawson and his political party agree that interest
rates fell too low in the circumstances. But low interest rates are
intrinsically desirable, and the policy of lowering them was supported
by all but a few monetarist economists whose influence had waned. The
monetarists may have had a point within the circumstances, but were
the "circumstances" really to blame?
When abuse of the system is so widespread that it appears systematic
it becomes permissible to ask if it is the system that is wrong rather
than its "abusers". A correctly functioning self-regulating
system ought not to be predisposed to abuse, as the "deregulated"
money supply has been in western economies. The question arises
whether the financial system itself requires further reform, or
whether there are other systems bearing upon it which require reform.
If the former, given that a return to the widespread credit controls
of the 1970s is not the answer, should reform be in the direction of a
politically independent central bank mandated to prevent inflation
(like the German Bundesbank), or some form of decentralised, radically
free banking system? If the latter, which non-monetary systems might
The probable answer is that both the monetary system and other
systems that it is embedded in require reform. Here we look at the
impact of the non-monetary system that has the most obvious bearing on
the business of credit creation: the system of land ownership.
The land cycle
The first statistical studies to demonstrate a link between land
prices and business cycles were conducted in America by the historian
Arthur H. Cole[
3] and the economist Homer
Hoyt. Cole found that the
quantity of farmland that was alienated from the public domain each
year before the Civil War correlated closely with the business cycle.
The price of land was fixed, so the quantity of acres sold bore the
full brunt of variations in the demand for land.
Hoyt found that there was a land value cycle in Chicago in the
nineteenth century, also. As the quantity of land in a city is
relatively constrained, price was the major variable. Hoyt's prices
synchronised exactly with Cole's quantities. They peaked and fell
roughly every 18 years, and on each occasion an economy which was
booming fell into recession a year or two later. On each occasion,
also, the land price peak was accompanied by a building boom, and the
boom became a bust before the rest of the economy turned down.
Despite the fact that land price crashes appeared to be a leading
indicator of downturns in the economy, Hoyt did not believe that the
relationship was causal. Land prices merely reflected trends in the
real economy and the money supply, in his view. Economic growth caused
land prices to rise, and economic recession caused them to fall.
Over-investment during booms led to over-supply of buildings;
over-enthusiastic creation of credit during booms led to disciplinary
contraction of credit by bankers. Slack in the property market and
high interest rates naturally bore down on property prices. But once
property prices were low, and the supply of money safely down
(bringing prices and wages down), interest rates could fall, and
economic growth could resume. Economic progress was bound to be
periodic - given the exhibited tendencies of consumers, businessmen
and bankers to excess - until management of aggregate demand was
introduced by the Keynesian Revolution. Persistent inflation of the
money supply spelled the end of the land cycle, Hoyt predicted in
1933. He stood by that prediction in 1978.
Credit or land speculation? - A Georgist Monetarist decides
A leading contemporary of Hoyt in the American economics profession,
who would have been expected to emphasize the role of the land market
in business cycles if it had one - especially since he was a renowned
enthusiast for land reform - also did not do so. Harry Gunnison Brown,
like Homer Hoyt - and
The Economist today - saw the business cycle mainly as a
product of the monetary sector. Treating of the "speculative
holding of vacant land out of use", and of monopolies, both of
which restrict "the opportunities for productive labour", he
judged that they "are probably, in the main, chronic evils (when
society permits them) rather than sharply oscillatory ones, except as
they are made oscillatory by monetary inflation and deflation. It
seems likely that the tremendous fluctuations in business activity are
closely tied up with monetary influences and that, in any case,
effective control must include wise monetary policy as a main feature."
We shall concentrate on Brown's analysis, as presented in his
Basic Principles of Economics, because such a study provides a
unique vantage point on the parting of the ways between the monetarist
economist and the land reform economist in the line of Henry George.
Brown was both. He was a valued colleague of Irving Fisher at Yale,
and also the leading exponent of land value taxation in his profession
from the 1920s to the 1950s. His failure to find a significant place
for land values in the theory of business cycles must be taken into
account in any attempt to revive Henry George's late nineteenth
century contribution to cycle theory.
Brown did assign a role to rising land rents, alongside rising wage
rates and interest rates, in helping to choke off business profits at
the end of a boom. But unlike Henry George he located the essential
turnabout on the demand side: credit crisis-induced falling prices
raised the attractiveness of saving money (which was rising in value)
rather than spending it. Rising business costs were secondary - merely
the coup de grace.
What Brown's account of the business cycle lacked was a sufficient
account of why "good business" conditions invariably lead to
"boom" conditions, the excesses of which create credit
crises. "The explanation appears to lie in the eagerness of the
business man, as such, to take advantage of what he regards as good
business," he wrote (p.101). This was surprisingly weak coverage
of the pivotal moment of the whole cycle - the moment when stable
growth becomes unstable growth. What about the natural corrective
mechanism built into the banking system to keep the "eagerness"
of the business man in check? Unsustainable growth can only take hold
if that mechanism is overridden. Brown did not suggest that that
happens. Instead, he described the mechanism as if it were the final
credit crisis: towards the end of prosperity... the amount of money in
circulation bears a larger proportion to the amount of money in bank
reserves than during the previous stages of the cycle. Because of
deficient reserves (or central banking policy) the banks are charging
higher interest and discount rates than before. And they may even be
putting an arbitrary limit on their lending. The higher interest by
itself doubtless has some tendency to restrict borrowing. And as it
operates to reduce the saleable value of many securities and so to
reduce the value of their collateral, it may lessen the borrowing even
of some to whom the high interest rates would be no deterrent (p.107).
There appears to be no intrinsic reason why this natural banking
process should operate in any other way than to gently restrain
businessmen when they become over-eager for loans. Credit crisis
should only occur if this corrective mechanism fails to work. Yet the
paragraph quoted was intended to describe "the growing
restriction of credit" which acts in a cumulatively causal way to
produce full-blown "crisis and depression."
The writer himself, in prefacing this account, indicated that
significant matters were left to one side. The corrective mechanism
described "has sometimes been the cause of a crisis," he
wrote (p.103). "But it is certainly not necessary for the
production of a crisis that reserves should be at all near the legal
minimum or, in any sense, inadequate. A crisis may result from any
condition or opinion which leads to an unduly sharp credit
restriction." In other words, credit crisis may be "the
immediate cause of depression" (p.102), but that which initiates
a credit crisis is the ultimate cause of depression. Brown provided
only one example of an ultimate cause - and that in a footnote. He
clearly regarded initiatory causes as random events with no systematic
features. The footnote, on page 111, was to explain the crisis and
depression of 1929 and after, which he appears to have regarded as a
random event brought about by undue restrictive action on the part of
the Board of Governors of the Federal Reserve System. Central banks
can "produce the evils of depression almost at any time," he
commented. The footnote elaborated: In 1929...the Federal Reserve
banks greatly raised rediscount rates, notwithstanding average
commodity prices were even lower than in 1928, probably with the idea
of discouraging stock speculation. This action tended, of course, to
decrease not only demand of speculators for stocks [much of which was
on borrowed money] but also demand of business enterprises for raw
materials and other goods and for labor. Business depression followed.
It seems hard to justify such an increase of the rediscount rate just
to control the stock market... But it may be desirable that the Board
should have the power to regulate margins [the proportion of the
purchase price of securities that may be borrowed]. Thus it may
exercise some control over speculative flurries in the stock market
without making use of changes in the rediscount rate. The initial
cause of the Great Depression was therefore the Wall Street bubble of
1929. It was not the over-eagerness of the business man but the frenzy
of the asset price speculator that led to a rapid withdrawal of the
life-blood of the economy - credit. The Great Depression may have been
a special case, but it raises the possibility that it is speculation
fever - which severs asset prices from the reality of their moorings
in annual income streams - that is the disruptive influence causing
the major swings of the economic cycle.
Speculation chips and the "real" economy
The prices of certain types of assets not only form collateral for
the supply of credit but are buoyed up by the supply of credit. They
are liable, therefore, to self-reinforcing price rises, which are then
fortified by induced speculative demand. The two major forms of such
assets are stock market securities and real estate. Physical assets,
like plant and equipment, lose too much value in the second-hand
market to foster serious speculation mania. Commodity prices are too
easily punctured by increases in supply.
Share prices and land prices have an innate tendency to increase
faster than the rate of economic growth, because the income streams
upon which they are based - profits and rents - are "geared
residuals". Relatively small increases in aggregate demand cause
proportionally greater increases in profits and ability to pay rents,
which comprise firms' surpluses after all necessary expenses are paid.
Decreases in aggregate demand likewise slash surpluses throughout the
economy in far greater proportion than they reduce wage bills or
capital costs. Such gearing of profits and land rents is the initial
trigger that sets off asset price spirals - either upwards or
However, there is a medium term tendency for rapidly rising security
prices to be self-correcting, because rising prices encourage the
issue of new securities.There is also a tendency for rapidly rising
real estate prices to be self-correcting, because rising prices
encourage building and expansion of higher value land uses at the
expense of lower value land uses. The self-correction is lagged,
however, due to the lengthy duration of construction projects and the
inefficiency of property markets compared with stock markets. Owners
may hold property off the market rather than drop prices or rents,
awaiting rescue from their debts by either inflation or a genuine
upturn in demand. The day of reckoning takes longer to arrive, but
when it does it is correspondingly darker, and stretches into months
Downward spirals in asset prices also tend to be self-correcting as
investors become alert to "bargain basement" prices.
The link between asset price speculation - mere trading of pieces of
paper - and the "real" economy goes further than its impact
on credit conditions. In the case of land, speculative owners may have
no interest in using the land productively and so may hinder efficient
land use. Or they may be misled by the temporary high price of land
into placing too much permanent capital upon the land. That is
squandering scarce resources on "white elephants".
On the demand side of the economy, land owners will be affected by
the "wealth effect". The spending behaviour of individuals
and companies depends on their net wealth - how rich they are, or
feel. Land titles are one of the major forms of net wealth. Extreme
swings in the value of land titles lead to significant swings in the
spending behaviour of land owners.
Thus both the supply side and the demand side of the economy are
affected by conditions in the land market. The land market's inherent
disposition towards speculation in combination with its significance
for the "real" economy makes it a destabilizing influence
with great potential for driving business cycles.
A mechanism for the longer term business cycle:
(1) Demand side distortion
Rapidly rising land prices, rising consumer prices and a rising
current account deficit are all signs of an economy that is growing at
rates faster than it can sustain. To an extent, the last two symptoms
are alternative responses to the same phenomenon - consumer and
investor demand rising faster than the capacity of the domestic
economy to increase supply. Either domestic prices are pushed up, or
goods and services are imported from abroad and domestic firms switch
from exporting to supplying the home market.
The evidence from the UK and Australia is that strong land price
growth foreshadows demand booms in the economy, and the peaking and
subsequent decline of land prices are a prelude to demand downturns.
Figures 3 and 4 compare an indicator of demand pressure in the
economies of the UK and Australia with land price growth rates. The
indicator is constructed by adding the country's balance of trade in
goods and services as a percentage of money GDP (inverted) to the
percentage increase in consumer prices over the previous year -
doubling the former to give it roughly equal weighting. The trade
balance figures are inverted to make a deficit, like inflation, a
positive indicator of demand pressure. The composite index is moved to
one year earlier (e.g., the 1960 figure is plotted as a 1959 figure).
The graphs show a clear coincidence of the swings in both land prices
and demand. As land prices are (relatively) lagged one year, this
means that they provide an accurate
forward indicator of unsustainable aggregate demand pressure
in the economy and its eventual collapse.
The well-documented "wealth effect" provides a causal
mechanism linking land price changes with changes in spending
patterns. Rising land prices encourage personal sector landowners to
spend more on consumer goods and company landowners to spend more on
capital goods. Landowners feel that their land is accumulating savings
for them by rising in value, so they can afford to save less of their
disposable incomes. Or they can divert savings into servicing debt,
and so borrow more for consumption or capital spending. Land price
appreciation occurs when the economy is growing steadily. At such a
time general confidence in the economy makes future repayment seem
secure, so borrowing is further encouraged. As financial institutions
are not immune to the germ of optimism, rising collateral becomes
increasingly bankable. Savings in the personal and company sectors
fall and borrowings rise (in the absence of restraining monetary
policy by government or the central bank).
The lending gap is filled either by an inflow of savings from abroad
or by net repayment of public debt by government. The former is the
capital account complement of the nation's current account balance of
payments deficit. The latter, in the UK in the late 1980s was,
ironically, due to an attempt by government to reduce its own
borrowing. Bank lending to the "unproductive" public sector
was thought to be the major reason why money supply surges ahead of
the volume of production, In fact, the money supply does much the same
through bank lending to the private sector.
The divergence between saving and borrowing is reflected in rising
personal and company sector debt levels. According to the Treasury,
the UK's personal sector debt level was between 40% and 50% of
disposable incomes from 1968 to 1981, with a hiccup betwen 1972 and
1974 when it reached 55%. However, during the 1980s that ratio
doubled, peaking in 1990. At least three-quarters of the net borrowing
was for house purchase, though a significant proportion of that was
used for consumer spending through "equity withdrawal". In
the company sector, undistributed income after taxation fell short of
expenditure on capital stocks from 1988 to 1991 and financing the
deficit by borrowing rather than share issues was fashionable.
People are only happy (and able) to borrow on such a scale because
their net wealth is increasing. Personal net wealth rose from 4 to 5.5
times personal disposable income (PDI) between 1981 and 1989 in the
UK, which was far from adequate to maintain net wealth to debt ratios.
It also jumped from about 4.25 to almost 5 times PDI between 1970 and
1972, before crashing to 3.7 during the year from the second half of
1973. These were the periods of asset price "bubbles", in
which stocks featured more strongly at first, then land prices took up
the running and extended the bubble for a further dangerous year.
Inspection of the UK personal sector balance sheet in the Blue Book
of 1988 (p.87) shows that even at the end of the peak stock market
year of 1987, net personal wealth in the form of housing equity
exceeded stock market related securities (which themselves constituted
equity ownership of much commercial property). Direct equity in land
and buildings of all kinds, including non-marketable tenancy rights,
equalled all other forms of net wealth combined (about £770 bn
each). During the following year land prices (not bricks and mortar,
though their quantity exceeded trend growth rates) surged forward
while the stock market remained flat. It can be safely stated that the
imbalances in the economy created by the boom of 1988 would not have
had to have been worked out through the long recession years of the
early 1990s if it had not been for the speculation-driven land price
explosion of 1987-1988.
We have touched on one of the initiatory causes of land price
explosions: the fact that rent is a geared residual. Another is tax
policy. In both the UK and Australia, land is a favoured form of
wealth holding - the relative absence of taxes on home ownership is
notorious. The heat was turned up further under the property market
during the 1980s in both countries. In the UK, Development Land Tax
(mainly of psychological significance) was abolished, and income tax
and corporation tax, which fall on investment properties, lowered.
Capital allowances against corporation tax were reduced, however, thus
favouring investment in pure land. Finally, from 1986 to 1990 the
abolition of the only direct tax on houses - the local government
domestic rates - was adopted as the government's "flagship"
policy, deliberately steering households into home ownership as part
of its philosophy of "popular capitalism".
In Australia, from about 1975 the effective tax rate on annual land
rent (excluding minerals) in the economy began a steep decline from
over 30% in that year to less than 15% at the end of the 1980s (see
Figure 5, which is derived from Table 1 in Appendix 2). Rent as a
proportion of the national income began to rise in 1975, but property
tax rates were adjusted downwards so that property tax revenues did
not increase as a proportion of the national income. The public
sector's share of the equity in land therefore began to fall. The
private sector's share, as reflected in land prices, began to rise.
The picture of continually rising land prices shown later in Figure
10, would have been different if rising real interest rates (from
minus 6% on long bonds in 1974 to 10% in 1984, inspiring yields in
property markets to nearly double) had not been offset by increasing
tax leniency in state and local government property tax rates.
Martin Feldstein, later to become US President Reagan's chief
economic adviser, highlighted the economic significance of lowering
taxes on land in an academic paper. His interest was in the
consequences of a tax on pure rental income, but with the removal of
such a tax the consequences may be presumed to be removed:...land and
produced capital are alternative components of individual life-cycle
wealth. Each generation wishes to accumulate a certain level of wealth
with which to finance retirement in old age. If the tax on pure land
rent reduces the value of land, a larger amount of the desired wealth
must be accumulated in the form of produced capital. The tax on rental
income thus induces an increase in the equilibrium capital stock and
therefore in the equilibrium ratio of capital to land. This raises the
marginal productivity of land [i.e., rent] and reduces the rate of
interest at which net land rents are capitalized. Part of the tax on
pure rent is thus shifted in the form of a lower net yield on capital
and a higher wage rate. Moreover, the price of land does not fall by
as much as the traditional theory [of tax capitalization] predicts.
In other words, the portfolio and income effects of reducing taxes on
land, by implication, are the same as those considered above as
flowing from the wealth effect. The transmission mechanism in both
cases is the changing price of land and its effect on the ratio
between consumption and saving. Rising land prices lower the supply of
savings and raise consumer and investor demand, thus producing a
capital shortage which raises interest rates and lowers the
productivity of labour and land.
To the extent that this process is significant then the land market
is a causal influence in the economy, not just a mirror of the economy
as free marketeers claim. Further, its susceptibility to speculative
excess and to tax favours from politicians enhances its status as an
achilles heel of production. Land prices certainly mirror the real
economy during the early phases of the business cycle. But when a
period of steady growth related to rising rentals has begun to attract
speculative interest in land prices, they begin to take on a life of
their own. Speculative interest has a habit of turning into
speculation mania as the message spreads and the demonstration effect
of fortunes being made from mere land ownership takes hold. Any fairly
accurate econometric model of aggregate house prices has to build in a
mathematical function to imitate the "frenzy effect"
resulting from land speculation.
Ross King, in his study of the Melbourne housing market, found that
house price fluctuations were far greater than could be predicted by
statistical analysis of fluctuations in the real cost of borrowing to
The siren signal of increasing landed wealth lures consumers and
investors onto the rocks of big spending, so the economy "overheats"
periodically. Coolant has to be applied, principally by the monetary
system realizing its mistake in permitting a surge of credit based on
illusory collateral. As far as the economy as a whole is concerned
wealth in land is indeed illusory. Any spending increase based on a
rate of land price appreciation in excess of the rate of land rent
growth (which occurs when speculative demand forces prices up faster
than rents) is nominal aggregate demand increase unmatched by real
aggregate supply increase. Either prices have to rise or imports have
to increase. Real interest rates then have to be raised to safeguard
lenders against depreciation of principal and to suck in savings from
abroad to balance the current account deficit.
Even for individual landowners land price increases are not like
other forms of wealth acquisition. The Governor of the Bank of England
made this point in a speech to the Building Society Association annual
conference in the UK: "There was of course always an element of
illusion in this feeling of greater wealth: house-owners benefitted in
a tangible, durable sense only if they were prepared to move
down-market or leave less to their heirs. But the impression - however
false - of rising wealth must have been a potent force encouraging
high levels of borrowing."
(2) Supply side disruption
Land prices, which measure a large proportion of the wealth of
nations, are thus misleading market signals upon which to base
spending decisions. Spending includes both consumption and investment.
Firms are tempted by the value of their land stocks into extravagant
investment. Property developers particularly are lured by temporarily
rising land prices into sinking capital permanently into construction
projects. And banks are prone to providing the capital.
In the UK, bank lending to the property sector clearly follows land
prices. Figure 6 charts changes in the proportion of bank lending
devoted to the property sector against changes in residential building
land prices in England and Wales (adjusted for consumer price
inflation). The latter are a proxy for commercial land prices (data
for which is not available), and so may change direction earlier. Bank
lending also tends to increase for some time after the banks would
prefer to withdraw, due to the long lead times in building projects
and the reluctance of banks to allow ailing companies to collapse. The
bank data (supplied by the Bank of England) is therefore shifted
backwards in time two years in the chart (e.g., 1980 to 1978).
The property development industry not only responds to orders but
itself initiates speculative projects, either on existing land banks
or on sites bought for the purpose. It moves into action only when it
forecasts that land prices will keep on rising - certainly not fall -
while projects are being completed. Falling real land prices would
signify a shortfall in demand for the projects. And it moves into
action when rising land prices are making many existing land uses seem
uneconomic. Landowners are finding, because of rising site values,
that they can sell their properties, buildings and all, for more to
developers than they can to new owners who wish to keep sites in their
present uses. Potential use site values exceed existing use property
values, so a land owner can enhance the value of the asset simply by
allowing a change of the use to which it is put - that is, by allowing
a more intensive use.
From the economist's point of view, rising land values make
land-substituting capital more attractive. They signal the need for
redevelopment to reduce the amount of land used per unit of
circulating capital or labour, for new routeway building to make
cheaper land more accessible, or for projects to open up new lands and
Thus, if land value appreciation is exaggerated by either
speculation fever or by entirely politically-motivated decisions to
reduce land taxes or increase public development projects then
construction is initiated in excess of the nation's requirement for
fixed capital, and the seeds of a property market crash are sown. To
the extent that land prices are bid up to levels based on illusory
expectations or manipulation, sites are moved into uses justified only
by illusory expectations or manipulation. Those flights of fancy must
eventually come home to roost.
Misdirecting savings by setting them aside for future uses (which may
never fructify) when land values are rising shortens their supply to
effective current users when they are most needed, and thus raises
interest rates. Circulating capital that is currently producing final
output gives way to fixed capital that is not yet producing. Indeed,
much currently productive fixed capital is withdrawn from use by the
demolisher's bulldozer. Excessive land development also pulls land and
labour away from current final production just when consumers are
demanding more of it, and so raises their supply prices. The seeds of
decline are directly sown throughout the economy.
Vacant sites are not the only sign of the land speculator.
Speculative construction projects are a form of land speculation. They
also withdraw sites from current production of goods and services for
short or very long periods, raise the rent costs to users on other
sites and squeeze profitability. Building activity does not guarantee
that land rents are not being squandered or capital is not being
wasted; in fact, a building boom probably guarantees the opposite.
Rising interest rates eventually choke off the surge of consumer and
investor demand just as production costs go up. Nominal interest hikes
are reality's megaphone dispelling false consumer and business
confidence; real interest hikes hurt. They begin by dispelling the
source of the hubris - buoyancy in the land market. They expose the
hopes upon which values are based and raise the rates used for
capitalizing rents. Land prices peak and decline, the lever is thrown,
the processes of the boom go into reverse, the economy, against its
natural inclination, switches from growth to shrinkage, and prestige
capital projects are stranded as hulks by the receding tide.
But the downside of the business cycle, too, is unsustainable, for
falling land prices paint as false a picture of the future as rising
land prices do. However, the legacy of over-supply of fixed capital
takes a decade or more to work itself out, so it is many years before
the logic of the geared land rent residual can reassert itself.
Perhaps that was why Cole and Hoyt's land cycles were roughly of 18
The mechanism at work
Does the UK and Australian evidence support this account of the
mechanism of the longer period business cycle? Land ownership is of
particular significance for economic behaviour in these countries. It
is relatively widely spread through owner-occupancy of homes and
farms. In the 1960s, over 80% of the individually-owned parcels of
land in Australia were occupied by the owners of the greatest interest
in the land.[
10] In the UK, the
owner-occupancy rate of homes had risen to two-thirds by the late
1980s, catching up with the rate on farm land. Land forms a higher
proportion of private wealth than in most countries - almost one-fifth
in Australia, according to Scott,
and more in the UK. Thus,
if the land market has a causal influence on economic cycles it should
be evident in these countries.
Figures 7 and 8 map the winding paths of the economies over the
post-war period, using the real growth of the Gross Domestic Product
at market prices, and business survey assessments of the percentage of
manufacturing firms operating at full or above normal capacity.
Cycles with a frequency of around 4 years are immediately apparent.
Some of these troughs are little more than "growth recessions".
Others are severe, involving decline of annual production: 1953 in
Australia, 1958, 1974 and 1980 in the UK, 1983 in Australia, and 1991
in both. The protracted low growth period of 1975 to 1978 in Australia
qualifies it as equally severe, a verdict which accords with the
business survey data.
In the UK, there were two outstanding bull markets in land - during
1972 and 1988 - as shown in previous charts. Figure 9 especially
brings out this fact. The
minor bull market of the late 1970s was little more than a recovery
from the trough of 1975. Both the major land booms preceded major
economic collapses by about 2 years. The other deep recession of
1980-81, like the land price inflation before it, appears to have been
of a different kind. Neither the construction industry, as Figure 9
shows, nor the money supply were instrumental in the build up to it.
The rate of growth of the money supply peaked in 1973, 1981 and 1988,
and fell to a half or a quarter before and after these peaks. In other
words, the situation was reversed in the middle period. Instead of the
broader money supply expanding rapidly in the boom, it expanded in the
collapse. The government's action in jacking up the Bank of England's
minimum lending rate from 5% to 17% over the course of two years from
late 1977, without waiting for the usual danger signs of demand
pressure, clearly suggests that the recession was politically
In Australia, the four outstanding bull markets in land - 1950, 1973,
1981 and 1988, when prices grew at over 30% per annum (Figure 4) -
each preceded by 2 years the severest output troughs of the post-war
period. Again 1981 appears to be different in that it was not
accompanied by equivalent broad money growth or by an exceptional
burst of construction activity (see Figure 10).
The pattern in the two countries is, therefore, rather similar. The
UK was held back more in the post-war decade by the requirements of
austerity, but less affected by the Korean War commodity boom, so a
far less extreme short cycle developed. However, a more developed
cycle straddled the middle 1950s, ending in a real decline in 1958. "Normal
service" may be considered to have been resumed. The next decline
in output was 16 years later. For Australia, the equivalent gap was 22
years. Assuming that the early 1980s recession was different in both
countries, the subsequent recession came 16-17 years later in both.
This periodicity matches fairly closely the 16 to 20 year Cole-Hoyt
cycle identified for 19th century North America. The ingredients of
the cycle, as indicated in Figures 9 and 10, are the same.
Australia's severest downturn of the post-war period is not shown in
the Figure 10, but it provides an interesting snapshot of the
components of the Cole-Hoyt cycle.
The post-war Labour Government encouraged a massive house building
programme which saw the real interest rates charged by savings banks
(the Federal and State government-owned home loan institutions)
reduced to minus 15% by 1951, from a positive 2% in 1946. Median house
price rises in Melbourne, at about 10% per annum in 1948, leaped to
almost 50% in 1950, before falling to 5% in 1952. Housing starts
peaked at almost 15,000 in 1951, from virtually nil during the war,
and fell back to 8,000 in 1953. Inflation, which had been running at
about 10% per annum, 1948-1950, lept to 19% in 1951, and continued at
17% in 1952, partly due to the Korean War commodity price rises.
The peak of the property boom would already appear to have passed,
but the conservative Liberal-Country Party Government's "horror
budget" of 1952 tightened both fiscal and monetary policy to
tackle inflation and induced a contraction of output of almost 5% in
1952-53. Real interest rates became positive again in 1953.
In this instance it might be argued that land prices were not the
principal destabilizing influence on the economic growth rate. It was
government policy which created the property boom in the first place,
just as the government's austerity programme in the UK prevented one.
That would be the monetarist's, and most free market economists',
However, the proposition may be looked at from the opposite angle. It
seems desirable to conduct the loosest monetary policy consistent with
not causing savings rates to fall and inducing inflation. If land
prices are the principal amplifier of the government's monetary
policies, then the government can choose to be less tough on credit so
long as at the same time it takes appropriate action to prevent land
prices rising. The Australian government of the late 1940s could have
increased the Federal tax on the unimproved value of land. It did not,
but instead handed that macroeconomic policy instrument over to the
States in 1952.
Moving forward to the UK in the early 1990s, political parties of all
complexions vied with each other in the general election of 1992 to
claim superior monetary prudence. The Conservatives in power had to
admit their error in responding too readily to calls from all sides to
reduce short term interest rates hurriedly after the stock market
crash of October 1987, in order to prevent a re-run of the 1930s
Depression. That had been the source of the 1991 recession in which
the debts incurred during the property speculation and spending spree
of 1988-89 in the personal and company sectors were having to be
worked out by reduced borrowing and increased saving. In their defence
they claimed that other parties had pressed them to loosen monetary
policy further, and that all were wrong with the benefit of hindsight.
What was not discussed was the possibility that the response to the
stock market crash was the correct one (that is, opposite to the
response in 1929) and that all had been right on the monetary score.
Where the error had been made was in fiscal policy. Instead of
reducing the overall tax burden, thus further stoking up the
propensity to borrow, the government could have balanced its income
tax cuts by spreading taxes onto land values. It did the opposite: it
abolished the local property tax on houses.
Land prices as a constraint on monetary policy
A measure of the tightness of a country's monetary stance is the
slope and direction of its yield curve. The government is able to
determine short term interest rates through the price at which the
central bank lends to the money market. It cannot determine long term
interest rates, which depend on investors' expectations on how the
real value of bonds will hold up in the future.The more inflation, or
some other risk, is anticipated, the higher have to be long term
interest rates to encourage investors to buy.
Thus, the slope of the curve between short and long term yields
reflects the market's judgement of the bearing of the government's
macroeconomic policy on the value of assets (hence both fiscal and
monetary stances are causes for concern). If it believes that policy
will drive up inflation, long bond yields will rise. This will tend to
be at times when the government is pulling down short rates. Hence,
the steeper the upward slope of the yield curve, the looser and more
reckless policy is judged to be. A certain degree of upward slope is
normal, because the future usually holds more risks for the value of
an investment than the present. So a downward slope is termed an "inversion".
A flat, or an inverted, curve indicates a tight macroeconomic stance,
which attempts to preserve the value of existing investments - but
perhaps at the expense of new ones. Wealth is kept short.
Figures 11 and 12 display how macroeconomic policy has varied since
1950. The slope of the yield curve is indicated by the gap between
long government bonds and either short government bonds (Australia) or
three-month Treasury bills (UK). Average yields for the year are
17] For the sake of visual
clarity the size of the gap has been quadrupled. Property price
changes have been plotted against this data, but set back to one year
The Figures show a fairly clear correspondence between relaxation of
monetary policy and uplift in land prices. The actual lag of one year
suggests that the former gives an upward stimulus to the latter. In
other words, a government's normal inclination towards a relaxed
macroeconomic stance, in order not to hold the economy back, leads
inevitably to the unleashing of property prices. Consequential
imbalances in the economy are set in motion.
Figures 13 and 14 indicate the close correspondence between a
relatively loose monetary policy and upturns in the economic cycle.
The GDP data, like the land data, is set back to one year earlier.
We have already noted from Figures 4 and 5 that strong land price
inflation precedes, with roughly a year's gap, the signs of
unsustainable growth in demand pressure. The signs force the
government's macroeconomic stance to change, and the slope of the
yield curve flattens and inverts. Land prices and output flatten and
move downwards, too, a year or so later. Hence the correlation in the
A sea change can be seen to have occurred during the mid-1980s. The
governments' resolve to conquer inflation was being taken seriously,
so long bond yields had fallen. But they had fallen from very high
levels due to the inflationary trauma of the 1970s. Continuing high
short term interest rates were recognised as the necessary insignia of
the government's resolve. So a flat yield curve on a high plane
replaced an upward sloping curve at lower levels as the perceived
norm. Any upward slope at all became a gauge of monetary laxity or
fiscal reflation. An upward slope appeared in 1986 in the UK, and 1987
in Australia. Output had been growing respectably in the
circumstances, so the main effect was on land prices, which brought "overheating"
in their train. By the same token, to choke off land prices, a far
more inverted curve than had previously been experienced was required.
What had brought about this change? We have noted that the tax burden
on land rents was being reduced in both countries. This helped make
land prices more lively, so that a tighter hold on the monetary reins
became necessary.Clearly, financial deregulation in both countries was
also oiling the transmission mechanism from the credit-creating
institutions. Finally, high real interest rates had become a permanent
necessity to hold back the catastrophic decline of savings that had
occurred in the UK in 1970-75 (see Figure 15), and in Australia from
about 1973 to 1983 (see Figure 16).
The genesis of the sea change may be traced, therefore, to the early
1970s - the time of the first great post-war land boom (excluding the
late 1940s in Australia). In Australia it was spurred on by land tax
reductions and other policies relating to land tenure (see below). The
legacy of the catastrophic decline in national saving in both
countries, stimulated principally by capital gains in land, was a
shortage of capital - that is, chronically low rates of net
investment. The long term prospects for economic growth inevitably
suffered. Attempts to regain the level of earlier years produced the
need for the toughest fiscal and monetary constraints of the post-war
period in 1990, precipitating one of its worst recessions. This lesson
is likely to result in a yet lower growth trend.
It has been argued that the immediate cause of high interest rates is
the evidence of a shortfall in domestic savings relative to the
requirements of investors. Figures 15 and 16 may be translated into
figures which plot the actual savings shortfall. This is accomplished
in Figures 17 and 18.
The Australian figure indicates an obvious link between the savings
shortfall and real interest rates. The latter are shifted two years
backwards in time in the figure, which suggests that a shortfall leads
to a rise in real interest rates about two years later. Nominal
interest rates rise immediately, but in response to inflation, so real
interest rates do not rise until later.
The UK data, however, indicates a perverse interest rate response. We
have already mentioned that short term rates were pushed up in the
late 1970s at an inappropriate time. Figure 15 shows that national
saving had just made a dramatic recovery. The earlier decline of both
nominal and real rates just when savings were collapsing also seems
inappropriate. Record inflation reduced real rates exceptionally. The
implicit rationale of policy was to bail out those who had become
heavily indebted during the 1972-73 property boom. The policy
succeeded in making increasing savings ratios an unnecessary response
to the collapse in land prices, and contributed to the permanent slow
growth of the economy thereafter. (Higher spending on consumption of
OPEC oil, meanwhile, was replacing savings.) This was an experiment in
not allowing the land market to constrain monetary policy. It ended in
the Chancellor's, infamous trip to the IMF in October 1976. The
experiment was not repeated in 1990-91.
Apart from these episodes, the UK graph looks different from the
Australian one because the UK ordinarily has a domestic savings
surplus - that is, it traditionally invests much capital abroad. The
heavy demands on fixed capital at the cusps of the two long term land
cycles clearly choked off this outflow, however. North Sea oil helped
maintain it in the first half of the 1980s.
The episode around 1973 in Australia is worth a closer look. Unlike
in the UK, the cusp of the land boom was marked by an increase in
savings and a decrease in investment. As shown in Figure 18, real
interest rates became negative in 1972 (allowing for the 2 year shift
in the series). Ross King, from a left-wing perspective, states that "Capital"
deliberately encouraged purchasers to buy an over-supply of houses
from debt-laden speculator-developers. Credit terms were liberalised.
Second incomes became acceptable backing for loans for the first time.
Then, in the mid-1970s a corrupt State land banking system was
developed to maintain the demand for land, hold up its price, and
prevent deflationary disruption of consumer confidence.
King argues that capital "switched" from manufacturing into
mining in the late 1960s in order to maintain profits, into office
building in 1970-1972, and into housing in 1973-1974, before
depression could no longer be averted in 1975. This is a conscious
elaboration of David Harvey's Marxist hypothesis that property booms
are the last ditch of capital's continuous battle against
over-accumulation and declining profits. When the possibilities for
profitable investment in the "primary circuit of capital"
(manufacturing industry) are exhausted after a period of growth,
capital must find alternative outlets, so switches to the "secondary
circuit of capital", the built environment, which aids production
(factories, offices, houses, roads, etc.). Financial institutions
mediate this switch by relaxing the terms of credit, thus making
construction more affordable in the short term. However, profits are
soon exhausted once more by over-accumulation, and unless switching to
the "tertiary circuit of capital", spending on the quality
of capital and labour (research and development, education, health,
etc), or back to the primary circuit, avails, depression follows.
There was clearly a relative increase in gross fixed capital
expenditure on construction of all types from about 1970 to 1974 and a
relative decrease in gross fixed capital expenditure on machinery,
equipment and all other types of physical capital at about the same
time (see Figure 10). We have already offered an explanation for this
"switch" in terms of the unsustainable lure of land price
gain. Land prices rose relative to GDP in 1972-1974.Nevertheless, the
view that there was a "wall of savings" seeking profitable
investments in the early 1970s harmonises with the commodity price
boom (feeding mineral rents) that occurred in the flourishing world
economy of the late 1960s.The Australian economy closely reflects
swings in world commodity prices. Another upswing added fuel to the
boom of 1988.
The assumption of an inherent tendency in free market economies to "over-accumulate"
capital - which has been used to explain short cycles relating to
circulating capital and longer cycles relating to fixed capital -
ignores the basic question. Is it simply greed and hubris that cause "over-accumulation"
of one type of wealth or another? If so, human nature cannot be
changed. Or are the price signals which direct human accumulation
faulty? They can be changed. We have suggested that "over-accumulation"
of fixed capital is spurred by rising land prices and causes long
economic cycles. The signals in the land market need repairing.
Solutions for the UK and Australian business cycle
The structural reforms of the 1980s in both countries - deregulation
of financial markets, privatization, the purging of protectionism from
other industries (in Australia), reform of personal taxation - have
helped speed up the response of the economy to land market signals.
But the structural reform most needed is the one reform that no
political party has been prepared to embrace in either country. Reform
in the property market is correctly perceived as a threat to "the
national hobby of land speculation." The quote comes from
Australia, but the label applies equally to the UK.[
Ross King, of the School of Environmental Planning, University of
Melbourne, relies heavily in his proposals on attempts to change human
nature. He proposes education against class structuration, and a
planning system designed to foster self-help. However, despite his
pro-Marxist leanings, he is prepared to accept that structural
solutions are available to ameliorate the defects of
capitalism.Principally, the tax bias in favour of owner-occupancy of
housing should be removed.
He advocates an inflation-indexed capital gains tax to include
housing. CGT has only recently been introduced in Australia, yet in
the post-war period land price appreciation has been the source of
massive redistribution from tenants to owner-occupiers, and from those
property owners in unfavoured localities to those in prestigious
King notes ideological pressures towards home-ownership, and mentions
another tax on this form of land ownership that is absent: income tax
on imputed rents. As marginal tax rates have increased, this tax break
relative to tenancy has become increasingly significant. Until the
1970s, even the property taxes that were paid were deductible from
taxable incomes - another benefit which increased with rising marginal
tax rates. King, however, neglects to propose rises in the rates of
these taxes: the state land taxes, and the local government property
taxes - mainly site value rates.
Robin Pauley, in a Financial Times Survey of Australia, noted
that despite "impressive policy successes...[w]here the
Government is most open to criticism, according to many commentators,
is on the savings front. There are various ways to boost and redirect
savings: the least politically acceptable redirection would involve
removing the distorting tax breaks from home ownership to produce an
incentive for individual investment in productive enterprises rather
than in a non-productive appreciating personal asset."
In response to a letter to the Australian Prime Minister recommending
him to reintroduce the Commonwealth Land Tax, Mr Bob Hawke's office
replied that "it is important to recognize that the introduction
of the capital gains tax by our Government, together with other
tax-broadening measures, has done much to reduce the need for other
taxes on wealth and to ensure that high income earners pay their fair
share of taxes."
This reply might have been acceptable to Ross King, though not to the
receiver, if it were not for the fact that the taxpayer's principal
place of residence is exempt from CGT.
The letter went on to stress that the tax "would be affected by
the community's preparedness to have the taxpayer's principal place of
residence included in, or excluded from, the tax base. In a practical
sense it may be impossible to consider such a tax without such a
concession, and additional exemptions for rural land. Overall, a land
tax may yield only meagre additional revenue."
There is clearly a need for achieving a consensus among economists
that the wider good of the economy is at stake, in order to be able to
convince land-owning voters that land value taxation is to their
benefit. The economics professor, Mr John Hewson, who has taken over
the role of the leader of the opposition, prescribes a massive shift
from direct to indirect taxation, with a 15% across-the-board Goods
and Services Tax (instead of wholesale taxes) and reductions in income
tax, as his elixir for the economy. Taxing consumption may sound like
a way of "converting a nation of profligate spenders into thrifty
savers" (and driving the black economy into the open), but The
Economist's survey of Australia described the idea as "a
triumph of hope over British experience."
In Britain, which had a similar 15% value-added tax throughout the
1980s while the personal savings ratio declined from 13% (1980) to 5%
(1988), economists are increasingly aware of the need to take physical
asset prices into consideration in their models, as well as financial
assets. The Treasury has "admitted that its forecasting
techniques have failed to take into account the effect of the
depression in the housing market on the recession."
It is consequently amending mathematical equations in its computer
model of the economy which acts as a base for its economic forecasts.
After the consumer boom took the model minders completely by surprise
(and consequently the government), the Treasury incorporated housing
wealth in its "consumption function" for the first time.
Apparently, it did not do so adequately, for the depth of the
recession has also confounded the model. Perhaps, incrementally, the
model is getting closer to simulating how the economy works?
The government, certainly, is having to reconsider its light touch on
land rents, and is attempting to place a firmer hand on them. In the
budget of 1991, tax relief on home loan interest was limited to the
basic rate of income tax. At about the same time it was announced that
a new local government tax on the capital value of houses would be
introduced in place of the notorious "poll tax", which had
only just replaced the old local property tax.
After the Government's re-election in 1992, Barry Riley of the London
Financial Times offered some apposite advice regarding the
choices that lay ahead for the Prime Minister: The "bunch of
carrots" inherited from Mrs Thatcher's years in office had been
dangled on the assumption that the middle classes, in chasing them,
would naturally head in the right direction. "Now John Major will
maintain the incentives, but does he also need to apply the occasional
touch of the whip in order to keep his troublesome cart horses in
line? Certainly he will want to keep any recovery in the house market
well under control, or excessive credit growth will lead to problems
for sterling within the European Monetary System [i.e., require
devaluation].... Moreover, a nation can only get rich quite slowly,
and if large numbers of individuals are getting rich quickly it is a
sign of the misdirection of resources."
A nation will get rich more quickly if its homeowners do not stand in
the way of a tax which achieves the goal of keeping land prices under
control. It should help them to know that lower interest rates are a
necessary part of the package that introduces a tax on all land. They
will prevent land prices actually falling when some of the rent is
recovered to fund tax cuts elsewhere or much needed infrastructural
investment. Falling land prices are as bad for the economy as rising