Land Markets and Business Cycles
in the United Kingdom and Australia

David Richards

[March 2000]



Credit and the economic cycle

The land cycleCredit or land speculation?

- A Georgist Monetarist decides Speculation chips and the "real" economy

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 Australia.


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 run.

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 2 shows.[ 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 upon it.

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 financial deregulation.

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."[ 2]

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 debt-saddled banks?

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 be implicated?

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.[4] 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.[5]

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."[6] 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 downwards.

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 and years.

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.[7]

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.[8] 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 house purchasers.[9]

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 natural resources.

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 years duration?

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,[11] and more in the UK.[12] 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.[13] 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.[14] 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 inspired.

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.[15]

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.[16] 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', position.

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 used.[ 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 earlier.[18]

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 graphs.

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.[19]

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.[ 20]

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.[21] 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 localities.

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.[22]

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."[23]

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."[24]

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."[25]

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."[26] 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."[27]

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 land prices.

Appendix 1 * Appendix 2 * End Notes