Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability -2019

PALGRAVE STUDIES ON HENRY GEORGE FOR THE 21ST CENTURY

Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability Edward Nell

Palgrave Studies on Henry George for the 21st Century Series Editor Edward Nell New School New York, NY, USA

This is a series in memory of Henry George, taking off from his writings and dealing with the issues he raised in his time, as they persist, but also taking his approach into our time and dealing from his perspective with some of today’s most pressing issues and problems in the political economy.

This series contextualizes Henry George as an important figure in what is currently a widespread pattern of interest in critiques of mainstream economics. Much critical work in economics in the late twentieth century was aimed at critiquing and destroying mainstream theory, particularly those aspects that appeared to support and justify neoliberal policies. But after the crash of 2008, much more attention is being paid to non-mainstream approaches that offer new explanations of economic phenomenon. This series fits that mold, drawing on a uniquely significant American figure once widely known and venerated but lost sight of during the dominance of mainstream neoclassical theory.

More information about this series at http://www.palgrave.com/gp/series/16249

Edward Nell

Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability

Edward Nell New School New York, NY, USA

ISSN 2524-8847 ISSN 2524-8855 (electronic) Palgrave Studies on Henry George for the 21st Century ISBN 978-3-030-18662-3 ISBN 978-3-030-18663-0 (eBook) https://doi.org/10.1007/978-3-030-18663-0 © The Editor(s) (if applicable) and The Author(s), under exclusive licence to Springer Nature Switzerland AG 2019 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed.

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This book is dedicated to the memory of Andrew Mazzone, my friend, colleague, and the President of the Henry George School of Social Science from 2013 until his death in 2017. Andy’s commitment to bring Henry George’s ideas into the twenty-first century was the reason for my joining the Board and the driving force behind this book.

Preface: About Henry George

Henry George was born in Philadelphia in 1839, the second of ten children.

His father was a clerk at the Philadelphia Customs House, a devout Episcopalian, and a publisher of religious works. But the family lived modestly.

George attended school until the age of 13, when he told his father that he desired “to go out into the world” to work and help support the family.

He worked odd jobs and learned to set type. At 16, he sailed to Australia and India as a ship hand, eventually returning to the United States. At age 18, he headed west in search of gold.

George spent 1858 in West Coast mining camps and settled in San Francisco in 1859. He found employment as a compositor. He met and married Annie Corsina Fox in 1861. George struggled to find employment and pursued a career in journalism. George published his first book, Our Land and Land Policy: National and State, in 1871.

In his landmark book Progress and Poverty (1879), George proposed a deceptively simple solution to the problems of economic inequality and industrial depression. He called for the replacement of all federal, state, and local taxes with one tax on land. His proposal became known as the “single tax.” Taxing only land values, George believed, would generate all the revenue needed to operate government and produce ever greater levels of opportunity.

In the winter of 1881–1882, George embarked on the first of several tours of the British Isles. He influenced English politics, helping spur not only a popular land reform movement but also modern British socialism and Irish nationalism. vii

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Back in the United States, George was invited to testify before the Senate Committee on the Relations between Labor and Capital in 1883.

He published Social Problems, a compilation of his editorials. The United Labor Party nominated him to represent the interests of more than 150,000 working men and women in the New York City mayoral race of 1886. Although he lost the election, his campaign attracted national attention as the culmination of what some commentators called “the year of labor.” He out-polled Theodoee Roosevelt in that election.

The campaign also ignited religious controversy. In 1891, Pope Leo XIII placed Progress and Poverty on the Vatican’s List of Forbidden Books. George wrote a powerful commentary on the Pope’s approach to land and rents.

George edited a weekly newspaper and authored three books: The Condition of Labor (1891), The Perplexed Philosopher (1892), and The Science of Political Economy (1898).

He was nominated again for mayor of New York in 1897. Three days before the election, on October 29, 1897, he suffered a stroke and died.

His funeral two days later was likened in size to that held for General Grant. The New York Times reported: “No demonstration of popular feeling on the death of a public man since Lincoln’s body lay in the City Hall has been so imposing in extent and character as that of yesterday. Call it, if you will, hero worship; but its object was really a hero.”

New York, NY, USA

Edward Nell

Acknowledgments

This book was written on the run and produced in a flash in order to honor Andrew Mazzone at the opening of a new phase—which he himself planned—in the history of the Henry George School of Social Science. To make this happen a number of people had to work exceptionally hard and do exceptionally good work. Tom Phillips did an immensely helpful reading and editing of the first full draft. Barbara Ross then followed up with subsequent drafts. Kenneth Wapner discussed every stage of the book with me and helped over and over with difficult passages, seeing it through from start to finish. Sam Truitt did wonderful work preparing the book and cleaning it of errors and infelicities. Many thanks to the President, Board of Directors, and Staff of the HGSSS, especially Andrada Chercheres, for supporting this project and providing help at crucial moments. And I owe a special debt to the outstanding editors at Palgrave, Elizabeth Graber and Sophia Siegler. Finally I want to thank my wife Marilyn Adams for her patience, sound advice, and common sense.

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Contents

1 Introduction: Reviving the Work of America’s Most Original Economist 1 A Quick Look at Henry George 4 Bibliography 7 Part I Progress and Rents 9 2 Understanding Rents in the Real Economy 11 Henry George’s Idea of Progress 12 Growth Models and the Treatment of Rent 13 The Classical View 17 Factor Markets 18 Henry George’s Treatment of Distribution 21 Rents and Real Estate 23 Bibliography 25 3 Growth and Rents in the Real Economy 27 4 A New Look at the “Henry George Theorem” 35 The Traditional Case 36 Rents, Demand Pressure, and Taxes 39 Discussion of Revised 2016 GDP Accounts, by Andrew Mazzone 45 Bibliography 49 xi

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Part II Moving to Macroeconomics 51 5 Savings and Investment, from the Price Mechanism to the Multiplier 55 The Price Mechanism and Marshallian Technology 56 Growth and the Price Mechanism: Flexible Prices and the Golden Rule 61 The Growth Rate in Diagrams 63 Bibliography 69 6 From Craft to Mass Production 71 Changes in the “Production Function”: The Multiplier Replaces the Price Mechanism 73 Adjustment to Demand Fluctuations in the Mass Production Economy 76 Moving Ahead: Land 82 Bibliography 83 7 Growth and Rents in Today’s Economy 85 Growth Today: A First Look 88 Bringing in Rents 92 Bibliography 96 Part III Rents, Real Estate Values, and Financialization 97 8 Real-Financial Linkages and Holding Securities 99 The Question of Real-Financial Linkages 100 The Financial Sector: Portfolio Holdings of Securities 103 The Securitization of Rents 106 Bibliography 111 9 Growth and Inequality in the Financial System 113 The Influence of Liquid Capital on Wages and Salaries, the Role of the Financial Sector, and Why This Phenomenon Was Not Seen Before 114 A Simple Model of Wealth Accumulation and Inequality (with Linear Coefficients) 116 Toward a More Complete Model 119

CONTENTS

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10 Rents and the Securities Markets 121 Real-Financial Instability 127 Bibliography 134 11 Conclusions 135 Bibliography 139 Index 143

List of Figures

Fig. 5.1 Fig. 5.2

Fig. 5.3

Fig. 5.4 Fig. 6.1 Fig. 6.2 Fig. 6.3 Fig. 6.4 Fig. 6.5

Adjustment to demand fluctuations in the craft economy (showing a rise in the real wage) 58 Growth rates and marginal products: in this diagram the marginal product of capital equals the growth rate, g, as described below. But the diagram can be re-imagined by relabeling the axes as Y/K vertical and N/K horizontal. Then, following the same line of argument, the slope of the line rising from the origin will be W/N = w, the real wage, and the section of the vertical axis marked will measure I/K = g, while the tangency point will show the real wage = the marginal product of labor. (A project for readers: sketch the relabeled diagram and trace out the argument showing that the system will settle at the point of tangency. Evaluate the underlying assumptions.) 64 Adjustment to an increase in growth rate. (The vertical distance between the dotted parallel lines should be less than that between the solid lines, indicating that the real wage is now lower.)

65 An upward shift of the production function, leading to a fall in prices and a rise in the real wage 66 Consumption moves with investment 73 Behavior of profits 75 Adjustment in the mass production economy 77 Effects of interest on saving and investment 81 The central bank’s interest rate determines employment 81

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Fig. 7.1 Fig. 8.1 Fig. 8.2 Fig. 8.3 Fig. 10.1

Growth and wages The issuing and holding of debt and equity All securities issued will be held The level of risk Growth and the valuation ratio

87 104 110 110 128

CHAPTER 1

Introduction: Reviving the Work of America’s Most Original Economist

Abstract The book begins with Andrew Mazzone, his desire to reexamine Henry George’s work, his sudden death, and how the book came to be written. It takes George’s dynamic vision and approach as a position from which to challenge mainstream economics’ obsession with equilibrium, enabling a focus on the paradoxical fact that progress also generates poverty. The book has three parts: the first on rents, land values, and the costs of government; the second filling in a picture of macroeconomics for George, who long preceded Keynes; and the third, drawing on George’s approach, examining the contribution of rents to the growth of inequality and financial instability.

Keywords Henry George • Equality • Rent • Macroeconomics • Economic growth Andrew Mazzone and I collaborated on a project to review the work of the nineteenth-century American economist Henry George, especially his landmark book Progress and Poverty (1879), to see how George’s work stood up in the light of modern economics and to determine what could be brought up to date and applied to the contemporary world. We wanted to establish that George’s work was relevant and also to criticize American academic economics for having overlooked or rejected George both in his own time—when his work was a worldwide sensation—and afterward, © The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_1

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even today. Andrew died suddenly in the middle of the project. This book is a tribute to him and completes what we began.

George began his career as an author and public personality with Progress and Poverty, arguing that progress brought poverty in its wake and that poverty might even outpace progress—an important, original point of view that has not lost any of its relevance since George’s time. In fact, in our age of burgeoning inequality it may be more relevant today than ever. The grounds for this paradoxical interlinking of progress and poverty lay in the effects of rising rents. For George, rents were payment— not for the use of land in the usual sense, but for pure access to specific spaces and locations. But why should some people have the right to limit others’ access to the use of the earth; surely it belongs to us all? Worse, he argued, the limiting of access—by demanding payment—would undermine the benefits of innovation and hard work.

To prevent this linking of progress and poverty, George said a major policy shift in taxation was required. This is well known among economists as the Georgist “single tax” on rents, based on the Henry George Theorem, linking overall rents and the cost of government.

Since George’s time there has been progress, both in the economy itself and in economic analysis: the economy has been growing, and growth models have become highly sophisticated (in many cases focusing on matters that were central to George a century earlier). But that progress has also led to poverty, obvious in the economy itself. Our mainstream economics is also poverty-stricken, intellectually, however. Our analytical models do not explain the persistence of poverty very well, nor do they account for crises and crashes, let alone the recent and stubborn growth of inequality. The mainstream theory of income distribution—marginal productivity (which assumes diminishing returns for all three factors of production and that markets will “coordinate” their adjustment)—is hopelessly flawed (George rightly rejected an early version of it). And contemporary economic theory has almost completely lost sight of rents and real estate—even though real estate was center stage in the global financial crisis of 2008, a crisis directly resulting from speculation in the housing market. And in 2016 Donald Trump, a real estate developer whose rise to power is intimately linked to rents and real estate speculation, was elected president. With a solid Republican majority in Congress, he began to implement a set of relentlessly regressive “trickle-down” economic policies that can be expected to lead to more poverty among vast segments of the population. Andrew and I wanted to find insights and tools in George’s thought to counter this trend—to support progress and alleviate poverty.

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Before Andrew died, we had settled on five main points in George’s writing that we wanted particularly to explore: 1. George emphasized cooperation as well as competition in regard to increasing productivity. He saw that the division of labor and cooperation that emerged, based on mutual trust, as settlements developed on new land, created value in “location” and generated increases in output, while bringing about innovation. This is what generated the “differentials” on which rent is based (as we will explain). The emergence of differentials could be associated with increasing productivity.

2. George and his followers claimed that the total value of land in a region would tend to equal the value of the aggregate output of that region.

3. Further, they claimed that total rents would tend to equal the costs of government, so that taxing rents would pay for government.

4. They contended that, unless prevented by an activist government, inequality in wealth and income, roughly between the upper and lower classes but also between other significant groups, would tend to rise inexorably.

5. And, finally, George repeatedly attacked land speculation and its tendency to withdraw land from productive use and to promote concentration—a point that seemed to both Andrew and myself to have a direct bearing on today’s world. Only today it’s not land alone but finance generally that is subject to speculative excesses, leading to booms and crashes. The extension of George’s ideas from land to finance needed to be worked out.

I wrote up notes on theory, while Andrew worked on national accounts, reexamining rents, costs of government, land values, and gross national product (GNP). I eventually put my notes together into two more-or-less finished articles to present at the annual Conference of the Eastern Economic Association in March 2017, in New York City. Andrew’s illness had prevented him from being able to keep up with his research; all he had were notes. He died suddenly, just before the conference. Nevertheless, I presented what we had, including his notes. The talks I gave at that conference formed the basis of this book.1 1 There will be a second phase in the work that Andrew and I began. This will pull together a range of other papers presented at the conference and contributions by interested parties associated with the Henry George School of Social Science and Andrew, to make a larger volume that will cover a range of issues concerning modernizing the economics of Henry George.

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A Quick Look at Henry George Economists have given George short shrift, which is a shameful oversight—he has much to teach us. He was uniquely American, perhaps our greatest economist, certainly our most original. He was justly famous and heralded in the nineteenth century, and his book Progress and Poverty, which is the source for much of our analysis in these pages, was the best-­ selling book on economics of that century. Today, George is obscure and all but forgotten, although his arguments, shockingly effective in their day, are still pertinent and powerful—and are currently being reexamined in some advanced quarters! (Posner and Weyl 2018).

George was a force to be reckoned with in the America in which he lived. He was a kind of archetypal American, a strong individualist but equally passionate about the values of the community. He was a self-made man, an autodidact who withdrew from formal education in favor of home tutoring and never attended university. He left his home in Philadelphia at the age of 15 and went to sea for three years, traveling first to Australia, then after returning, leaving the East for the West and settling in San Francisco in 1858. He became a printer, then a newspaperman, an editor, and, finally, a writer. The frontier and the dynamics of westward expansion shaped his economics—and the railroads shaped his views of “monopoly,” or market power. He developed a picture of the way the economy works that balanced individualism and cooperation, expressed our strengths as both a country and a people, and identified an enduring tension in our character and polis. He lectured on this in Europe and debated Alfred Marshall. George returned to the East and entered politics, running for mayor of New York in 1886. He died prematurely (having earlier suffered a stroke) in 1897 at the age of 58, at the height of his popularity.

Moral insight is the bedrock of George’s economics. He favored initial equality: everyone has an equal right to share in what the earth has to offer—a powerful claim, difficult to reject, hard to make precise. He was enchanted by the West’s great prairies, its vast expanses of meadow and forest, the land that stretched on and on, America’s wide-open spaces with deep rich soil. He saw the implications of free land in the frontier of his day, a place where labor could reap the full proceeds of its work, thus providing a magnet for workers from the cities of the east. As a result of this attraction, wages in the east had to stay high enough to keep labor from migrating to the frontier. High wages also meant that manufacturing would benefit from labor-saving innovations. So American business had a high-wage, high-tech profile from the start.

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George saw the significance not only of cooperation but also of trust, that each part of a process created by the division of labor has to trust that the other parts will work responsibly. George understood the importance of honesty and keeping promises. Who will extend credit to someone who cannot be trusted? Who will accept bills from them? Will they deliver the goods in good shape? We have to believe that the other party or parties will do their share on time and in the right way. One of the most important moral issues for George was land ownership: who had the right to own land, and so to exclude others from any part of the earth or from the use of its fruits? His answer was that the right to ownership arose from labor—you owned what you made or created. But no one made or created land (in the pure sense), so no one had a right to own it; no such right could exist.

For George, the American economy of the nineteenth century was a dynamic system. Technology and productivity were continually improving. But the greater the progress the system made, the more poverty it created. Why? This was the fundamental question he asked and sought to answer—and it is still, arguably, the most important question for economists and one of the most enduring and troubling paradoxes in our world today.

“Ownership,” George argued, results from making things: if you grow vegetables, they are yours; if you make a hoe to cultivate your garden, it is yours—because you made it. If you make it with a friend, it belongs to both of you. If a company makes it, it belongs to the company. That is the foundation of ownership rights, and, of course, there are complications.

Land, however, is not made by anyone (think of space); it is there for everyone. And it should not be polluted or despoiled by anyone. In this, George anticipated both the conservation movement of the 1890s and today’s environmental movement.2 No one should be able to exclude others without good and specific reasons that rest on the public good. These questions are not simple, and neither are George’s arguments. But they are very much worthwhile, and they call for a critical examination of the tendency so evident today toward greater and greater concentration of ownership.

George supported fair treatment and the rights of indigenous peoples, but he wrote very little about them. The issues of ownership, rights to use, and access are extremely complex, and they are only touched on here. However, what seems more readily defensible is that everyone has an equal claim at birth. One can’t reasonably be punished for choosing the wrong parents.

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I have expanded the points Andrew and I investigated to give the book the kind of technical detail that we both wanted when we first began our conversation. It was our hope that the book would be read by economists and others interested in policy and the fraught, often improperly understood, relationship between politics and economics. Although the book is largely technical, we have tried to make this introduction and some of the basic arguments in the text clear enough to be understood by everyone.

The book is divided into three parts. The first lays out the basic concept of rent, so central to George, and how it is driven by growth. It presents the idea of rent as an unjust payment, in George’s view, and it critically reviews some of his basic doctrines, accepting and praising his account of rents arising on the “unbounded savannah,” and accepting (partially and for special circumstances) his theory of wages. The book rejects his theory of capital and interest but then explores and partially accepts two important claims: that the total land values of an area will tend to be equal to or near the total GNP of that area, and that the total cost of government in an area will be equal to or near the total aggregate of rents in that area.

The book’s second part takes George’s idea of “progress” and turns it into macroeconomics. We move the center of our analysis from a largely agrarian economy to an economy based primarily on industry and services, a trend that was already happening while George lived and would continue and accelerate during the twentieth century as economic activity moved from the countryside to the cities. As we study this we find a new “margin of production” at the point where new plant and equipment outstrips the old and adds what economists call “superprofits” to rents.

George does not examine how saving and investment work or how they interact with the price mechanism. But we do it for him, relying on Marshallian ideas with which he was familiar, and the result is a picture of how the pressures of supply and demand, governed by “marginal conditions,” provide a degree of stabilization. And then we see this picture gradually dissolve under the pressures of innovation, to be replaced by the destabilizing mechanism of the multiplier-accelerator. Keynes-Kalecki, in short. Understanding this is necessary to drawing a complete picture of “progress”—economic growth—that works for today, making it possible to examine how progress regenerates poverty now.

The third part of the book extends George’s ideas about growth-driven rents, now affecting the value of securities in real estate companies, and brings this into the globalized world of modern finance. We clarify the mix of independence and interdependence between the real economy and the

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financial system. We can then explore George’s claim that the economy tends to move toward greater and greater inequality. We find that claim justified, but driven by financial sector relationships as much as by land and rent issues. Rents are now a part of a larger private sector financial system that excludes (or excessively burdens) a majority of the population, just as private property in land excluded or burdened them in George’s time. Rents, themselves, however, do reappear in a new guise in the financial system, and we will see that they now play a dangerous and damaging role, pushing the economy into instability.

As we discuss in the book’s conclusion, Andrew and I came to agree with George’s suggestion that growth that drives rents creates instability and has a tendency toward greater inequality, a tendency that, in today’s economy, is manifested through the financial system, which has largely absorbed real estate but is still responsive to the pressures it creates. We appreciated George’s excellent analytical economics, and we came to see that he was also a philosopher and a visionary. He asked for the justification of our institutions and the grounding of our beliefs, and he challenged the status quo—asking, in particular, how great wealth could coexist with deep poverty in a civil society. We both felt strongly that there is a great need for such vision and such questioning among economists today, in an era marked by the ascendance of the reactionary economic ideas of Paul Ryan and Donald Trump. We hope this book will be a beginning, providing the tools for economists and others to start evaluating and utilizing George’s uniquely American ideas. It is designed to provide a sound foundation on which committed researchers in the field can help to build a more just and stable economy. This is what Andrew wanted.

Bibliography Posner, Eric and Weyl, E. Glen, 2018, RADICAL MARKETS: Uprooting Capitalism and Democracy for a Just Society, Princeton, NJ: Princeton University Press.

PART I

Progress and Rents

The starting point for Henry George’s argument, and what is missing in most mainstream textbooks, is a good account of rents—what they are, what (if anything) justifies them, how they work, and what effects they have on the economy. His answers were clear and straightforward: rents are unjustified and unjustifiable payments for access to the space and fruits and enjoyment of the earth—the inheritance of us all—and they rise with “progress,” ultimately generating increased inequality and, therefore, poverty. Quite a claim, and off-putting to the economists of his day, who were generally well disposed to the emerging capitalist system and did not like what they regarded as wild and extreme criticism. Even if private land ownership is, in the end, unjustifiable, nothing can be done about it, his critics said. Confiscating land would cause chaos, unmanageable uproar, and so on. How much worse, then, that George should have advocated a quite different, and clearly manageable, position: land ownership should be left alone, but rents should be taxed to the full—and used to pay the expenses of government, expenses that, if government is truly democratic, should be beneficial to the general public, to us all. Land belongs to us all; by taxing rents to support government, the earnings of land will go to the benefit of all.

The first chapter in this part surveys the idea of rent, contrasting George and Ricardo, and showing that George’s approach, though it makes use of a notion of the marginal product of labor, is incompatible with, and superior to, conventional marginal productivity theory. The second chapter examines the connections between growth, rents, and land values, assessing and finding support for the surprising claim that aggregate land values in an

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area will tend to equal or be near to the GNP of that area, while the third shows that George’s claim that rents, properly understood and fully taxed, can finance the costs of government was good for his time and is not so far-fetched even today, although saying this requires us to reconsider “monopoly rents.”

CHAPTER 2

Understanding Rents in the Real Economy

The rent of land is determined by the excess of its produce over that which the same application can secure from the least productive land in use.

—Henry George

Abstract George understood “progress”—economic growth—to be disruptive and innovative, taking place through developments that changed the proportions and relative prosperity of different sectors. He began his analysis with the movement of settlers to the “unbounded savannah,” where they cultivated fertile land, cooperated and established the division of labor, increasing productivity, and, as a result, they became a complex society with differential advantages and disadvantages to certain locations and parcels of land. Rents thus emerged (modeled using Sraffa’s equations). This picture is a good basis on which to build an approach to inequality and instability, but it is not consistent with the factor markets of conventional marginal productivity theory. George’s approach is superior.

Keywords Progress • Poverty • Division of labor • Rent • Differentials Henry George grew up in an era in which America’s westward expansion was a primary force in the young country’s economic development. Feudal Europe and its economic stasis were, for George, not part of the distant © The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_2

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past. Following the breakup of feudalism, he saw agriculture dependent on human and animal power, and manufacturing dominated by small-­ scale, craft technologies. In postfeudal Europe, rents went to landlords— the former feudal lords—and were paid by capitalist farmers and small business craftsmen. Wages were more related to subsistence than to the productive value of labor. In the United States, however, family farmers generally owned the land (but often subject to mortgages), just as small businesses were owned and operated by families. And in the West there was free land—good, productive land. Anyone in a low-wage occupation could pull up stakes and move west to acquire and cultivate it.

George anticipated many of the ways in which the nineteenth-century craft economy would change—the growth of monopoly and big business, the development of corporations and joint stock companies. What he could not have anticipated was how the role of rents, real estate, and monopoly in the economy would change greatly with the arrival of mass production. Rents and monopoly earnings have since been folded into profits; real estate is now valued by capitalized earnings and has been securitized, becoming another part of capital. George did not accept folding rents into profits, and we shall see that he was right to keep them separate.

Rent on land and rent from monopolies arise from economic forces that are distinctly different from those that determine profits on capital. George is one of the few, perhaps the only, major economist to have built his theory of long-run development largely around the impact of progress on the behavior of rents, and the consequences for the composition of output and the distribution of income.

Henry George’s Idea of Progress “Progress,” in George’s thinking, is based on what we call “economic growth”—but it is much more than that. It drives the economy; it leads to prosperity; it means greater command over nature, greater productivity, and new inventions. And it also brings about poverty. That is the problem George proposes for political economy: how is it that progress brings about poverty?—a good question, for George’s time and for ours. Contemporary mainstream economics does not ask this question; rather, it asks, how do free markets bring about the best possible use of scarce resources?

Optimality, not poverty, is what economics textbooks give us today.

Progress, for George, is disruptive, bringing about turmoil and change. By contrast, in most mainstream growth models expansion takes place in given, fixed proportions: the system swells up, and all the parts stay in the same

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ratios—a “growth equilibrium.” This makes measurement much easier and gives the economic model builders greater freedom to deal with problems.

Modeling such balanced, equiproportional growth is not that useful, however, because such growth never actually takes place in the real world. Growth is always messy, unbalanced, and irregular. Of course, all mainstream growth economists say that their models and methods are idealizations, and they take account of the messiness when they apply their ideas. But this misses the point. The apparent messy irregularity of actual growth is not the result of deviations from an ideal, well-balanced path—growth is unbalanced because changing proportions and distribution is what growth brings about—and, in turn, those imbalances stimulate further growth. Growth takes place through changing the proportions of the economy: agriculture declines, and industry expands; industry changes its power source from animals to steam to electricity, services change character (from household to business), white-collar work expands relative to blue-collar, wholly new sectors—automobiles, telephones, airplanes, computers—emerge, and new skills are required as old ones die out.

Growth also changes the relative wealth and positions of social classes; the aristocracy changes character (from feudal to financial), an upper middle class separates itself from the newly emerging middle class, the lower middle class enlarges and takes on a definite character, especially toward the working class, which differentiates itself sharply from the underemployed underclass (Nell 1998a, Ch 3). But none of this takes place smoothly, as Marx and a whole tradition of scholarship after him have shown. George concurs, but argues that landlords play a special role; they prosper relative to everyone else, because of the movement of rents relative to other forms of income, so that landlords eventually become speculators, and in the resulting squeeze labor will eventually be driven into poverty. “Progress” affects both the sectoral composition of output and the class shares of income and wealth. Progress transforms the economy; it is transformational growth, as opposed to the common or normal concept of growth as replication. George’s concept of progress is not only dynamic; it is unbalanced, operates in disequilibrium, and explicitly historical—far ahead of its time.

Growth Models and the Treatment of Rent When rents are explicitly considered, most schools of economic analysis model the Ricardian process of diminishing returns: rents arise from differentials created by bringing poorer lands into cultivation in response to the increased demand caused by growth. But rents are a transfer from

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households to landlords, from largely working-class families to l­ andowners or urban developers or property owners. One might easily think that this would imply that purchasing power was being shifted from those with a high propensity to consume to those with a lower propensity to consume, thus weakening aggregate demand. However, the available evidence is inconclusive.

Here is the traditional classical picture: In spite of the differences among them, Adam Smith, James Anderson, Thomas R. Malthus, Edward West, and David Ricardo considered rent a consequence of the increasing cost of growing agricultural production when productivity declines. Rent is a surplus which depends on the difference between the costs of any production in comparison to the costs incurred in the least favorable production owing either to the decline in land fertility (extensive diminishing returns, which give rise to extensive rent) or to the decline in labor productivity on the same land (intensive diminishing returns, which give rise to intensive rent). The higher cost of the last unit of corn produced, which determines the price, in comparison to the costs of the previous units of corn, determines rent as a surplus of the “landlord.”

(Quadrio-Curzio in Kurz and Salvadori 1995, p. 289)

The crucial point here is that as the economy expands and more agricultural products are required, productivity on average falls, as poorer-­ quality land is brought under cultivation. Prices and profits are determined on no-rent land, so rents play a relatively minor role in contemporary economic analysis.

Most theoretical growth models today leave out rents and real estate; in practice, rents are widely treated as part of profits. This is understandable but problematic. Rents are widely considered to be 2 or 3 percent of gross national product (GNP), although many real estate experts would put the figure a good deal higher. More importantly, rents and profits have different origins and respond differently to economic conditions. So the practice of lumping rents and profits together must be considered flawed. To be clear, this tendency is not accidental: rents and profits are lumped together in theory because business lumps them together in practice. We will see that this matters when it comes to finance.

Neoclassical models of rents are inconsistent. For example, even models with imperfect competition assume conditions in which factors can be readily and smoothly substituted, and in which agents have extensive and accurate knowledge of markets and technology—that is, marginal ­productivity theory. Yet this makes no sense. If rents are substantial there must be

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­ idespread rigidities and irregularities, to create and sustain differentials, in w which case smooth substitution cannot be widespread. Likewise, most classical or neo-Ricardian approaches assume sufficient competition to establish a uniform profit rate, uniform wages, and uniform prices. However, as noted, if “differentials” are widespread, rigidities and irregularities must be as well, upsetting uniformity. As for post-Keynesians, they are concerned with the distributional conflict between capital and labor; when rents are mentioned at all, they tend to be lumped together with profits. For most of these approaches, landlords are just a subcategory of capitalists.

Indeed, in many mainstream and some post-Keynesian writings, profits may be referred to as “rents.” The underlying idea is that entrepreneurs can be assumed to rent machinery, equipment, and buildings. Some writers (e.g., Alchian 1950) treat all payments for productive services as “rents”: thus wages are the rent for labor, interest is the rent for money, profits are the rent for capital equipment. “Economic rent,” from this perspective, is then defined as payment for a “service” (such as the use of land or a machine), the supply of which is completely fixed. This overemphasizes fixity and fails to bring out the importance of differences in technology in determining rents, calling attention to a need to distinguish scarcity rent and differential rent, and raising the question of “rent-­seeking behavior” and “rents” as indicators of wasteful activity.

We can do better by considering modern classical analysis, which tends to follow Sraffa’s version of Ricardo (1951), in which rents arise from the simultaneous operation of two or more techniques for making the same product. Sraffa (1960) has shown how rents can be “handled” mathematically, but this is sometimes taken to justify setting the issue to one side, to be considered “later.” Importantly, however, Sraffa shows that Ricardian rents depend only on differentials, and it is not necessary that returns must diminish as production increases.

Here, a modified version of Sraffa’s equations for rents1 will be the basis for the treatment of rent in our growth model. Sraffa treats “land” as the prime example of a “non-basic good of type II”—a good that enters into the production of all goods, either directly or indirectly, but is itself not produced. Non-basics of type II, like land and location—perhaps “space” more generally—are fixed in amount and are often set immovably in place.

So “space,” being appropriated and needed, commands rents. (This accords very well with George in Science of Political Economy, Bk III, Chs 5, 6, 7.)

1

See Sraffa (1960), chap. 11.

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The equations for production, exchange, and distribution are given, and are understood to be simultaneous. They represent private sector activity; no analysis of public goods is offered. They are price equations; no analysis of quantities is offered (although we shall do so in our version).

A uniform period of production with an annual market is assumed; otherwise, the approach abstracts from time. Prices are assumed to be uniform, the rate of profit and the wage rate both uniform and universal. In the equations, the amounts for the various basic inputs are in the first column (on the far left), the labor coefficients are in the next column, and lands and rents are in the third column, before the equal sign. The quantity of labor is assumed to be given and constant, and to be measurable without reference to prices.2 The size of the system is arbitrary. Barter takes place until the inputs are allocated in such proportion that production could begin again, but there is no growth from period to period, in Sraffa’s system. HOWEVER, we will model growth. The system reproduces itself; no intertemporal issues are dealt with. Land of various qualities is represented by Λ1, Λ2, … Λn, and rents are given by ρ1, ρ2, … ρn, which will be the unknowns.

In Sraffa’s notation—for comparison with the original—the system is written:

(1 + r ) ( Aa pa + Ba pb +…, K a pk ) + wLa + ρ1Λ1 = Apa (1 + r ) ( Ab pa + Bb pb +…, K b pk ) + wLb + ρ2 Λ 2 = Bpb

 (1 + r ) ( Ak pa + Bk pb +…, K k pk ) + wLk + ρn Λ n = Kpk

And ρ1 ρ2 … ρ n = 0 . One of the rents must be zero.

Here, Aa is the amount of commodity “A” used in the production of good “A”; Ab is the amount of “a” used in the production of “b,” and so on. The letters indicate absolute amounts rather than the usual coefficients,3 but why or how the indicated scale was reached is never discussed. Each

2 I have argued elsewhere that this is a mistake and can be avoided, but requires a serious change in how we think about labor (Nell 2017).

3 Divide the first equation in the text by A, the second by B, and so on; the result will be the equation in its more usual form.

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row represents the cost structure of an industry, while each column shows the allocation of a commodity among the industries.

It is assumed that A > or = Aa + Ab +  + A; B > or = Ba + Bb +  + Bk , and so on.

And also that La + Lb +… Lk = 1

(Labor is given in amount, and, it is assumed, can be added up independently of value.)

The equations here are the same as for the discussion of wages and profits, with an expression for land and rents added to the equations where appropriate.4 Rents do not enter into the determination of prices and the rate of profits; rents are earnings above the normal profits on no-rent land, so they depend on differentials. An important finding here is that “the order of fertility” itself depends on distribution. The concept of non-­ basic-­type II is pretty general, so we have a way of formalizing the analysis of many different kinds of non-produced inputs into production.

Ricardians, and some neo-Ricardians, continue to assume that moving to the margin will lower productivity, on average. But such a decline was not to be found on the US western frontier—quite the contrary. In fact, it is not a necessary implication of theory, and the account of rents here will follow the illuminating analysis of Henry George rather than Ricardo’s.

The Classical View In a modern classical approach, showing how the economy works requires showing how it can continue to exist, operating in a regular fashion, consuming products while producing replacements. This can be abstract, but it should be realistic. Production and consumption use up things that have been produced; those things must be replaced for the system to continue working. Capital must be maintained intact, retiring workers must be replaced, inventories must be replenished. Consumer goods are used up and must be replaced. Everything essential to the regular reproduction of 4

See Quadrio-Curzio, in Kurz and Salvadori (1993), Kurz (1990).

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the economy must be included; other things—luxuries, the intricacies of money and finance, regulation—can be set aside (until needed), but nothing can be distorted, and assumptions must be realistic. When this is properly set out, prices, wages, and profits can be calculated, as in the Sraffa equations above, with growth, consumption, and sector sizes following as the “mathematical dual.” (For non-economists this means that when we set out the equations for the price, wage, and profit side of things, we implicitly define the quantity, consumption, and growth relations too.)

This is very like what George does, though not mathematically. He builds on the division of labor, showing that what he calls “stored-up labor”—that is, capital—contributes to the creation of wealth. He divides the economy into sectors, according to the character of the inputs and the usefulness of the outputs—especially, of course, distinguishing agriculture, industry, and services—and also, separately, government. How these sectors operate depends on the technologies and changes with them, under the influences of history, science, and social pressures, but in George’s view, regular improvement in technology is the norm.

It must not be assumed that we have found the secret key, the permanent and timeless laws of the economy. Yes, these relationships are essential in that they tell us how the people, places, and institutions of the economy are maintained—how they are kept running. But they don’t keep running in the same way period after period, as George very clearly understood.

(He had little use for equilibrium reasoning; he repeatedly refers to “dynamics.”) Everything changes as the economy grows and develops—or stagnates, for that matter. The economy innovates and develops. We do need to unearth and set forth these essential relationships, but they are only the beginning. The equations must be updated regularly, and we must keep an eye on all the basic relationships, as they too will be evolving.

Factor Markets A modern classical and post-Keynesian approach is the way to reinterpret and reinvigorate the work of Henry George, who wrote at the end of the “classical” period. By contrast, in the patronizing opinion of the modern (neoclassical) mainstream, “George may have contributed the best classical analysis in history, but it was Marshall who constructed the bridge from the classical to the contemporary world of economics” (Bryson 2011).

That bridge, of course, is the theory of factor markets, or “marginal productivity theory,” which tells us that the same principles govern the

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working of the markets for each of the three “factors of production”— land, labor, and capital—which should be understood as working the same way in the marketplace. Of course, they are different, but the differences don’t matter, while the similarities do. Each factor supposedly exhibits diminishing returns at the margin—that is, when more of it is applied successively to a fixed amount of the others, the addition to output diminishes. In competitive conditions, the resulting marginal product curves (MPs as a function of quantities of a given factor in relation to the others) govern the demands for the factors, and these demands, together with supplies, determine the factor prices and returns. The amounts of the factors, multiplied by their prices, “add up” to the value of the product—the so-called adding up condition of neoclassical theory.5 In true marginal productivity theory each point on the production function is a “long-period” position, the result of “decision makers” making and carrying out a choice of technique in response to factor prices. The solution to the equations for factor markets therefore “explains” the adoption of new technology, of whatever kind, as a result of changes in factor prices, and at the same time explains the distribution of income. The point to be emphasized here, however, is that this is a long-run equilibrium analysis, not a picture of short-run adjustment in conditions of small-scale technology. Short-run realistic adjustment is something we want to consider, and it will involve diminishing returns from applying more labor to given plant and equipment. This plays a significant role in the adjustment of a craft economy; short-run marginal products can be identified, but this is not “marginal productivity theory.” That takes place in models addressing different questions—long-run choices of technique in conditions of full employment. By contrast short-run adjustments to changes in demand are constructed on different assumptions (fixed plant and equipment, with variable labor). But the history of distribution theory has been haunted by the tendency to confuse the short-run story of adjustment, plausible in the craft technology context, with the serious, but implausible, long-run mathematical model of distribution. These sometimes look the same, but they are totally different and incompatible.

Today, the marginal productivity/factor market approach to explaining distribution is widely discredited. The important differences between the 5 This really doesn’t work out, as Joan Robinson repeatedly suggested. See Harcourt (1972), Garegnani (1970), Sraffa (1960), Laibman and Nell (1977), Kurz and Salvadori (1993), Petri (1982), Schefold (1997).

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factors are generally appreciated. “Land”—more appropriately, “space”— does not really “enter into” production at all; it is monopolized, as George said, and rent is the price for permission to use the space. “Labor” is produced by education and supported by consumption, but it is activated only when “on the job”—hired by a capitalist. And “capital” is the aggregated value of means of production owned and managed by a capitalist, most likely a company or corporation, and expressed in money or on the stock market. “Real” and “financial” capital must be distinguished but are significantly related and regularly interact. Marginal products are almost impossible to measure (outside of some very simple cases) and diminishing returns are hard to find. Case studies of technologies provide little or no support for a general assumption of diminishing returns—constant costs are widespread in industry—but recent studies have uncovered many instances of “network externalities” and increasing returns. Studies of company or corporate costs (e.g., last century Hall and Hitch [1939], Andrews [1949]) and more recent survey (Nell 1998a, Ch 3) all find widespread constant costs.

Nevertheless, in early- and mid-twentieth-century academia, marginal productivity theory swept the field; even though unrealistic and problematic, it became the mainstream position, partly because of apparent mathematical elegance. But in the last decades of the twentieth century it was upended, first by the great “capital controversies” and then by the discrediting of empirical production function studies. The “capital controversy” showed, in a sophisticated set of models, that the relationships required in marginal productivity theory between the rate of profit and the value of capital cannot be presumed to exist. The regular, smooth relationship marginal productivity is based on—namely, a continuous inverse function between the rate of profit and the value of capital—simply need not exist.

As for the empirical studies, they are haunted by identification problems: they cannot adequately separate their “production functions” from the income payment identity.6 In short, George cannot be criticized for not moving to the so-called modern scientific theory of distribution. That theory, as George sensed, was defective from the beginning, and he understood very well that the “three factors” were not equals: they were seriously different, and different rules and market forces governed their earnings.

6 This issue is discussed in Nell and Errouaki (2013), pp. 410–15, Shaikh, Ch 5, in Nell, ed.

(1980), and Shaikh, in EEJ Symposium, Summer 2005; see also Kurz and Salvadori (1993).

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Henry George’s Treatment of Distribution George himself proposed a seriously problematic approach to distribution, on which, unfortunately, one of his central claims rested: that rents would increase in proportion to other forms of income. His account of rents was drawn initially from Ricardo but went well beyond him, recognizing that differentials, not diminishing returns, were the key, and that differentials could as easily arise from increasing as opposed to diminishing productivity. In this he stressed the importance of Smithian themes: division of labor, separation of function, cooperation, and trust. The emergence of rents does not have to portend diminishing marginal returns, which would appear to imply a decline of wages; on the contrary, rents could emerge from cooperation and advances in the division of labor, leading to improvements in the technology of farming, fencing, tool making, and so on.

What can be earned on marginal land might actually increase! This implies that the emergence of rents could conceivably coincide with a rise in wages, because wages, according to George, are set by what can be earned on marginal land.

If, as George argued in the nineteenth century, wages were set by what could be earned on free land in the west, this would attract workers from the east. This idea became important for Frederick Jackson Turner and Charles and Mary Beard—authors responsible for the “frontier thesis,” a major and influential interpretation of a very significant part of American history. Yes, the wage may indeed be set by the earnings of the self-­employed on free, marginal land, adjusted for the cost of moving west. However, what happens when the frontier closes? According to George, the wage will fall to socially determined subsistence. But that did not h ­ appen: US wages remained high. Strong growth may have played a role here—a “high-wage economy” seems to have been a viable pattern, especially as the labor movement gathered strength.

George’s account of capital is, at first glance, excessively simple: capital, he argues, is created by restricting consumption and taking the time to make tools. He explains this by considering a settler moving to new land.

The tools the settler makes will increase his productivity, and this increase will compensate for the earlier restriction of consumption. This is a very particular story, and it does not cover the many other ways that capital can emerge (e.g., more recently, mergers and enclosures); for earlier times, see Marx on “Primitive Accumulation” (meaning the initial formation of capital). In any case, capital, even on the frontier, became more complex and

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multidimensional than George’s model—on the one hand, there is capital as machines, buildings, and equipment; on the other, we find capital as marketable financial claims to such real equipment, or to the earnings of that equipment. Both the real and the financial are forms of capital, and they are, of course, related in complex and unstable ways, as we shall see.

However, George proposes a theory of interest/profit that depends on capital’s productivity: if capital assists labor by increasing productive output per worker, then lenders of such capital should be able to charge for this, or they might lend and share the proceeds from the activities financed by the loan. But at this point George takes a very interesting, although we think unsuccessful, step: he divides capital into two kinds —ordinary tools, like those of a carpenter, that assist labor but are essentially passive; and agricultural capital (cattle, chickens, wheat, bees, racehorses) that produces surplus on its own. Because capital can be shifted about in search of the best return, passive capital and its products must be priced so as to provide a return equal to that earned by active capital on average. This bears some similarity to Sraffa’s interpretation of Ricardo, which contended that the rate of profit was determined by the returns in “corn,” because corn served as seed and thus was capital, but it also provided the support for labor. So the rate of profit in corn could be expressed without reference to prices, as corn output, divided by seed corn and corn for the support of labor, or corn wages. Prices must then adjust so that all other goods earn the same returns that appear as a pure ratio in corn. George does not exactly say this (Ricardo didn’t either, but Sraffa shows that he implied it), but there is more than the germ of the idea in his discussion. However, he does not see the connection with the standard of value nor how this idea could be used to understand “plowing back” equiproportional parts of any surplus into growth—that is, a growth model. In short, however interesting or suggestive, he does not have an acceptable theory of interest.

Most important for our argument, modern classical and post-Keynesian thinking builds on an inverse relationship between (potential) wages and profits: higher wages mean lower profits. However, George claimed that interest or profits and wages had to move together—directly, not inversely.7 The reason he advances for this is that at any given time there will be a regular or equilibrium level of capital per worker; wages call forth work, and interest calls forth capital. So, if the ratio changes, then the level of capital per worker will change: 7 Not altogether wrong if the level of aggregate demand is low; higher wages will lead to higher household spending which will increase revenues. But this is not what George meant.

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Any tendency on the part of interest to rise above the equilibrium with wages must … direct labor to the production of capital… while any tendency of wages to rise above the equilibrium with interest must… turn labor from the production of capital. (George 1915, p. 168)

Higher interest may call forth more capital/savings; lower interest, less.

This is a traditional claim, with widespread support, and it has a ring of plausibility; but the evidence for the relationship is not very strong. The case is different with wages. Higher wages can reasonably be thought to call forth more hours of work, and will likely bring more workers into the labor market. However, more work does not mean less “capital.” In particular, higher wages do not mean less saving; quite the contrary. In general, higher incomes of any kind will lead to higher savings. So, George’s contention that wages and interest must move together is flawed.

The problem is that George takes it that both wages and interest are set, and that they are fixed relative to one another; then growth takes place, with no direct effect on interest, but it drives up rents, which means cutting into the surplus, so wages will tend to fall—which, in George’s view, will tend to pull interest down. Thus typically, he argues, rents will increase and wages and interest fall, so inequality will increase, and, eventually, so will poverty.

But, in fact, for quite some time in the US economy rents seemed to rise right along with growth, and so did the total wage bill; interest and profits fluctuated more, perhaps, in the early era, but later settled down and grew at more or less the same rate. For a long time, from the late nineteenth century to World War II, income shares tended to remain constant or vary within fairly narrow limits. Certainly, there was no obvious tendency for the share of rents to increase, and, indeed, in conventional accounting that share has tended to decline somewhat—though Georgists regard this as mistaken. From a theoretical point of view, however, growth will increase rents if it increases differentials, but it is not obvious that increases in population will lead to a fall in earnings at the margin (especially a margin in the American frontier West). Rents and wages may both go up.

Rents and Real Estate Reconceptualizing Ricardian rents à la Henry George and relating them to real estate securities reveal a new and very powerful linkage between the real and financial sectors, a linkage that will help to account for recent bubbles and bursts. This linkage is complex but not hard to understand: growth drives up rents, but this does not lead to the dismal results of

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Ricardo, because rents do not arise from moving to poorer land. They arise from innovation and a more sophisticated division of labor. In the past, rents were normally paid by active economic agents to largely passive landlords, and the economic effects were not very large. In the case of owner-operated family farms and owner-occupied housing (very important in the craft economy and in early mass production) higher rents had no current impact but rather implied higher land values should they sell— a distant and necessarily uncertain prospect. Rents that are actually paid reduce the spendable incomes of wage and salary-earning households and tenant farmers but increase the incomes of landlords, developers, and farmers with extra acreage. Theoretically, this transfer could affect aggregate demand, but it does not seem ever to have had an important impact on it, even in full-scale mass production, with a large part of the working class living in rental units in cities and suburbs. This is partly because the payers and recipients of rents seem to have had similar propensities to consume, and partly, but more importantly, because unionized wages were normally adjusted to cover housing costs. Today’s economy is different in several relevant respects. For the most part, farming is conducted by large corporations, while real estate development for housing, shopping malls, and offices is performed by corporate entities. These in turn are financed by bonds and stock issues; in effect, today, rents are securitized.

It is estimated that between 35 percent and 65 percent of all bank lending in the 17 largest economies is for real estate (Turner 2014), especially for speculation on future real estate values. It is still the case that the payment of rents by working households and businesses probably does not itself seriously affect aggregate demand, that is, the current level of overall spending. But now, an increase in rents, due to further growth, in turn raises the value of real estate, and so drives up the prices of real estate– based securities—and this will tend to lead to portfolio adjustments. These adjustments will in turn disproportionately benefit the wealthier portfolios, an effect that will tend to increase inequality, and this will likely weaken effective demand.

The rise in rents, caused by the greater pressure on fixed resources resulting from growth, will increase the value of current rental properties, thereby increasing competition between real estate and other categories of assets, which will feel pressure to improve their profitability, either by raising productivity or by lowering wage and salary costs. This will prove significant in our forthcoming analysis of financial crises.

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Bibliography Alchian, Armen. (1950) “Uncertainty, Evolution and Economic Theory.” Journal of Political Economy (58): 211–21.

Andrews, P W S (1949) Manufacturing Business. London: Macmillan.

Bryson, Philip J. (2011) The Economics of Henry George: History’s Rehabilitation of America’s Greatest Early Economist. New York: Palgrave Macmillan.

Garegnani, Pierangelo. (1970) “Heterogeneous Capital, the Production Function, and the Theory of Distribution,” Review of Economic Studies, 73(3) 407–36.

George, Henry. (1915) Progress and Poverty. Garden City: Doubleday.

Hall, R, and Hitch, C. J. (1939) “Price Theory and Business Behavior,” Oxford Economic Papers, 2: 12–45.

Harcourt, G. C. (1972) Some Cambridge Controversies in the Theory of Capital.

Cambridge: Cambridge University Press.

Kurz, Heinz. (1990) Capital, Distribution and Effective Demand. Cambridge: Polity Press and Basil Blackwell.

Kurz, Heinz, and Neri Salvadori. (1993) “The ‘Standard Commodity’ and Ricardo’s Search for an ‘Invariable Measure of Value.’” In The Dynamics of the Wealth of Nations, edited by Mauro Baranzini and G. C. Harcourt. London: Macmillan.

H Kurz and N Salvadori, 1995, THEORY OF PRODUCTION:A Long Period Analysis; Cambridge, UK: Cambridge University Press.

Laibman, David, and Edward J. Nell. (1977) “Reswitching, Wicksell Effects, and the Neoclassical Production Function.” American Economic Review (63): 100–13.

E. J Nell, ed. 1980. GROWTH, PROFITS AND PROPERTY, Cambridge UK: CambridgeUniversity Press.

Nell, E J. (1998a) The General Theory of Transformational Growth: Keynes after Sraffa. Cambridge: Cambridge University Press.

Nell, E J, ed. (1998b) Transformational Growth and the Business Cycle. London: Routledge.

Nell, E J. (2017) “Unemployment and Transformational Growth in the Long Run,” in M Foster, and M Murray, eds., Full Employment and Social Justice: Solidarity and Sustainability, Berlin: Springer.

Nell, E J and Errouaki, K. (2013) Rational Econometric Man. Cheltenham: Edward Elgar.

Petri, Fabio. (1982) “The Patinkin Controversy Revisited.” Quademi dell Instituto di Economia, no. 15.

Ricardo, David. (1951) Principles of Political Economy and Taxation. Vol. 1 of The Works and Correspondence of David Ricardo, edited by Piero Sraffa.

Cambridge: Cambridge University Press.

Schefold, Bertram. (1997) Normal Prices, Technical Change and Acculmulation, London: Macmillan.

Sraffa, Piero. (1960) Production of Commodities by Means of Commodities.

Cambridge: Cambridge University Press.

Turner, Adair. (2014) “The Consequences of Money-Manger Capitalism,” Oct. 4, YouTube.com.

CHAPTER 3

Growth and Rents in the Real Economy

The fundamental principle of human action—the law that is to political economy what the law of gravitation is to physics—is that men seek to gratify their desires with the least exertion.

—Henry George

Abstract Settlement and growth are explored in more detail and the processes driving up rents are modeled mathematically. Net aggregate product is increased each period by growth, and at the same time rents are driven up each period. Total land value is the capitalized value of rents capitalized at the long-term rate of interest, usually very close to the rate of growth. The formula derived here allows for growth to drive rents strongly or weakly, and for the growth rate to differ from the interest rate; but it nevertheless shows that George’s insight was well founded.

Keywords Land value • Economic growth • Settlement • Consumption • Investment In this chapter, we will delve into the second of the five main points that were briefly described in the introduction, namely, that the total value of land in a region tends to equal the value of aggregate output of that region (or country). This claim has not been given the recognition it merits.

© The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_3

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Using a simple, twentieth-century economic model, we will show that aggregate real estate values in an area or a nation—that is, capitalized rents—tend to equal the gross national product (GNP) (the total value of all output) for that area or nation. This is far from intuitively obvious, and, at first glance, is not easy to understand. The model presented here, however, demonstrates that there is a connection between real estate value and GNP, and George’s claim can, indeed, be the case.

In Progress and Poverty, Henry George praises the Ricardian theory of rent but contends that it has been fundamentally misunderstood. Ricardo, following Malthus et al., sees growth pushing cultivation to poorer land, yielding diminishing returns and lower average productivity. By contrast, George sees growth leading to greater specialization and division of labor, and so to higher average productivity. Either way produces the differentials that are the basis of rent. Also, Georgist scholars have always sought to advance this new approach to rent but have run into frustration related to other claims that George made. For instance, Georgist empirical work has come to suggest a strong connection between the GNP of an area and the value of real estate in that area—that they have a close, even one-to-one, relationship to each other. Yet what is the rationale for this? It certainly does not follow from mainstream economics, but up to now it has not found a Georgist foundation either. Both issues will be tackled in this chapter.

To begin the analysis we need to consider George’s divergence from Ricardo regarding rents. In place of the alleged pressure to move to more marginal (less fertile) land, George proposes two quite different processes that lead to increasing rents. He starts from an imaginary condition in which a single settler (and family) arrives at a vast and fertile plain, the “unbounded savannah,” in which all the land is rich and there is no economic reason to choose one plot over another, so he settles arbitrarily. Life is difficult though the soil is highly productive. Then other settlers arrive and, to have companionship and the prospect of mutual help, choose lands very close to his. There is plenty of land, and still no particular reason to choose one plot over another: no rents here.

The settlers living in close proximity are able to cooperate, helping one another use the land more productively. As still others arrive and join them, they are able to take advantage of separation of function and division of labor, and productivity increases rapidly. So, living close to this community offers benefits; living further away means a lesser ability to take advantage of its innovations, cooperation, and productivity. Location matters: certain locations offer advantages, others disadvantages, relative to normal profitability. These advantages have a value—a price—and thus we have rents.

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George thought in terms of “progress,” roughly meaning growth and development—more worker-settlers, greater division of labor and higher productivity, and general diversification. Newly arriving settlers will set up family farms or small family businesses—a country store, a blacksmith shop, a furniture maker. Many will come with capital (tools, materials, etc.), and they will maintain their capital, “abstaining” from consuming and accumulating. This is equivalent to “saving” in real terms, and such saving is automatically invested.

The first process is settlement, the moving-in of new families. This produces “population pressure,” and while this may lead to expanding cultivation to poorer lands—as Ricardo and Malthus argued and which would give rise to Ricardian rents—George rightly does not consider this important.

The arrival of new settlers should be understood not as “expanding the area of cultivation,” but as “expanding the area of settlement”—enabling the entire population to specialize more and cooperate better, allowing for greater separation of function and division of labor. Very Smithian. The older, original areas of settlement benefit from this; they are the centers of commerce. Regardless of the quality of the land, the location of the original settlement becomes a focal point for business and culture, and thus earns rents. Locations that are further away are not as desirable and will earn lower rents. As the population expands, settlements will spread outward; distant settlements will be the poorest, and will offer no, or minimal, rents, even if the land is just as productive as in the more populated areas. As the more populated, and more productive, city grows, the closest settlement will earn higher and higher rents as settlement expands, due essentially to the benefits of location. Some locations will turn out to have special features—hills and cliffs that provide shelter from the prevailing winds, hillsides that face the sun (important for vineyards), and so on.

The second process that comes into play as settlement expands leads not only to division of labor but also to innovation and new methods of production—and new products. As labor’s productivity rises, the labor released from existing activities will be redirected into new activities—but these will normally require land also. Hence, there will be a rise in demand for land, which will tend to drive up rental values and land prices.

The first process—expansion of settlement—as described by George— clearly implies expansion of demand. Let us assume that is so—that demand expands in proportion to population growth. The second process is one of productivity growth. Let us say that the growth in productivity leads to an exactly equal rise in demand for land, resulting in an

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e­ quiproportional rise in land prices. So, both processes taken together will expand overall output by a certain percentage and thus, in short, will tend to drive up rents by more or less the same percentage.

One could reasonably argue that this has been true since the time of the original settlers. Rents will always tend to be a percentage of aggregate output, proportional to the growth rate. Thus, land values are the capitalized value of rents, and the appropriate interest rate for capitalization is the long-term rate, which will always be close to the growth rate. This, and another remarkable result, can be demonstrated by using a simple, twentieth-century, Keynesian model.

Let Y0 stand for the level of “no-rent” output in the early stages of development. At this point everything is “nearby”; all locations are equally good, and there is no scarcity of land or resources.

Y0 = C0 + I 0 = W0 + P0 , where W0 = C0 and P0 = I 0

The output (Y) will consist of consumer goods (food, clothing, shelter, transport) and capital goods (tools, equipment, buildings, machinery), where each category of goods is produced by the industries of the corresponding sector. We can provisionally assume that wages (W) are spent on consumer goods (consumption, C), while profits (P) go to investment (I) in capital goods. As development proceeds, industries will become increasingly defined by the separation of function, and the firms will find favored niches and locations, better resources, and more convenient ways to cooperate—and to compete. As development proceeds, there will turn out to be both exceptionally rich deposits of resources and much poorer ones. As the firms settle in, many will find that they are able to earn above-normal profits—or that some have ownership of an advantageous location or resource that they can rent out to another producer. Some unlucky firms will end up struggling in unfortunate places, hard-pressed to keep afloat.

A great deal of “unpaid” or non-monetized labor will be performed in households—cooking, cleaning, laundering, nursing, repairing buildings and equipment, even fundamental construction work. (Part of d ­ evelopment will consist of shifting this labor into the monetary economy, mechanizing or “technologizing” it in the process.)

In these early stages, government will be very small, and consist mostly of services—police, courts, and some infrastructure (e.g., schools and sewers, paid for by taxes). The argument so far neglects government, because it is small. Once it becomes larger, however, it must be shown that if taxes

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fall on income and sales, while spending goes toward goods and services, it does not affect the argument that growth will push up rents. Of course, the Georgist point—which we will pursue in subsequent chapters—is that taxes should fall wholly on rents, and that if they did so, growth would be stronger and employment higher.

Now consider growth from the initial period to the next period. New settlers move in, new patterns of cooperation emerge, certain locations prove highly advantageous, others have serious drawbacks, some resources are better than others, some land is easier to cultivate—in short, there are many differentials of many kinds. Those who have positioned themselves in favorable locations will benefit, either by producing at an advantage or by renting their positions to other producers. The pressures generating growth work themselves out partly by expanding economic activities— investing and building capacity, intensifying cultivation, producing more goods and services, furthering the division of labor and innovation—but also partly by paying rents for access to and use of superior locations and resources, and by driving up the prices of scarce skills, specialized knowledge, and tools.

(1 + g ) Y0 = Y1

= C1′ + I1′ ,

The apostrophes indicate that consumption and investment, still the only two categories of goods, have been increased as a result of the pressures from growth (g) but not in a neat or proportional way. In fact,

Y1 = C1′ + I1′ = W1′ + I1′ + R1 .

Wages no longer equal consumption nor profits investment. Instead, the pressures of growth have led to a new category of returns to ownership— rents (R)—that are totally “unproductive.” These rents accrue to the owners of the various locations, resources, and so on, described above; they are deductions from wages and profits, and in the early stages will be largely spent on consumption goods, but also at times on investment goods, although most analysts favor the idea that the spending of rentiers tends to be wasteful—luxury consumption. (In later stages of development, rents will be “invested” not in productive facilities, but in speculation on asset values—stocks, bonds, real estate itself, foreign exchange, and so on.)

The size of the rents at any time—the amount of purchasing power drawn away from wages and profits—will be proportional to the rate of

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growth, g. Let us call α the proportionality factor; it could equal 1, so that g puts full pressure on rents, as Henry George thought; or it could be significantly less, in which case growth will increase rents but the effect could be small or negligible. In either case, the rents in any period will equal α times g times Y:

Ri = Ri −1 + α g (Yi − Yi −1 ) = Ri − 2 + α g (Yi −1 − Yi − 2 ) + α g (Yi − Yi −1 ) = so

Rn = R0 + α g (Y1 – Y0 ) + (Y2 – Y1 ) +  (Yn – Yn –1 )  .

Rents are proportional to g, but if at any point g = 0, rents do not disappear; they fall to their previous level, Ri−1. If g < 0, then rents will diminish from the previous level in proportion to negative g. For the moment let us assume that g is always the same; or perhaps, that a moving average of g’s over several years is constant. Clearly, then, we can replace the rental term at the beginning of the right-hand side of the appropriate formula for rents all the way back to the beginning of the “settlement.”

Now consider the value of the rental properties, that is, of the total “real estate.” That value will be the capitalized value of the rents. The rents should be capitalized at the long-term rate of interest, usually close to or equal to the rate of growth. Let the difference between the long-­ term rate of interest and the growth rate g be indicated by the factor γ. If this factor is equal to 1, there is no difference; if it is greater or less than 1, the long-term interest rate is greater or less than the rate of growth. Then the value of real estate will be REvalue = 1 / gγ [ rents]

= (1 / gγ ) α g {(Y1 − Y0 ) + (Y2 − Y1 ) + (Y3 − Y2 ) +  + (Yn − Yn −1 )}

But the sum of the differences between Y in one period and the next, from the first no-rent period to the present, is the current level of Y, and the g’s cancel out. Then we have

REvalue period n = α / γ Yn

If α and γ are both unity, the value of total real estate in any period will be equal to the aggregate GNP of that period. If α and γ are close to unity,

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or to each other, the value of real estate will be close to the level of GNP. Such closeness was the finding that mystified Georgist and other investigators—but it follows very naturally from George’s approach.

It also follows that today capitalized land is, for all practical purposes in the market, a form of financial capital. It is a claim to a real asset, and it has regular earnings: rents. It can be bought and sold; it can be securitized, so that the actual asset need not be involved—land-backed securities can be bought and sold like any other securities. This point will be dealt with when we consider the contemporary world of finance and speculation.

CHAPTER 4

A New Look at the “Henry George Theorem”

[T]he value of land is at the beginning … nothing, but as society develops by the increase of population and the advance of the arts, it becomes greater and greater. In every civilized country, even the newest, the value of land taken as a whole is sufficient to bear the entire expenses of government. In the better developed countries it is much more than sufficient.

—Henry George

Abstract The Henry George Theorem states that the level of total rents in a country is nearly equal to the total costs of government in that area. There are several unconvincing “proofs” that make this claim. A widely circulated such proof, when inspected closely, is incoherent and unrealistic in its assumptions.

Applying the previous chapter’s approach, one can develop a model that shows how rents and the growth of government move together, while allowing for plausible divergences. This suggests that the Henry George Theorem offers a good approach and should figure in policy discussions. An appendix

by Andrew Mazzone recalculates rents in the 2016 US National Accounts and shows that redefining rents in a more inclusive manner suggests that rents could come close to financing the costs of government.

Keywords Henry George Theorem • Economic policy • Demand pressure • Rent tax

© The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_4

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The “Henry George Theorem” states that the level of rents in a country or a given area will be equal to, or close to, the regular spending of government in that area, so that a simple uniform tax on land (and location)— a tax that would not reduce or distort economic activity—will raise enough to support the costs of normal government activity. Clearly, this theorem is central to George’s major policy proposal, the single tax on land, which became the basis for a popular movement worldwide and caused a huge upheaval in the British Parliament, though support for it never reached that high a level in the United States.

The Traditional Case Many arguments for this have been advanced, and alleged proofs offered— starting, of course, with George himself, who chiefly noted that the advances in output that gave rise to rents also depended on parallel increases in government. More public goods and services will be needed to support increases in private output, so government activity tended naturally to move together with the growth that drove up rents. But George had a further point: private growth would be faster and more reliable if government were able easily to deliver the public services—roads and bridges, schools and sewers, police and courts, and so on—needed to support development and markets. Moreover, government spending tended to increase land values. Taxing labor and investments would just slow down development, but taxing rents would not; the recipients of rents performed no necessary services—indeed, they often stood in the way of productive activity. Taxing rents would provide a fund for government investment in public services. Rents should therefore be taxed to the full and the taxes spent on public investment. Government spending would then not only rise to the level of rents, if the latter were taxed to the limit, but would also push up land values as it increased, raising rents as well. (The assumption must be that this sequence—higher government spending, bringing increases in land values, thus higher rents and tax receipts and so a further rise in government spending—will converge. But will it? Always?)

In fact, rents were never taxed to the full; taxes on rents tended to be a part of property taxes, varying across jurisdictions, especially in the United States, and at different times. For a long time, it still seemed that rents and government spending moved together and stood at roughly comparable levels. Georgists offered an argument to explain this—that public spending drove land values higher—which seemed plausible, but why was the increase in land values about the same in magnitude as the additional public spending? What about private investment spending—did it not also drive up land values? Was it not also true that some kinds of capital

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­ evelopment—the new factory produces a smell, there goes the neighbord hood!—reduced land values? Neighborhoods might simply deteriorate, losing value—how would we know? It seemed likely that many factors were involved, so the Georgist claims were not very convincing.

Economic theorists interested in the George tradition offered mathematical “proofs”—building models and deriving the result that the level of aggregate rents equaled the level of government spending. The so-called proofs, however, are neither very convincing nor very Georgist: not Georgist because they start from an individualist neoclassical framework, so they do not capture the essentially classical ideas of Henry George, let alone his ideas on cooperation and trust. Not convincing, because this neoclassical starting point characteristically makes wildly implausible assumptions in order to avoid “imperfect markets,” and is anyway much too static, often running together profits and rents or even consumption and investment, altogether failing to come to terms with growth. Finally, as with much mainstream thinking, it assumes that “individuals” can make “choices” based on information they could not possibly have.

Here is an example, a simplified version of a model by Stiglitz and others, presented step by step as it appears in several publications1: • It begins by assuming that the population is “optimal,” which is taken to imply that the land/labor ratio is optimal. The entire exercise is concerned with the properties of a position of static equilibrium.

• Wages and investment are combined—profit as the payment for the services of capital equipment is ignored. The Ricardian inverse relation between wages and profits does not figure in the argument.

• The variables are Y = output, N = employment, G = public goods (government), X = private goods, R = rents. Taxes are not considered.

The demonstration works through simple equations as follows: Y = f ( N ) = XN + G, from which it follows that X = (Y − G ) / N . Next marginal productivity is introduced: dY/dN = X = “wages.” But X is also described as investment plus consumption per worker, that is, private goods per worker (as if investments were the tools for the workers), so 1

See the website www.foldvary.net/ec156/week-4/hgt. Also Atkinson and Stiglitz (1987), pp. 523–5. Plus the article by R Arnott and J Stiglitz (1989), in QUARTERLY JOURNAL OF ECONOMICS, 93.

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dY / dN = (Y − G ) / N . Thus G = Y − XN = f ( N ) − f ′ ( N ) N . But Rent = Output − Total Private Earnings (or private goods). So Rent = f ( N ) − f ′ ( N ) N = G

This is really not acceptable. Normally Y = C + I + G = consumption plus investment plus G = aggregate demand, and Y = f ( N ) = output, where I is volatile and C dependent on N. This is the basis of the multiplier, but here it seems that Y = XN + G = output and that is all we are given. Output is divided between private goods, XN, and public goods, G. The division of private goods between those intended for consumption and those for investment—a key determinant of the rate of growth—is not considered, in spite of the fact that the increase of rents depends on the rate of growth. But worse, if Y = XN + G, then when N = 0, Y = G. But how is G produced without labor? Yet if there is an assumed fixed workforce, Ng, that produces G, then they will have to be paid the same wage, X = marginal product of labor, and the wage bill will then be X(N + Ng) > XN. More private consumer goods will be demanded than are produced. Note that the private sector produces XN and its wage costs are XN: no profits. So no investment, no growth.

But next, how does the government pay for G? The model does not discuss taxes, but if taxes were imposed on wages, so that tXN = G, it would be necessary to rewrite the initial equation as Y = XN = (1 − t)XN + G. But this won’t do; we have to ask, what is the relationship between G and Ng? Is it the same as between Y and N? Is G fixed, or is Ng fixed? We are left in the dark.

Finally, rents. R = Y − XN = Total output − total wages. But consider the above—what should this be? If Y = XN, we could have Y = XN – tXN + XNg = XN, that is, R = Y − XN = 0. Nonsense, of course; but how are taxes to be levied, how is G produced and how financed? The model is not coherent as presented.

Perhaps these issues of internal logic could somehow be fixed, but the entire approach is wrong; it is all static equilibrium, whereas Henry George examined the growth of rents and government, during a process of development.

Empirical studies, however, do show that over long stretches of time the two were fairly close,2 although after World War II it seems that gov Correspondence with Andrew Mazzone, 2015–16.

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ernment spending came to substantially outstrip rents, although they may be brought closer again if “rents” are defined quite widely (that is to say, to include all kinds of earnings from monopoly or oligopoly power, not just land and location and resources3; see the section at the end of this chapter). But was that long-term closeness merely an accident? And what about today? Let’s consider the question.

Rents, Demand Pressure, and Taxes The argument can be made that rents arise because of demand pressure against fixed positions—land, location, resources—driving up prices, creating rents. Demand pressure, in turn, arises because of expansion, itself partly the result of government. But government development is, in turn, driven by the desire to expand the economy, which requires police and courts, schools and sewers, roads and bridges and harbors. And public health and welfare. Not to mention military preparation or science and technology. So we might consider how things might look, if, in fact, the expansion driving the rise in rents, and the expansion driving the increase in spending by government, both resulted from the development of private (and others, e.g., cooperative) investment. How would this be affected by taxes?

Suppose taxes fall on income and sales, while spending goes on goods and services; it might seem that the taxes would reduce the demand pressure driving up rents, but would also reduce the pressures to expand the government. If the tax is collected before or during the economic activity 3 Mason Gaffney (2009), argues that rents and land values are systematically understated, and distorted, in official statistics, and that reconceptualizing them would make it possible to define new kinds of taxes on land and rent that would replace many other taxes—income and sales—so that taxes on “land and rents,” newly understood, would be sufficient to cover today’s government spending. (Andrew Mazzone, in a manuscript edited by me and published at the end of this chapter, develops a similar case.) This position is not widely accepted, though a careful reading of Gaffney’s commentary on official reporting of real estate is immensely rewarding and illuminating. The problem: Gaffney and Mazzone show us that undoing what they consider distortions of “land and rent” in the official figures will give us taxable concepts of both, sizeable enough perhaps to provide the necessary funds, especially by clearly defining “monopoly rents.” Many economists disagree. But while the reconsidered figures do tell a good story, it is not at all clear that the “clarified” ideas designate what is driven by growth. Yes, perhaps we can define “land and rents” in a wide enough way to provide taxes sufficient to support modern government, without creating a heavy drag on the economy, but does that concept of “land and rent” designate the features of the economy whose value is driven by the Ricardian and Georgist forces defined earlier in the account of the development process? Are “monopoly rents” driven by growth in the same way that “land rents” are? We can easily think of examples of monopoly/oligopoly increasing in stagnant industries (radio, newspapers), for example. More work is needed.

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in question, then it well might reduce demand, so that rents would not rise as much, nor would government feel such a need to grow. That is to say, growth would still drive up rents and press on government; but growth financed by taxes would drive them up less. The taxes would reduce private spending—unless they were uncertain in amount and collected at the end of the period, as with many income taxes! Growth financed by borrowing, however, might be more stimulative since the funds borrowed might come from banks in a flexible monetary system.

The issue is complicated, however. Consider: suppose the initial impetus to demand is an increase of government spending to hire new employees (police, fire fighters, administrators). Assuming wages and salaries are spent on consumer goods, if this new government employment is financed by a tax on wages (or a sales tax on consumer goods) then if the tax is just sufficient to cover the additional spending, no net stimulus will be given to the economy; the tax will reduce overall consumer spending by just the amount the new government hiring will increase it.4 So there would be no additional pressure on fixed positions, leading rents to rise.

But if the tax is collected later—especially if it is calculated later, as with many income taxes, then it may not have as much impact on spending. In this case taxes would not have such a great effect on the impact of growth on rents. If it is financed by bonds underwritten by banks operating in a flexible monetary environment—such as we have today in the United States or the United Kingdom—general investment expansion will definitely increase overall demand, and drive up both rents and government.

(As long as there is excess capacity in the economy, expansion can take place without “crowding out.”) This will also be the case. If the government funds its spending directly by “creating money,” although in this case there may be a need to “sterilize” the new money in order to forestall inflationary pressures. (This means taking policy measures to prevent the new money from flowing into respending channels, for example, by attracting it into financial markets.)

Of course, the Georgist point is that taxes should fall wholly on rents, not on the productive economic activity that generates the pressures creating rents, and that if they did so, growth would be stronger and employment higher.

4 Actually—to nitpick a little—the net stimulative impact will also depend on the difference between the consumer spending of the new government employees, and the spending they were undertaking before, adjusted for how this was financed.

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Analyzing Growth Now consider growth from the initial period to the next period. New settlers move in, new patterns of cooperation emerge, certain locations prove highly advantageous, others have serious drawbacks, some resources are better than others, some land is easier to cultivate or more fertile; in short, there are many differentials of many kinds. Those who have positioned themselves in favorable locations will benefit, either by producing at an advantage or by renting their positions to other producers. So the pressures generating growth work themselves out partly by expanding economic activities—investing and building capacity, intensifying cultivation, producing more goods and services, furthering the division of labor and innovation—but also partly by paying rents and bribes for access to and use of superior locations and resources, and driving up the prices of scarce skills and specialized knowledge and tools.

(1 + g ) Y0 = Y1 = C1′ + I1′ ,

The apostrophes indicate that consumption and investment, still the only two categories of goods, have been increased as a result of the pressures from growth, but not in a neat or proportional way. In fact,

Y1 = C1′ + I1′ = W1′ + I1′ + R1

Wages no longer equal consumption nor profits investment. Instead the pressures of growth have led to a new category of returns to ownership—rents—which in themselves are totally “unproductive,” but which result from differentials in productivity. These rents accrue to the owners of the various locations, resources, and so on, described above; they are deductions from wages and profits, and in the early stages will be spent partly on consumption goods but also on investment goods, although most analysts have tended to think that the spending of rentiers tends to be wasteful—luxury consumption. (In later stages of development, rents will tend to be “invested” not in productive facilities, but in speculation on asset values—stocks, bonds, real estate itself, forex, and so on.) To represent these relationships the economic system can be set forth in the form of a model showing the wages, profits, and rents accruing in each industry, along with the outputs of that industry and the price of the

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goods produced (Sraffa 1960; Pasinetti 1977; Nell 1998a, b, 2004).

It is important to do this, to provide a check on our argument—see Chap. 6—but our analysis does not need to draw on this full-scale model.

So here goes: Growth and Rents The size of the rents at any time—the amount of purchasing power drawn away from wages and profits—will be proportional to the rate of growth, g.

Let’s repeat the argument of the previous chapter, and call α the proportionality factor; it could equal 1, so that g puts full pressure on rents, as Henry George thought; or it could be significantly less, in which case growth will increase rents, but the effect could be small or negligible. But in any case, as before, rents in any period will equal α × g × Y;

Ri = Ri −1 + α g (Yi – Yi −1 ) = Ri − 2 + α g (Yi −1 – Yi − 2 ) + α g (Yi – Yi −1 ) = …

Redoing the numbers for the periods and rewriting,

RN = R0 + α g (Yi – Yi −1 ) = (Y2 – Y1 ) + (YN – YN −1 ) 

Rents are proportional to g, but if at any point g = 0, rents do not disappear; they fall to their previous level, Ri−1. If g < 0, then rents will diminish from the previous level in proportion to negative g. For the moment let us assume as before that g is always the same; or perhaps, that a moving average of g’s over several years is constant. Clearly then we can replace the rental term at the beginning of the RHS by the appropriate formula for rents all the way back to the beginning of the “settlement.”

Transformational Growth and Costs of Government Now let’s consider growth and development—transformational growth— as new settlers move in and find a place on the “unbounded savannah,” noting that new settlers inspire transformational growth, not growth through replication. With more people there can be more cooperation, and more opportunity for the separation of function and division of labor to create greater productivity and greater prosperity. But as this takes place it will require more and more public goods—roads, bridges, public health

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measures, police and courts, schools—to take full advantage of the possibilities opening up. Suppose new settlers arrive, and are able (with funds they brought with them, or drawing on loans from the newly emerging banks) to expand cultivation, opening new lands. This additional demand for lands traditionally drives up rents. But they also open blacksmith shops, grocery stores, and hardware stores, and set up doctors, nurses, and lawyers. The new areas will be further from the established center(s); will very likely (but not always) have poorer resources, and less advantageous locations. Differentials are created, so rents will rise. But the new areas will need police, roads and bridges, schools and sewers, and so on. Government will expand in pace with the advance of settlement.

To model this, let τ be the coefficient indicating the amount of new government spending required, calculated as a fraction of the new growth in economic activity. Put another way, it shows how much government must increase its activities in order to manage and support the growth of the economy, expressed as a fraction of that growth. (Note that τ is exactly analogous to α.) Then we can write an equation for government, G, that echoes the equation for rents:

GN = G0 + τ g (Y1 − Y0 ) + (Y2 − Y1 ) +…+ (YN − YN −1 ) 

Now compare this with the equation for rents; they are the same except for the coefficient, and the initial terms. As a result, we can combine and solve, giving us:

( RN − R0 ) / [GN − G0 ] = α / τ .

The ratio of aggregate rents to the total costs of government depends only on the coefficients. If they are equal, then the Henry George Theorem will hold; if they are not equal but are close, then rents will be close to covering the costs of government—though the discrepancy could go either way.

In any case, it seems that rents and costs of government must tend to rise together in the kind of society Henry George envisioned. Consider the case just described: New settlers invest in land and in businesses, expanding the area of settlement. Now government must expand in this area also, in pace with the rise in business. But an increase in government tends itself to lead to increases in productivity and in innovation. However

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an increase in productivity will lead to an increase in the demand for land, since existing businesses can make do with fewer workers, and workers so released will seek land in order to set up new businesses, driving up rents.

So there is a good case for something like the Henry George Theorem to hold in a society that is largely agrarian and craft-based, prior to mass production. But once industry adopts mass production technology, labor will be displaced on a large scale by farm machinery and will flow to the city. Rural rent payments will tend to fall, urban to rise; aggregate rents will tend to increase, because urban rental rates will tend to be higher, but the total impact on rent is likely not to be that great, certainly less than doubling it. However, there are new sources of rents: for example, new forms of “appropriable” space—air rights, light, intellectual property rights. Financial claims and derivatives will develop. But most of all there will be the growth of “monopoly,” that is, economic power that arises from market position and market strategy, as small-scale firms are merged into or swallowed by giant corporations, as Walmart replaces the corner store. And this kind of rent definitely rises as the economy moves into mass production. Why exactly and what drives these rents may not be fully understood.

A case could be made, for example, that rent-yielding market positions develop due to economies of scale and scope, and that rents will rise or be driven up by urbanization. But large increases in scale are likely to create potential congestion and problems of traffic management, and will also call for storage. Public goods—roads, bridges, policing, inspection—will be needed. Increases in scope—interaction across different but related activities—could very well lead to safety issues, calling for inspection and regulation. So the developments that lead to increases in rent may very well also call for increases in government.

Urbanization may drive up rents, but the move to the cities and suburbs will certainly have an enormous impact on the costs of government, leading to increase it by factors of 3, 4, 5, and more. Think of congestion costs, of public infrastructure, of public health expenses, of additional education; think of the increase in policing and in the courts; think of the changes in the nature of the family—and the consequent need for caring for children and the aged. A room could be added to the farmhouse for the grandparents, but one can’t be added on to the apartment in the city. Henry George pointed to the congestion, pollution, and potential for crime in the newly developing big cities; all of these call for more government spending and more regulation. Moreover, these changes tend to interact, intensifying

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one another, rising not additively but multiplicatively as growth and development take place—congested schools lead to a public health issue, which calls for new school buildings and better housing, as sick children spread disease to grandparents in overcrowded apartments. This kind of interaction implies that government costs—or the need for government spending—may rise exponentially, in contrast to rents, which simply rise in pace with growth.

This is not the place to spell this out; it’s enough to look at the statistics: as the rural percentage of population declined and urban increased, the agenda of government changed and the costs of government rose dramatically.

In the age of mass production, and still more in the information economy, the Henry George Theorem seems to be out of date—unless it can be rescued by the “superprofits” of “monopoly”—market power has certainly expanded to an astonishing degree. Traditional rents alone will not cover all the costs of government. But a more comprehensive notion of “rents,” applying to an extended concept of “land” and more contemporary forms of monopoly, might. (In the appendix below, Andrew Mazzone recasts the 2016 GDP accounts for the United States to account for the influence of monopoly power.) This still needs to be studied further. The single tax should still have a role to play—the case for it is still sound— though it probably can’t do the job alone.

In this regard, the Henry George approach could be extended: instead of focusing only on rents and real estate, it could consider the whole financial sector. Just as Henry George advocated taxing rents to the fullest extent feasible, we could now consider taxing financial earnings that way.

Discussion of Revised 2016 GDP Accounts,

by Andrew Mazzone In today’s world, the discussion of monopoly has become prevalent. Since the 2008 financial crisis and the consequent examination of its causes, speculation and the unequal distribution of income have been cited as proximate causes. There is plenty of good literature on this subject today, which I will bypass in the following discussion. My contribution to these debates revolves around the application of the philosophy and economics of Henry George. George wrote his seminal work, Progress and Poverty, in 1879. In that book, his essential proposition was that land speculation was a prime mover of the boom-and-bust cycles in capitalist economies, and that taxing away land rents and using them as the basis for funding government would go a long way toward curing the basic ills of the capitalist

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system. The fact is that there is no one supercure for any one wrong in a social system. But George’s model has emerged repeatedly as one that warrants testing. However, testing has occurred only in sporadic ways at various times and in various countries. When tried, it has exhibited positive tendencies, but not in a manner sufficient enough to persuade wholesale adoption of his policy. It is true that, in effect, taxing land typically amounts to taxing the very wealthy in a capitalist society. As a practical matter, there is no expectation that this group would enthusiastically back such a tax, and I will not further belabor this point. But the one reason that is cited over and over as the reason to dismiss the George Theorem out of hand is the assertion that there simply would not be enough land-­ tax revenues to fund a modern-day government. This study seeks to dispel that notion.

In George’s day, government expense as a percentage of the gross domestic product (GDP) was 5 percent or less. Today, it is 25 percent in the United States. In current-day US GDP accounts, rental income is recorded as 2–3 percent of GDP. Leading economists of our day, such as Paul Krugman, rightly dismiss the 2 percent figure as not worthy of discussion. As a prelude to my further commentary, I am going to broaden George’s concept of monopoly from land only into land plus other monopolies that have arisen in a modern economy. Thus, even though land and land-related monopolies remain a significant driver of monopoly in the capitalist world, I am extending George’s theory of monopoly to encompass the broader instances of monopoly that are found in today’s economy. To that end, I have recast the 2016 US GDP accounts to ­illustrate the amount of monopoly in the US economy, by line item. The details are available for inspection in Table 4.1, but together they amount to approximately 22 percent of GDP. (This could be carried further: We could add $440B in interest payments on homeowner properties to Table 4.1 in the Real Estate and Excess Monopoly section. There may also be another $300B to be collected in user fees on government-owned infrastructure. We should distinguish cash flow items from those that represent accounting changes—but we have not carried out these changes at this time.)

If you take total tax collections in the United States—including local, state, and federal—these equal 25 percent of GDP, close to the amount in my recast GDP accounts, especially with the additions above. Moreover, one could easily fund a half-trillion dollars in the US tax collections if you

Table 4.1 Reconstructed 2016 GDP accounts Economic indicator

2016 GDP (actual) USD trillion

Percent USD trillion

Gross domestic income 19.0 100.0 Employee compensation, paid Wages and salaries to persons 8.0 42.1 Supplements to wages and salaries 1.9 10.1 Taxes on production and imports 1.2 6.3 Net operating surplus Private enterprises Net interest and miscellaneous 0.7 3.7 payments, domestic industries Proprietors’ income with 1.4 7.4 inventory valuation and capital consumption Rental income of persons with 0.42 2.2 capital consumption adjustment (return from structures) Excess rental income (return (0.28+0.5) 1.5 from land) 0.78

Corporate profits with inventory valuation and capital consumption adjustments, domestic industries Consumption of fixed capital Private Government Capital gains (not land related)

A monopoly adjustment

1.7

9.0

2.4 0.5 0.49

12.6 2.6

2016 GDP (modified) USD Percent trillion 19.1

100.0

7.0 1.9 1.2

36.6 10.0 6.3

0.7

3.7

0.87

4.5

0.42

2.2

0.56d 0.7a 0.3a 0.1b 0.2b 0.75e 0.5c (0.2)b (0.15)a (0.25)c

3.89

20.4

0.97

5.1

(0.75)e

1.65 0.5 0.49

8.7 2.6

(0.7)a

(0.1)b (0.15)a (0.25)c

a Monopoly due to excess (in billions of US dollars): finance ($350), patent charges ($210), CEO and executive compensation ($150), professional charges ($200), and technology profits ($90). Source: Baker (2015) b To reverse resource rents credited to both corporate profits and proprietors’ income. Source: Royalty Exchange, Denver, Colorado, 2017 c Returns due to leasing land. Sources: AIG (2011), Loopnet.com (2016) d Capital gains not listed in the GDP accounts are allocated to excess rental income for illustrative purposes.

GDP calculation is for real estate/land only. Source: CBO/JCT (2016) e Depreciation due to nonresidential fixed investment. $2.3 trillion is adjusted by the following factors: 0.66 to separate real estate depreciation from non–real estate depreciation; 0.66 to identify non-residential depreciation; and 0.75 to adjust for recapture of depreciation. Source: Federal Reserve Bank of St. Louis FRED database, January 2016

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assume the following: first, by making income distributions much more favorable to middle-class and working-income people, who have a higher marginal propensity to consume goods and services than the top few ­percent of the population; and second, by shifting, where possible, from income, sales, and corporate taxes to taxes on monopoly. Such approaches would result in far better alignment of the motivational tendencies across workers and business owners. These would probably increase economic activity and, by extension, increase tax revenues.

The implementation of such taxes would have to be done over a reasonable time period. For, while we can speculate on the possible good benefits, we can’t know their impact for certain from a macro perspective until they are put into practice. Practically speaking, it’s highly unlikely that we would make a total shift to taxing 100 percent of monopoly rents; however, we should attempt to precisely identify the magnitudes at issue.

Therefore, to aid in establishing a mechanism for assessing land rents, which are not formally developed for taxing purposes and are constantly open for debate, I have proposed a simple empirical approach, which suggests conclusions as follows: . Land rents are a function of economic activity in a given area.

1 2. The proxy for economic activity is either city domestic product, or state domestic product, or national domestic product.

3. Over any given real estate cycle, the average values of land will approximate the GDP for that area. In other words, we can postulate a one-to-one correspondence between the value of land and the value of GDP. 4. If we analyzed land values by individual states in the United States, we would find that land values are greater than GDP in the slow-­ growing states and lower than GDP in the fast-growing states. They average to a one-to-one ratio when combined.

It’s a fact in the United States that there is a tendency to both underassess land and to delay reassessment of land. From a real estate operator’s point of view, this is rational, because structures can be depreciated but land cannot. Thus, the market value of real estate can be shown to be primarily that of structure, not of land by means of lagging land assessments.

4 A NEW LOOK AT THE “HENRY GEORGE THEOREM”

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Bibliography American International Group. (2011) “National Survey of Ground Leases.”

Preparation for a ground lease at the Los Angeles Convention and Exhibition Center. November 3.

Atkinson, A., and Stiglitz, J. (1987) Lectures in Public Economics. London: McGraw-Hill.

Baker, Dean. (December 2015) Washington, D.C.: Center for Economic and Policy Research.

CBO/JCT (Congressional Budget Office / Joint Committee on Taxation) (2016) The Distribution of Asset Holdings and Capital Gains. Washington, D.C.: CBO/JCT. August.

Loopnet.com. (2016) “Capitalization Rates for Nationwide Ground Leases.” December.

Gaffney, Mason. (2009) After the Crash: Designing a Depression-Free Economy, (edited by Clifford Cobb). New York and Oxford: Wiley-Blackwell.

Nell, E J. (1998a) The General Theory of Transformational Growth: Keynes after Sraffa. Cambridge: Cambridge University Press.

Nell, E J, ed. (1998b) Transformational Growth and the Business Cycle. London: Routledge.

Nell, E. J. (2004) “Monetizing the Classical Equations: A Theory of Circulation.”

Cambridge Journal of Economics, 28(2), 173–203.

Pasinetti, L. (1977) Lectures on the Theory of Production. London: Macmillan.

Sraffa, Piero. (1960) Production of Commodities by Means of Commodities. Cambridge: Cambridge University Press.

PART II

Moving to Macroeconomics

One point is clear: the larger the GNP, the higher the real estate values. A corollary appears to be that the faster real growth is, the faster real estate prices will rise. But in the modern financial system, real estate, like most sources of income, has been “securitized.” Real estate values translate into security prices. This is a crucial change since the time of Henry George, and it means that the destabilizing pressures created by rents will show themselves in the financial system as well as (and perhaps more markedly than) in the real economy. In other words, the system of securitized rents delivers a boost to asset markets every period, in proportion to real growth.

Fixed and often largely unproductive assets rise in value every period, as a consequence of the fact that the productive economy is growing. Growth of the productive economy raises the value of equity, of course, but this is because growth increases productive capacity. The increase in equity reflects an increase in the productive base. However, rents are in no way indicative of any rise in productive capacity; they are deductions from the surplus that is the basis of wages and profits. “Rental assets” rise in value regularly, but such assets are often no more than barriers or obstacles to trade or production (or sometimes special features that can help only a select few.) Rents are a transfer from those engaged in active economic operations to those who are passive recipients of largely accidental benefits, deriving from the effect of the overall growth of the economy on certain fixed features of the world. But this transfer provides a regular stimulus every period to asset price speculation—as we shall see in later sections.

To examine this in more detail, we have to show how the real economy grows and develops, starting with the craft economy of the nineteenth

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Moving to Macroeconomics

century—the economy as it was in the time of Henry George. George’s notion of “progress” is certainly an idea of growth, and indeed very modern in many ways, since he considers innovation and social change to be essential parts of growth. But as we have seen, both his theory of wages and his theory of interest/profits are deficient, and he does not discuss saving and investment at all.

We will first lay out a basic picture of the working of a craft economy, based on a simple price mechanism, then look at some of the pressures that helped transform this into a heavy industrial economy—an economy of mass production, with large, powerful oligopolies—adjusting by way of a multiplier-accelerator. (The model and equations presented here are examined more and adapted to other purposes in the following: Nell 2007, Ch. 11, 2012, Ch.14, 2017, Ch. 2; Nell and Errouaki 2013, Ch. 11.)

This will lead us to a study of growth and rents in a modern economy, first showing the wage-profit trade-off and determining the real wage, setting the stage without rents—prices, wages, and profits are determined on no-rent land—and then including them.

Unfortunately, George provides very limited guidance here, since he does not address the saving-investment nexus that virtually all economists agree to be the foundation of sustained growth, probably because George, like Marshall and other economists of that time, assumed that all savings were promptly invested. We will set forth an account of savings and investment, and then modify it to show long-term growth and bring in the elements that George, rightly, regarded as essential. These elements are strikingly “up-to-date.” They are the features of the economy that were highlighted in the so-called new growth theories at the end of the twentieth century: innovation, new technologies, economies of scale, network economies, cooperation, and externalities.

Bibliography Nell, E J (2007) “Aggregate Demand, Employment and Equilibrium with Marginal Productivity: Keynesian Adjustment in the Craft Economy” in M Forstater, Gary Mongiovi, and S Pressman, eds., Post Keynesian Macroeconomics: Essays in Honour of Ingrid Roma, London and New York: Routledge.

———. (2012) “Transformational Growth: from a Marshallian Neoclassical System to Keynesian Growth” in Gehrke, Salvador, i, Steedman and Sturn, Classical Political Economy and Modern Theory, London and New York: Routledge.

Moving to Macroeconomics

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———. (2017) “Unemployment and Transformational Growth in the Long Run,” in M Forstater, and M Murray, eds., Full Employment and Social Justice: Solidarity and Sustainability, Berlin: Springer.

Nell, E J and Errouaki, K. (2013) Rational Econometric Man. Cheltenham: Edward Elgar.

CHAPTER 5

Savings and Investment, from the Price Mechanism to the Multiplier

The Price Mechanism … stabilizes the economy.

—Almost Any Mainstream Economist

Abstract Henry George often argued in macroeconomic terms, though he did not develop a macroeconomic theory. In this chapter we present a model that is consistent with Marshall’s ‘supply and demand’, but applies to aggregate supply and demand. The model is based on a conventional short-period production function, which shows the outputs associated with various levels of both fixed plant and equipment employment. As the economy employs craft technology, returns diminish to additional employment. Then, wages support consumption, Kalecki-fashion investment generates realized profits, and the level of employment is found when we know the real wage and level of investment (at the point where the C + I line is tangent to the production function, so the real wage equals the marginal product). This system can be developed into a simple growth model, based on the “Golden Rule” that the rate of profit equals the rate of growth, replacing the misguided Solow model.

Keywords Craft technology • Price mechanism • Marginal product • Growth model

© The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_5

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Up to now, our analysis of Henry George’s themes has stayed close to his thinking. Now, however, we have to go beyond what he actually said to what he might have said, or should have said, had he known later economic realities and thinking. A key example: George’s concept of “progress” is, in fact, a fuller version of what economists call “economic growth” today, but the modern concept is built around the relationships between savings and investment, which George hardly mentions. To move from his analysis to today’s world we have to bring in savings and investment, and we have to move from a largely agricultural economy predominantly made up of small farms and small firms—the craft economy—to a largely urban and industrial economy, one of mass production, dominated by giant corporations (e.g., the largest 2000 firms produce roughly 70 percent of gross national product [GNP]).

Progress and Poverty describes a craft economy, small farms and small firms employing small-scale technology, but with the special feature of being a frontier economy as well—at the time it was written, there was free land available in the West. Arguably, this made America a “high-wage” economy, and it also made it difficult to accept George’s contention that rents would expand at the expense of, rather than along with, wages and profits. We need to examine the development of industry in the craft economy, something George mentions but doesn’t explore.

The Price Mechanism and Marshallian Technology Consider how such an economy adjusts to changes in supply and demand.

The principles underlying the craft economy are centered on the shortrun employment-output relationship. In the craft economy (Nell 1998a, 1998b), we can reasonably assume (short-run) diminishing returns to the employment of labor, in relation to a normal (or average) position.

Adding extra workers to work teams operating given equipment brings growing total output but progressively lower additional output, while removing workers leads to progressively larger losses of marginal output.

There will be a point in between where the given equipment is being operated most efficiently.

In general, it will take time and effort to adjust levels of employment; it will not be done lightly (Marshall 1890; Marshall and Marshall 1879). Workers cooperate in teams that cannot be easily broken apart or added to; all workers have to be present and working for a process to be executed at all; processes cannot be started up and shut down easily. Changes are costly and difficult.

5 SAVINGS AND INVESTMENT, FROM THE PRICE MECHANISM…

57

The craft e­conomy has not only diminishing returns, but also inflexible employment (Nell 1998a, chap. 9). The model applies, of course, to farming on “no-­rent” land, and in regard to industry, to production in the “no-rent” factory—that is, to production in the plant operating at a cost level that just barely earns the going rate of profit. All operations paying positive rents (or superprofits, since they may eventually be competed away) will do so because of location or position or special but fixed technological aspects that provide a boost to productivity. New plants will typically be superior and earn rents; as such new and superior plants come online,1 productivity rises—often at least partly due to better work teams—and with new plants we can expect wages to drift up, since the new factories can afford to pay more in order to attract the best workers.

Looking more closely at the “margin of production” for a craft-based factory, an analogy with agriculture can be found. New plant and equipment cannot be very large, the technology is small-scale, and plants must be built to optimal size (cf. A. Robinson 1931). Expansion is risky, so investment cannot run ahead of demand; likewise, credit is limited and won’t be advanced ahead of demand. Older plants generally cannot be retrofitted or improved if the technology is embodied in equipment; they have to be scrapped, or run for what they can earn. If there were retrofitting, the old labor force would have to be retrained; indeed, very often the cost advantage will be partly or wholly “embodied” in the specific labor force of the firm. In short, following an innovation, the positions of firms are “fixed,” just as land fixes the relative positions in farming.

Look back at the Sraffa equations in Chap. 2. In each, the various inputs are given, according to the technology; then the labor input; and, finally, the rental rate times land: 1 An unsettling possibility arises here, which is that investment might be undertaken not to improve the product or reduce the costs but for a firm or group of firms to impose costs on competitors. A mill owner might buy a farm upstream from his major competitor, and divert water from the stream for use in irrigation, reducing the force of the flow driving the competing mill. Regulators might stop this, although irrigation could surely be a legitimate use of water—but if it is not, regulators can sometimes be bribed. Very commonly, a firm will find some reason to sue its competitors, if it believes that the cost or inconvenience to them will be great enough to warrant the legal expenses—even though there is not much of a case against them (a practice widely attributed to Donald Trump). The targets of this kind of behavior may be asked, or may offer, to pay a fee to stop it—a rent! For an interesting survey of such “rent-seeking” behavior (which, if it absorbs investible resources, may thereby reduce growth), integrated into endogenous growth models, and starting from Adam Smith, see D’Agata, Ch 11 in Kurz and Salvadori, ed. (2003).

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Y C+I Y = Y (N)

Y0 Y1 I0 I1 W1 W1 > W0 {

w1

wN = W = C

W0

w0

N’1

N1

N0

N

Fig. 5.1 Adjustment to demand fluctuations in the craft economy (showing a rise in the real wage)

(1 + r ) ( Aa pa + Ba pb +…, K a pk ) + wLa + ρ1Λ 1 = Apa

The same holds here for industry, except that in place of land we have productive capacity of a certain quality, and in place of land rent we have industry superprofit (the percentage above the normal rate of profit, or of costs below normal costs). When overall demand fluctuates, the scale of activity changes, but in the same proportion for all, so the ratios of costs, and therefore profits, do not change.

The model here is based on an aggregate function, a representative factory times total capacity, shown in Fig. 5.1, where varying numbers of workers are operating given equipment—a factory. We have assumed a conventional shape and properties.2 Aggregation will be based on long-­ run normal prices, those ruling at the optimal points. It might reasonably 2 Note that in actual fact these relationships will be rough and ready, discontinuous; we are smoothing them out and assuming continuity—so that we can draw diagrams recognizable to economists!

5 SAVINGS AND INVESTMENT, FROM THE PRICE MECHANISM…

59

be thought that there is a normal distribution of efficiency; then the ­aggregate function would be the representative average function multiplied by total capacity.3 So, we assume that, for a craft economy, output increases with the labor applied to given equipment according to a curved line that rises from the origin with a diminishing slope. As the intensity of utilization rises, output rises, but at a diminishing rate. (By contrast, mass production will be characterized by a straight line rising from the origin.)

Finally, as a first approximation, consumption can be identified with wages and salaries, while for the purpose of drawing the diagram investment can be taken as exogenous. As employment rises, the wage bill—and so consumption spending—will rise at a constant rate, namely, the normal wage rate. Total expenditure will then be calculated by adding investment to the wage-consumption line.

Figure 5.1 presents the aggregate utilization function, with output, Y, on the vertical axis and labor employed, N, on the horizontal.4 This function is curved, its slope falling as N increases. The wage bill, W (including salaries), will be assumed to be equal to consumption spending, C, that is, no household saving and no consumption out of profits—but both assumptions are easily modified, and transfer payments could be included also.5 So the wage bill, also representing consumption spending, is shown by a straight line rising to the right from the origin; its angle is the wage rate. Investment spending, I, will be treated as exogenous in the short run, and so will be marked off on the vertical axis. The initial level of I is shown 3 To avoid complications, we will assume that when demand changes, it changes in the same percentage for all firms. In practice, the better firms might well use the opportunity of shifting demand to improve their competitive positions.

4 We call this a “production function” (more properly—a utilization function), though it is not the “true” neoclassical concept (Hicks 1932; Samuelson in Kurz and Salvadori, ed. 2003; Nell and Errouaki 2013), where each point shows the optimal adjustment of equipment.

5 Wages and salaries in the aggregate are closely correlated with consumption spending but do not fully explain it. Some obvious adjustments are easily made. Consumer spending also depends on the terms and availability of consumer credit; in addition, it reflects transfer payments. Wealth and profitability are significant variables. But for the present purposes, which are purely illustrative, a simple “absolute income” theory will suffice. Prices here are assumed to be flexible both up and down, more flexible than money wages, which are also adjustable.

Employment is inflexible; firms do not want to break up skilled work teams; output, however, is somewhat flexible, varying in different industries, depending on many factors. This is all spelled out fully, with supporting statistics, in Nell (1998a), Ch 3, under the heading “The Old Business Cycle.” See also Nell (1998b). For further support, see A. Marshall and M. Marshall, The Economics of Industry, London: Macmillan, 1879, Ch xiii, pp. 146–7, Book iii, Ch 1, pp. 150–3, see esp. sections 3–5, p. 165, sections 8, 9.

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as I0. Aggregate demand will then be the line C + I, rising to the right from the I point on the vertical axis; its slope is the wage rate. The level of equilibrium employment and output is given by the tangency of this line to the utilization function, at N0, Y0.

Suppose investment is unusually low, below normal, so that this line cuts the utilization function at a point below the normal level of output and employment, N1′ . Since it is difficult to adjust employment and output, there will tend to be overproduction, and prices will fall. Since it is even harder to adjust employment than output, prices will fall more readily than money wages. Hence, the real wage will rise, from w0 to w1 (the real wage is in italics in Fig. 5.1). As a result, the C + I line will swing upward, until it is tangent to the utilization function; employment thus settles not at N1′ but at N1. Notice that this point of tangency will tend to be close to the normal level of employment and output, and will become closer the more concave the function. In short, when investment is abnormally low, the real wage will rise; if the rise in real wages is proportionally greater than the decline in employment, consumption will increase. This is the case illustrated in the diagram: investment falls from I0 to I0, prices fall, and real wages rise. Clearly, the wage bill, and so consumption, is higher at N1 than at N0.

Conversely, suppose investment were exceptionally high, or that the C + I line had too steep a slope, indicating too high a real wage. In either case, expenditure would lie above output at any feasible level of employment. Under these conditions, prices would be bid up relative to money wages and the C + I line would swing down, until it came to rest on the utilization function at a point of tangency (Nell 1998a, pp. 455–57).

Again, this point would tend to lie close to the normal level, based on the concavity of the function. When investment is unusually high, consumption will tend to adjust downward.

The model has six variables and six equations. The variables: Y = GNP, w/p = average real wage, N = employment, g = growth rate, r = profit rate, I = level of investment. K∗ is given, and the production function is first degree homogeneous, with positive first and negative second derivatives.

The six equations are as follows:

Y = ( w / p ) N + rK ∗

Y = Y ( N , K∗)

5 SAVINGS AND INVESTMENT, FROM THE PRICE MECHANISM…

g = I / K∗

g=r

r = dY / dK∗

w / p = dY / dN

61

Notice that adjusting the real wage to equal the marginal product of labor both assures a unique equilibrium and maximizes profit.6 When the C + I line is tangent to the utilization curve, the distance to the wage line is at a maximum; if C + I cuts the utilization curve, there will be two equilibria, and the distance between the intersection points and the wage line will be less than that at the tangency. (Given the real wage, profit rises with employment at a diminishing rate from the origin to the tangency point; it then falls at an increasing rate until it reaches zero, at the point where the production function intersects the wage line.)

Growth and the Price Mechanism: Flexible Prices and the Golden Rule At any given time, the craft economy consists of a large number of small firms and farms, each normally operating at an optimal—minimum-cost— level, paying wages to its workers and what Mill called “wages of superintendence” to its managing owners (Robinson 1931). Profits will be distributed as interest and dividends to banks and owners, respectively.

(Taxes will support schools and sewers, police and infrastructure, maintaining and improving productivity, though the public sector will not be considered at this point.) Firms will be divided between established and new; the age structure of the workforce at established firms remains constant—new workers are hired as aging workers retire. Retired workers live off and consume their pensions. However, as a first approximation, apart from pensions and “saving up” for consumer durables, worker households do not save. Permanent saving (capital accumulation) comes out of capital income, not household wages—neither worker wages nor “wages of superintendence,” John Stuart Mill’s term for the profits that accrue to the business owner.

6 Even though K∗ is temporarily fixed, dK∗ is acceptable here because Y is a function of two variables, and when N changes, the marginal product of K is affected because the ratio N/K∗ has changed, even though K has not.

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As a first approximation, we can assume that all profits are saved and invested in setting up new firms,7 which may hire new entrants to the labor force or bid the best workers away from existing firms. New entrants are cheaper, but also inexperienced; the new firms will have to go through an internal organizing and learning process. New entrants are important because entry-level wages are flexible; wages of established workers tend not to be—and this matters, as we shall see.

Owners either invest profit income or they bank it and receive interest, and the banks loan the funds to entrepreneurs who wish to start new businesses.

Retired owners do not consume their capital (as retired workers do); they pass along the management of the firms they own and live off the interest of their holdings. (If they saved for retirement out of their wages of superintendence, they will consume those savings.) When they die, they leave their capital to their children. If the rate of growth of the population of capital-owning families is equal to the rate of capital accumulation (and family size remains the same, for example), then wealth per capita will tend to be constant. (But see Chap. 9; capital-owning families save and invest, but working-class families do not save, or save less. So wealth inequality will increase.) In the textbook approach, starting with Solow (1956), the growth of the labor force sets the growth rate of the economy. However, neither Solow nor later writers offer an account of a market mechanism by which this will be brought about. They simply show that there is always a capital accumulation path consistent with any rate of growth in the labor force—and then assume full employment. The capital/labor ratio then adjusts appropriately. This result—that the growth of labor sets the pace for the economy—may well be correct for a craft economy, and George seems to have thought so, but it has to be shown that it can be brought about by a market mechanism.

The argument is simple and need only be sketched (see Fig. 5.2; many qualifications can be imagined): starting from a balanced path in which the growth of the labor force equals that of capital, if the growth of labor speeds up (slows down), entry-level wages will fall (rise), encouraging (discouraging) the formation of new firms. When entry-level wages fall, for example, expected profits increase, so the incentive to invest will rise, encouraging investment—namely, the formation of new firms. But ­entry-­level wage variations will not affect the current level of consumption spending, because workers newly being hired will not yet have received their paychecks, and in any case are a small fraction of the labor force.

7 Note that in a craft economy—the Old Business Cycle—saving always tends to equal investment because investment spending, the active force, drives up prices (or, if itself slack, lets them sag), which changes profits, so that saving adjusts to investment.

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The Growth Rate in Diagrams The price mechanism described above can be adapted so as to show the key elements in the process of growth in a craft economy. Measure Y/N on the vertical axis, and K/N (real capital per worker) on the horizontal, as in the diagram 5.2. A line rising left to right from the origin will measure I/K, the rate of growth. Add to this the wage bill per capita (the wage rate); the result will be the aggregate per capita expenditure, which will adjust until it is tangent to the production function. If it lies above the production function, demand > supply, prices will go up, shifting the line down; if it lies below the production function, demand < supply, prices will fall and the line will shift up until it is tangent—prices adjust until the marginal product of capital equals the rate of growth. The same line of argument shows that in the relabeled diagram, prices adjust (causing the line to swing rather than shift) until the marginal product of labor equals the real wage. (It is important to remember that these are marginal value products, not “true” marginal products, as envisaged by high theory. The context is one of price adjustments due to changing aggregate demand, not abstract choice of technique. Also, though Fig. 5.2 looks similar, and has tangency solutions, it should not be confused with the preceding diagram.)

Let’s explore this further, at the risk of repetition. Figure 5.2 looks just like the textbook neoclassical model, but it shows the working of a price mechanism in which changes in investment impact on prices, so as to change the level of real wages.8 This changes profits, and profits are savings, which here adjust until they are equal to investment. The intercept of the aggregate expenditure line is (wN/π)/N = w/π. The slope of the line is the growth rate, I/K. The equilibrium will be given by the point of tangency. The tangency between the expenditure line, with a slope of g, 8 The similarity of this to the Solow growth model of textbook fame is unmistakable. But Solow added an assumption that is usually overlooked: although he introduces the marginal productivity relationships for both the real wage and quasi-rents, he assumes that prices will be constant (Solow 1956, p. 79). As a result there is no price mechanism in his model. There is no justification for Solow’s assumption of a constant given price level nor does he pretend to offer one—but it completely changes the character of the model. For, as we have seen, it is the price mechanism that ensures that the marginal productivity conditions are satisfied.

Solow, on the other hand, assumes that savings will drive investment, though no mechanism is specified, and that the equilibrium growth rate will be determined by the changing capital/ labor ratio, brought about by such saving. (Higher savings will drive interest rates down, and that will increase investment? Not a chance, empirically; not satisfactory theoretically, for Keynesian reasons.) The Solow model got mainstream growth theory off to a bad start and has stood in the way of progress for almost two generations.

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Fig. 5.2 Growth rates and marginal products: in this diagram the marginal product of capital equals the growth rate, g, as described below. But the diagram can be reimagined by relabeling the axes as Y/K vertical and N/K horizontal. Then, following the same line of argument, the slope of the line rising from the origin will be W/N = w, the real wage, and the section of the vertical axis marked will measure I/K = g, while the tangency point will show the real wage = the marginal product of labor. (A project for readers: sketch the relabeled diagram and trace out the argument showing that the system will settle at the point of tangency. Evaluate the underlying assumptions.)

and the production function implies that the rate of growth will equal the marginal product of capital—the slope of the function. If the expenditure line is not tangent to the curve, then the price level will rise or fall, adjusting the intercept until the line just touches the production function. This equilibrium maximizes the real wage (per capita consumption); it has optimality properties as well as market stability, which might be expected in a neoclassical approach, although neither is present in the textbook models.

For example, a rise in g will raise the expenditure line above the production function, indicating demand pressure that will bid up π, lowering the real wage and bringing the line back down to tangency at an optimizing short-run rate of profits, thus leading to a new equilibrium. This tangency

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Fig. 5.3 Adjustment to an increase in growth rate. (The vertical distance between the dotted parallel lines should be less than that between the solid lines, indicating that the real wage is now lower.)

point represents the golden rule,9 and contrary to Solow, it is the true, market-driven, small-scale equilibrium, based on profit maximization.

In this system, technical progress—increasing productivity—will be shown by a shift upward in the production function; if the expenditure line had initially been tangent, the upward shift would now leave it below the production curve, implying output in excess of demand and leading to a tendency for the price level to fall. The benefits of technical progress will be distributed by falling prices, with money wages constant (as happened throughout the nineteenth century, Nell 1998a, Ch 3; 1998).

Figure 5.2 shows the tangency growth equilibrium; Fig. 5.3 shows the adjustment when the growth rate rises (driving up prices so the real wage 9 The “golden rule” of capital accumulation, that the rate of growth should equal the rate of profits, was much discussed in the 1950s and 1960s, following a challenge by Joan Robinson. Neoclassicals argued that it maximized consumption per capita (Phelps, 1961, 1965); neo-Ricardians thought it represented a balanced path. Nell, 1970 argued that when r = g, the value of capital would be constant when distribution changed. See Robinson (1956), Harcourt (1972), Nell (1970, 1998a).

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Fig. 5.4 An upward shift of the production function, leading to a fall in prices and a rise in the real wage

falls) and both output per head and capital per head fall (see the new tangency position). When g rises, shown as an upward swing in the angle of the growth line, the C + I line rises above the level of output; this drives up prices, so that the real wage declines, as indicated by the downward arrow, and the system moves to the new tangency.

In the replicative growth process, the growth of capital per worker will tend to equal the growth of output per worker, which in turn will equal the growth of the real wage. As indicated in Fig. 5.4, when the production function shifts up (original curve not shown), the price levels will fall and real wages will rise. When the production function shifts upward (disembodied technical progress), it means that production processes have been reorganized, so that work will be done faster (Nell 1998a, chap. 7). Hence, more energy will be used, more materials will be processed, more wear and tear will take place—in other words, working capital will be increased in proportion to the speedup. Therefore, K/N will increase in proportion to the rise in productivity. So:

d ( K / N ) / ( K / N ) = d (Y / N ) / (Y / N ) = d ( w / π ) / ( w / π )

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This will also tend to be true for “mechanization,” where a proportional increase in K/N is matched by a proportional decrease in N per unit of output. This will maintain the equality on the left-hand side of the equation, and that on the right will follow as before, from a rise in productivity leading to a proportional fall in prices—as was true all during the nineteenth century. As a result, the capital/output ratio and the rate of profit will tend to stay constant. With both of these holding steady, the shares of profit and wages will also be unchanged.10 This is the “Victorian equilibrium.”

Rents and superprofits will tend to rise together with growth. George argues that rents will rise relative to wages and profits, because the wage rate is set by the margin of cultivation, and so will be either fixed or falling, while profit/interest is fixed by the qualities of capital—and tied to wages.

Since both are relatively fixed, growth would then end up increasing rents relative to other incomes. But as we have seen, George’s theory of capital and interest is weak, and while his theory of wages is plausible for a frontier economy, it won’t bring about falling wages if there is an “unbounded savannah” of equally good land—as he initially assumes. In his argument, when there is no longer free land, and especially if there is widespread monopolization of special factors, wages will tend to be driven down to subsistence, as in Europe. But in fact, in America real wages did not fall when the frontier closed; they rose during the 1920s, then fell in the Depression, but rose again during and after World War II, and did not weaken, in fact, until the last part of the last century (some fell, some rose, most stagnated). And as industrialization took place, as factories were built, starting in the late nineteenth century, a new margin opened, the “margin of production,” which was discussed earlier. New factories were superior to old, and as they came on line they earned a kind of rent, or superprofits.

Being lower cost, they were able to attract the best labor, further improving their position; hence, industrial wages tended to drift up from period to period. Unionization strengthened this tendency.

10 As the economy grows the banking system must grow pari passu, which means bank capital and bank reserves must be augmented along with other investment. The level of bank capital—the capital of the banking system—will support a certain level of bank loans, while the difference between deposit and lending rates will provide the profits of banks. The sustainable ratio of bank loans to bank capital can be indicated by λ; then λ(il − id) = rb, the profit rate of banks. When this profit is reinvested, bank capital, and therefore sustainable bank lending, will grow at this rate. If the profit rate in banking is the same as in the rest of the economy, and the rest of the economy likewise reinvests its profits and grows at the golden rule rate, then the credit money required will always be available.

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Rents did continue to rise, driven up by growth, and this largely overlooked feature of modern growth has an unsettling implication when we move from single proprietorships and small firms to the modern corporation. The analogy between land rent and superprofits is incomplete in an important way: superprofits in farming do not normally go to the low-cost farmer; they go to the landlord, who can charge for the land. But ­superprofits in industry do go to the owner/operator of the low-cost firm.

However, when firms become corporations, superprofits will go not to the operator-managers of the firm, but to the shareholders—who may have no interest at all in the management of the company. The separation of ownership and management creates a condition, analogous to land ownership, for outsiders with no interest in the actual operation of the enterprise to reap the benefits simply by virtue of owning shares.

We have examined an abstract, but not idealized, picture of the working of capitalism in an era of craft industry and traditional agriculture, portraying a system that is self-adjusting in a weakly stabilizing manner, with a slight tendency toward “full employment,” while tending to establish an equilibrium that can claim some optimality properties. It has some affinity with the traditional ideas of neoclassicism, but it does not rest on the foundations of rational choice. It is, however, a pretty good description of the growth process in the world of Henry George. It fits with his account of progress, which both brings about and rests on innovation, and in which simple capital turns multidimensional and complex, becoming corporate, and in which (though he does not see the implications of this) the system capitalizes rents and we lose sight of them, even though they continue to increase regularly. Contrary to George, it looks as though this system could very well grow in a regular fashion, with rents rising in proportion to growth, along with a consistent rise in wages and profits.

Land speculation would, however, be very disruptive, leading to the withdrawal of land of all kinds from the real estate markets. This could interact with the cycle of credit (as Gaffney [2009] suggests)—a cycle beginning with optimism and expansion, followed by excess, reaching a breakpoint, then a crash and downswing. (See Marshall and Marshall 1879, Ch XIII, Section 3.) Land speculation would tend to amplify the cycle, and to sharpen the turning points. And, as we shall see, speculation will become an even greater problem as we advance to the modern era of “financialization,” in which all operating assets have claims to their earnings attached to them—and many have financial derivatives (e.g., bets on

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the size of those earnings) attached as well. These claims and derivatives are all traded in financial markets, where values can be established that very often are only distantly related to the underlying real assets.

Bibliography Harcourt, G. C. (1972) Some Cambridge Controversies in the Theory of Capital.

Cambridge: Cambridge University Press.

Hicks, John. (1932) The Theory of Wages, London: Macmillan.

H Kurz and N Salvadori, 2003, eds. The Elgar Companion to Classical Economics, 2 vols. Cheltenham, UK: Edward Elgar.

Marshall, Alfred. (1890) 1961. Principles of Economics, 9th ed., edited by C. W. Guillebaud. London: Macmillan.

Marshall, A., and Marshall, M. (1879), The Economics of Industry. London: Macmillan.

E. J. Nell, 1970, “A Note on Cambridge Controversies in Capital Theory”, JOURNAL OF ECONOMIC LITERATURE, 8, PP 41–44.

Nell, E J. (1998a) The General Theory of Transformational Growth: Keynes after Sraffa. Cambridge: Cambridge University Press.

Nell, E J, ed. (1998b) Transformational Growth and the Business Cycle. London: Routledge.

Nell, E J and Errouaki, K. (2013) Rational Econometric Man. Cheltenham: Edward Elgar.

E. S. Phelps, 1961 “The Golden Rule of Accumulation: A Fable for Growthmen”, AMERICAN ECONOMIS REVIEW 51:4, Sept, pp 638–643.

E. S. Phelps, 1965. “Second Essay on the Golden Rule of Accumulation”, AMERICAN EONOMIC REVIEW, 55:4, Sept, pp 793–814.

Robinson, E. A. G. (1931) The Structure of Competitive Industry. Cambridge: Cambridge University Press.

Robinson, Joan. (1956) The Accumulation of Capital, London: Macmillan.

Solow, Robert. (1956) “A Contribution to the Theory of Economic Growth,” Quarterly Journal of Economics, 70, 65–94.

CHAPTER 6

From Craft to Mass Production

The remarkable generalization [holds, in a modern economy] that, in all ordinary circumstances, the volume of employment depends on the volume of investment, and that anything which increases or decreases the latter will increase or decrease the former.

—John Maynard Keynes

Abstract But this system is hard on firms; prices fluctuate with demand, so profits do too. Innovations will make it possible to adjust labor costs more easily, laying off workers when demand drops off, rehiring them when it recovers. In effect this means that the curvature of the production functions is being flattened into a straight line. This leads to a different pattern of market adjustment, replacing the partly stabilizing price mechanism with the destabilizing multiplier.

Keywords Layoffs • Multiplier • Keynesian adjustment Henry George did foresee the emergence of giant industry, in connection with monopoly, but he never considered whether widespread giant industry implied an economy that no longer worked through the price mechanism. Keynes initially accepted the idea that the price mechanism did adjust to ensure that the real wage equaled the marginal productivity of labor. He did not, however, explain how this equality was brought about © The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_6

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in labor markets in which behavior responds to money wages. In his view, the equality of the real wage and the marginal product justified calling the position an equilibrium, but as reconstructed here, the argument shows that there will be a large number (on plausible assumptions, an infinite number) of such positions, besides the full employment level. The way this works was shown in a diagram in the previous chapter (Fig. 5.1, p. 58), in which it is clear that price changes tend to move the system to a profit-­ maximizing position for any given level of investment.

This certainly appears to be a stabilizing pattern of adjustment. Each position of the economy is combination of a level of investment and a level of consumption (equal to the level of the real wage bill), such that higher investment (driving up prices, lowering real wages) would appear to be associated with lower consumption spending. This works in reverse and is stabilizing. When investment falls, for example, prices will fall, and consequently real wages, and therefore consumption spending, will rise, offsetting the decline in investment.

Such a pattern of adjustment puts the burden on profits; prices would fall in a slump, and firms would have to draw down their reserves.

Accordingly, firms should seek to develop greater flexibility, which would allow them to adjust the level of employment to market conditions, laying off and rehiring workers as demand changes. This provides an important incentive to innovate (Nell 1998a). Keynes did not examine this. However, he recognized that price adjustments did not work to stabilize the system.

On the contrary, fluctuations in investment appeared to set off destabilizing movements.

Keynes set out to explain this in his lectures leading up to the publication of the General Theory in 1936; he argued that investment and consumption moved together, not inversely, thereby increasing volatility. Although he did not demonstrate it clearly, this movement is a consequence of reducing the rate of diminishing returns, “flattening” the production function. What he did argue clearly was that investment was the active variable, the causative force, while consumption (and saving) simply reacted passively. But in addition, as we can now see, prices and employment could adjust in such a way that the real wage and the marginal product of labor were brought into equality, thereby maximizing profits, while at the same time investment and consumption moved together, rather than inversely, thereby creating “multiplier”-based volatility in the system. There is no pressure here to move to full employment, but each position can be reasonably considered an “equilibrium.”

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Changes in the “Production Function”: The Multiplier Replaces the Price Mechanism When the curvature of the production function is considerable, the elasticity of the marginal product curve will be greater than 1, so a fall in investment, I, will lead to a rise in the wage bill, W, and therefore in consumption spending, C, as shown in Fig. 6.1. But when the production function is rather flat, the elasticity of the marginal product curve will be less than −1, so that a fall in investment will lead to a decrease in the wage bill and consumption spending, as indicated. In this case, not only is there no offset to the drop in investment, the impact is made worse. And that is the conclusion Keynes reached and tried to explain in the lectures he gave in Cambridge.

The variability of profits in the craft economy provides an incentive to change the technology so as to control current costs; the innovations must change current costs from fixed to variable, which can be done by taking on additional capital costs. This will be particularly advantageous when Y

C+I Y = Y(N)

wN = W = C W0 W1

I0

W0 > W1

I1 w0

w1 N1

Fig. 6.1 Consumption moves with investment

N0

N

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there are pressures for the real wage to increase: at the higher wage, it will be worthwhile to mechanize, so at current prices capital per worker rises, and the scale effects allow for greater flexibility in adjusting employment, N, to changes in the level of demand.

Fluctuations in I will normally have some impact on N even in a craft economy. But there will be an offsetting movement in C so long as the curvature of the employment function is large. The price mechanism is stabilizing for the system as a whole, but the effect is that profits fluctuate sharply for individual businesses. Firms will be motivated to redesign their production systems to allow greater flexibility in adapting to demand fluctuations.

This means being able to add on or lay off workers without greatly disturbing unit costs. As such redesigning takes place, it will reduce the curvature of the employment function; that is, diminishing returns will be lessened. We can think of this as a progressive “flattening” of the employment function. When this reaches the point where the marginal product curve has unitary elasticity, such that the proportional change in the real wage is just offset by that in employment, then the total wage bill is unaffected by the price changes following the change in I. If the total wage bill is unaffected, then, based on the assumptions made earlier, total C will be unchanged.

This will be the case, for example, when the employment function takes the form Y = A(ln N). Hence, I may fall, for example, but C will not change. There will be no offset. So dY/dI = 1. Any further reduction in the rate at which returns diminish will mean that the change in employment will outweigh the change in the wage bill, so that C will move in the same direction as I. In this event, dY/dI > 1 will always hold (Nell 1998a).

We need to define the point of full employment—the point at which the entire labor force has jobs. An appropriate concept of full employment would be “no vacancies,” or, rather, “no vacancies except turnover vacancies.” Employment is full when all farms, factories, offices, and shops have hired the employees they need to operate at their optimal level. Output at the point of full employment will be associated with a marginal product; that marginal product will become a real wage; the real wage, multiplied by the level of full employment, defines the wage bill, which is equal, according to the assumptions, to consumption. The difference between full employment output and consumption must be filled by investment.

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Y C + I

W=C P↓

MaxP

P↑ I N•

dP dN

0>

0>

dP d2P >0 dN dN 2

d2P dN

2

>0

N

Fig. 6.2 Behavior of profits

Now let investment fall below this full employment level. As it does, it will trace the marginal product curve. At each lower level of investment, prices will fall and the real wage rise, while employment will fall; the overall effect on consumption will depend on the elasticity of the marginal product curve. Each point on the curve will be an equilibrium, in the sense that money wages and prices have adjusted to produce the profit-­ maximizing position (see Fig. 6.2).

That this pattern of price flexibility dampens fluctuations by partially offsetting them, in conditions of strongly diminishing returns, can be shown very simply. Recalling our equations: Y is real output, N employment, w/π the real wage, and I investment. All wages are consumed. As above,

Y = Y ( N ) , Y ′ > 0, Y ′′ < 0 Y = C + I

w / π = Y ′( N )C = (w / π ) N

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Clearly

Y = I + ( w / π ) N , so dY / dI = δ I / δ I + N δ ( w / π ) / δ I  + ( w / π ) [δ N / δ I ]

= 1 + N δ ( w / π ) / δ I  + ( w / π ) [δ N / δ I ]

Where N δ ( w / π ) / δ I  < 0 and ( w / π ) [δ N / δ I ] > 0, So dY / dI > or < 1 accord-

ing to whether N δ ( w / π ) / δ I  > or < ( w / π ) [δ N / δ I ] As long as returns diminish sufficiently, dY/dI < 1; price changes due to variations in investment demand will lead to a partial offset.

In short, so long as diminishing returns are significant, the price mechanism will lead consumption to adjust so that it will tend to make up for a shortfall, or offset an excess, of investment. It thus tends to stabilize demand around the normal level of output and employment. But this implies high variability in profits, and businesses will try to control this.

Adjustment to Demand Fluctuations in the Mass Production Economy Modern economies appear to be subject to strong fluctuations in demand.

Indeed, examples of market instability can be found everywhere, although the instability is usually bounded in some way. There do not appear to be, in the modern world, strong and reliable market-based forces ensuring stability. Investment spending, for example, fluctuates widely and appears to be a major source of demand variation.

But investment appears to be a tricky concept; some economists argue that it is simply the adjustment of the capital stock to its optimal level. Yet, if the purpose of investment were simply a corrective, moving the actual capital/labor ratio to its optimal level, stabilization would hardly be needed. Such a long-run position would be stationary, or, if the labor force were growing, the economy would expand uniformly. This is the picture presented by conservative neoclassical theory, articulated, for example, by Hayek (1941).

Keynes and the older classical economists, especially Ricardo and Marx (1967), offer a different view: investment is the accumulation of capital, a process by which productive power is created, organized, and managed. It is driven by the desire for power and wealth, and there is no definable

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“optimum.” Investment expands productive power but does not move the economy toward any definite destination. Given such motivation and the important role of technological innovation, the urge to invest will sometimes be strong and widespread, at other times weak and uncertain.

This may help to explain the need for stabilizing policies focusing on the demand side.

In postwar mass production economies, prices do not play an important role in adjustment to changing demand (Nell 1998a). In Hicks’ (1965) terms, this is a “fixed-price” economy. Employment is much more flexible, and constant returns appear to prevail in the short run; to put it differently, unit costs are broadly constant as employment and output vary over a wide but normal range. Prices can therefore be maintained at their long-term levels, while permitting only small temporary variations around that level. Workers need only be semiskilled and teams can easily be broken up and re-formed; processes can be operated at varying levels of ­intensity in response to variations in demand, and they can easily be shut down and started up again. It is likewise easy to lay off and recall workers.

So, in Fig. 6.3, we have an aggregate utilization function, but here the mass production economy will be characterized by a straight line rising from the origin, showing constant marginal returns in output to ­additional

C + I΄

Yf

C+I

Y*

W=C

N*

Nf

Fig. 6.3 Adjustment in the mass production economy

N

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employment—that is, to more intensive utilization. As a first a­ pproximation, consumption can be identified with wages and salaries, while investment can be taken as exogenous. As employment rises, the wage bill—and so consumption spending—will grow at a constant rate, namely, the normal wage rate. The wage bill—assumed equal to consumption spending—is represented by a straight line rising to the right from the origin; its angle is the wage rate. Investment spending will be treated as exogenous in the short run, so it will be marked off on the vertical axis. Aggregate demand will then be the line C + I, rising to the right from the I point on the vertical axis; its slope is the wage rate.

The origin is the point at which labor costs absorb all output.

Employment in such an economy will depend only on effective demand; there is no marginal productivity adjustment. Output will increase with the amount of labor employed (i.e., capacity utilized), with a constant average productivity of labor; all, and only, wages will be spent on consumption, and all profits will be saved as retained earnings. Investment can be taken as exogenous as a first approximation. Expenditure is given by the C + I line. (This ignores G, government spending, for the moment, although in the modern world it will be much greater than in the earlier forms of the capitalist economy.) But the output function will be a straight line rising from the origin with a slope equal to the average productivity of labor—a. Suppose investment is exceptionally high; then employment will be increased, and consumption will also be exceptionally high. Conversely, if investment is low, employment will be low, and thus so will consumption. Consumption adjusts in the same direction that investment moves.

When investment rises, consumption, output, and employment also increase in a definite proportion.

And rents? So far, in discussing macroeconomics we have largely left them to one side and that is what academic economics (apart from the work of James Meade [1966]) has tended to do.1 In spite of ignoring rents, our analysis does provide us with a number of powerful insights, mostly from a post-Keynesian perspective. Admittedly, they are derived on the basis of very great abstraction, so they cannot be “Rent” does not appear in the index of Hicks’ Value and Capital nor in his Capital and Growth nor is it found in Ferguson’s The Neoclassical Theory of Production and Distribution nor in Morishima’s Theory of Economic Growth, or Capital and Credit. These are serious books, and they seriously overlook land, rents, and real estate.

1

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expected to prove literally true; but they may nevertheless give us genuine insight into what will happen to the level of employment and output.

For example: • Investment and profits are equal here; this suggests that we should expect to find them closely correlated in practice—as we do (see Nell 1998a, chap. 7; Asimakopulos 1992).

• Investment determines profits here; investment is the driving force.

We should expect to find something like this in reality—as many studies, for example, Asimakopulos, do.

• The multiplier here will equal 1/(1 − w/a), where w is the real wage and a is the average productivity of labor. That is, the multiplier will reflect the distribution of income, and will not be very large. Again, this seems plausible.

• Real wages and the level of employment and output are positively related. This can be seen by drawing in a steeper wage line, with the same level of investment. The C + I line will then also be steeper, and will intersect the output line at a higher level of output and employment. In fact, most empirical studies of the postwar era (e.g., Nell 1998b; Blanchard and Fischer 1989) do find real wages and employment to be positively related.

• A rise in Household savings reduces output, employment, and realized profits. (Obviously, qualifications are needed, and it must be remembered that this is a short-run analysis—but the long run may never come. If this proposition seems hard to accept, think about Japan in the 1990s—and even more recently.)

• Unemployment is the difference between the level of full employment (marked off on the horizontal axis of the diagram) and the actual (current) level of employment. It clearly results from deficiency in demand. That is, either investment is too low or wages are too low, which implies that increasing either will reduce unemployment.

This is macroeconomics, the post-Keynesian variety; however, many of these propositions, or similar ones, can be found in other versions (Nell 1998a, b, under the heading “the New Business Cycle”2). None of this 2 The “New Business Cycle” (NBC) is to be contrasted to the Old. In the NBC prices are inflexible downward, but liable to inflation upward, labor is flexible; it can easily be laid off,

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would have been familiar to Henry George, who lived in an economy that operated according to a price mechanism, as we have seen. Today’s world is different. But the idea that rounds and rounds of respending spread through the economy like ripples on a pond would not have been unfamiliar. George would have had no trouble figuring it out.

Money and Interest Finally, let’s look at money; only a very limited perspective is offered, focusing on the rate of interest. (By contrast, George’s unfinished writing on money, at the end of Science of Political Economy, is extremely interesting, and far ahead of his time, starring credit as the central medium of exchange.)

The Keynesian/post-Keynesian perspective sees the rate of interest determined by liquidity preference conjointly with a supply of money from the banking system (usually considered at least partly endogenous), and then this interest rate affects both investment and consumption.

Let household saving increase with the rate of interest (as consumer durable spending declines), while business investment declines as the rate of interest rises (see Fig. 6.4). (Neither influence is likely to be very great.)3 More precisely, when interest is relatively high, businesses are likely to curtail or postpone investment projects, and households may cut back on consumer durables. Thus, when interest is high, the investment line must shift down to a lower intercept, while the household consumption line will swing down, reducing its angle. When interest rates are relatively low, investment and household spending will be correspondingly higher. Thus, we can construct a downward-sloping function relating the rate of interand adjustment to demand is done by varying employment and production. This pattern can be seen throughout the advanced world, cf. Nell (1998b). Studies of the contrasts between the “old” and the “new” business cycle have been made. Nell and Phillips (1995), studying Canada, find good evidence for an inverse relationship between product wages and employment in the old period, and a direct relationship in the new. They also find significant differences in the sizes and characteristics of firms, and in the nature of government between the periods. There is little evidence of a multiplier in the earlier period. Kucera (1998b), studying Japan, found similar results for product wages and output—with certain qualifications—and also found a weakly negative relationship between consumption and investment in the earlier period, in contrast to a strongly positive relationship in the later. Block (1998b), studying Germany, found strongly contrasting relationships between product wages and output in the two periods, as did Thomas (1998b) in an examination of British data for the two periods.

These studies are gathered together in Nell, ed. (1998b).

3 These inverse relationships reflect the “scarcity” of money, just as rent reflected the “scarcity” of land. But in each case it can be argued, along similar lines, that the scarcity is contrived.

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Fig. 6.4 Effects of interest on saving and investment

Fig. 6.5 The central bank’s interest rate determines employment

est, i, to employment, N (see Fig. 6.5). This function (in Fig. 6.5) will intersect a horizontal line representing the level of the rate of interest as pegged by the central bank; this will determine the level of employment.

The level of activity, in turn, reacts back on the demand for money.

There is no classical dichotomy here; monetary and real factors interact.

However, in the nineteenth-century craft economy the interest rate tended to rise and fall with the profit rate, moving procyclically. What if we imposed that condition here? Then the structure of asset prices would have to adapt to the real conditions of profitability—this could well imply that the long-term rate would tend at times to move independently of the

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short-term rate. A form of the dichotomy might reemerge (Nell 1998a).

This takes our story in new directions; we need to consider whether it is adequate so far—and the answer is, NO, it wholly ignores rents.

Moving Ahead: Land Land is used for many purposes—agriculture, of course, corporate farming.

But land may also be used for building—housing developments, suburbs, shopping malls, theme parks, office complexes, and so on—and these will each generate a different kind of rent. As industrialization proceeds, new factories will earn superprofits and at the same time pull up wages. In a mass production economy rents accruing to business are capitalized, and are treated as part of profits; rents paid are part of business expenses.

Household rents are part of consumption spending or are imputed rents for owner-occupied housing. These are important features of the economy, and they make up a large share of it. The simple saving-­investment-­growth models here overlook all of this.

George would have found the analysis of the craft economy familiar; indeed, he worked out some of it. He didn’t write much about supply and demand and prices, but the little bit he did fits in. He thought the system was self-righting until upset by excessive rents. His analysis of the frontier is outstanding; likewise his account of rents—up to the point where he argues that rents will often/always tend to rise relative to wages and to interest, and he in fact claims that wages and interest may sometimes decline absolutely. Those arguments, we think, are unacceptable. Our perspective suggests that as industrialization proceeds, with steady improvements in technology, wages should tend to rise, and many businesses, except the most marginal, should be in line to earn superprofits.

George’s overall perspective on growth—a classical perspective—is magnificent, and worthy of further development. This we have attempted in our account of George’s claim that the value of land will tend to equal GNP, and in our reconstruction of the so-called Henry George Theorem on the tendency of total rents to approximate the total costs of government. Today’s “macro,” however, is a wholly new way of looking at the economy; it brings in aggregate demand which is not part of George’s thinking, but, on the other hand, aggregate demand does fit together with the classical viewpoint, which provides a fine account of the aggregate supply and distribution side. We’ve brought in macro thinking, because this is

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how we have to approach growth in the modern era, and we want now to bring in rents—which are missing from almost all contemporary macro and growth models. Henry George gives us a good way to start.

Bibliography Asimakopulos, Athanasios. (1992) “The Determinants of Profits: United States, 1950–88.” In Profits, Deficits and Instability, edited by Dimitri B. Papadimitriou.

London: Macmillan.

Blanchard, Olivier Jean, and Stanley Fischer. (1989) Lectures on Macroeconomics.

Cambridge: MIT Press.

Hayek, Friedrich A. (1941) The Pure Theory of Capital. London: Routledge and Kegan Paul.

Hicks, J R. (1965) Capital and Growth. Cambridge University Press.

Marx, Karl. (1967) Capital. 3 vols. New York: International Publishers.

Meade, James. (1966) The Growing Economy: Principles of Political Economy, Vol II. London: George Allen and Unwin.

Nell, E J. (1998a) The General Theory of Transformational Growth: Keynes after Sraffa. Cambridge: Cambridge University Press.

Nell, E J, ed. (1998b) Transformational Growth and the Business Cycle. London: Routledge.

CHAPTER 7

Growth and Rents in Today’s Economy

The wide-spreading social evils that everywhere oppress men amid an advancing civilization spring from a great primary wrong: the appropriation, as the exclusive property of some men, of the land on which and from which all must live. From this fundamental injustice flow all the injustices that distort and endanger modern development, that condemn the producer of wealth to poverty and pamper the nonproducer in luxury, that rear the tenement house with the palace, plant the brothel behind the church, and compel us to build prisons as we open new schools.

—Henry George

Abstract A modern real-side growth model is developed, allowing for effects on distribution and for demand-driven innovation; it also features a wage-accumulation curve—Joan Robinson—and rents can be introduced, driven by both growth and innovation.

Keywords Markup pricing • Wage-accumulation curve • Growth and rents At the center of Henry George’s picture of the economy is the effect of “progress” on rents: it drives them up. But the economy he studied is one of agriculture and small business. The preceding two chapters have brought us to the modern economy—giant businesses in manufacturing and, most © The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_7

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of all, services: finance and health care each make up almost 20 percent of the economy, with very little employment in agriculture. Economic policy is based on macroeconomics and puts government in the center of the stage. It’s a different world, and we have largely lost sight of rents, as they are comingled with profits. But they are still right there (including superprofits) and still driven by growth, just as George said. To examine this in more detail, a neoRicardian/post-Keynesian growth model can be adapted to explore the relationship between growth and rents. In this case, however, not period-to-period growth, but long-term growth, the pattern that we can expect to hold over a business cycle (apart from the turning points). Faster growth leads to higher rents, but increases in rents do not seem to lower or weaken aggregate demand. However, they have an important implication for financial markets.

What we have just seen is a transition; the system moves from “replicative” growth, based on the price mechanism and small-scale technology, in which investment simply re-creates the existing form of production units, farms, and firms, to a different kind of growth—“innovative” or “transformational” growth—in which investment creates new productive capacity superior to the old, and in particular moves from craft technology to mass production—a system based on constant costs, which allows for layoffs of workers as output is adjusted rapidly to meet demand. (The pressure for change does not stop with mass production: innovation moves on to create the information economy.) Replicative growth can allow for improvements, but while the new capacity created by investment may be better, it will be the same kind of thing. By contrast, the growth model proposed here is one of transformational growth, in which new capacity is not only typically superior to the old, but involves new technology and therefore earns superprofits, a form of rents driven by growth, resulting from technological improvements that, over time, have a strong enough impact to lead to new patterns of adjustment. For example, in the craft economy, most labor costs are fixed because work teams have to be kept together, even when demand has fallen off, but with mass production and assembly lines, workers can be laid off, and rehired when demand rises again. Labor costs become variable.

Investment plans and long-run prices tend to be determined together, along with the choice of technology, including product design. Very broadly, firms will want to expand if they see their markets are expanding; they build new capacity in response to the expectation of growth in demand, which may be stimulated by better products, or by lower costs and prices, or by an expansion of incomes and credit in a large section of the population. The growth of markets, in general, will be greater or faster the lower prices are. This is based on the “accelerator,” the idea that if

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Fig. 7.1 Growth and wages

demand for output expands, demand for capital inputs will also have to expand (because there is a stable, fixed ratio of capital to output), but here it is combined with considerations of price (Nell 1998a).

The general idea: to determine the plans for growth as opposed to current spending on growth at least two equations are needed, because growth and prices will normally be determined together. As a first approximation, one equation could be defined to show the growth of demand as a function of prices, arguably sigmoid in shape (see Fig. 7.1), while the other would show the growth of supply, also dependent on prices, rising perhaps linearly. According to the growth of demand equation, higher prices will mean lower growth of demand; lower prices, higher growth of demand. High prices will make it harder to break into or develop new markets; low prices will make it easier. According to the growth of supply function, higher prices will provide the funds that will finance investment, for a higher rate of growth (see Nell 1998a, chap. 10 and 11). These two equations (or sets of equations) could be solved for planned prices and growth. Being forward-looking, of course, such equations must be subject to a great deal of uncertainty, and would thus be liable to frequent revisions. More importantly, such a framework is seriously oversimplified, as we shall now see, but the point this example establishes is that growth and prices strongly react to each other and must be determined together.

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This has been just a sketch. To fill it out, some other variables will have to be included. Here is how such a model might look.1

Growth Today: A First Look First, let’s look at growth, leaving rents to one side, since prices and profits are determined on no-rent lands and locations. This will help us to see how the parts hang together. To do this we combine a relationship between the real wage and the growth of demand with the well-­established real wage/rate of profit trade-off (Nell 1998a, b, pp. 477–78). The model has four variables: . growth of demand, 1 2. growth of output, 3. growth of productivity, and 4. the real wage.

The equilibrium condition is that growth of demand is equal to growth of output. Putting the variables together, we can define three important relationships rather than two.

First, there is what Joan Robinson called the “wage-accumulation” curve.

This is the wage-profit trade-off adjusted by the saving ratio, so that it shows the growth rate that can be associated with each level of the real wage.2 This relationship is inverse, and, following the argument in Nell 1998a, b,3 it is likely to be linear, or nearly so. It will shift with changes in productivity.

Second, there is the wage rate/growth of demand relationship already discussed, which includes an effect on productivity. This will be an increasing function, with a sigmoid shape. At low levels of the wage there will be some growth in demand but it will stay low and increase only slowly; at higher levels it will accelerate and rise steeply, leveling off again at still higher levels.

And third, Henry George argues strongly that growth arises from cooperation, and improvements in the division of labor, along with ­innovation, so we can adopt some form of the Verdoorn-Kaldor relationship, relating productivity growth positively to growth and real wages.

See also Nell (1998a), pp. 477–78, Nell (2002), pp. 261–63.

Each point on this curve will be associated with a set of prices. Such prices can be established as the result of firms following a markup pricing strategy, as demonstrated in Nell (1998a, b, chap. 10). The aggregate markup equations resulting from this process translate directly into Sraffa-like wage-profit trade-offs.

3 See also Shaikh (2012), Schefold (1997).

1 2

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At low rates of growth there will be little pressure on production facilities, thus little incentive to make improvements; at high rates of growth the pressure will be severe, and efforts to speed up throughput and improve processes will be great. If the improvements are easily copied and spread rapidly, so that all firms adopt them at more or less the same time, then costs will fall across the board, and the only effect on rents will be that of growth pressure. But if the improvements are hard to copy, if they affect firms selectively, benefiting some and not others, reducing costs for some without greatly increasing output, then they will have increased differentials, creating a new source of rents—but rents that will appear as superprofits! So, by including a Verdoorn-Kaldor equation we are already bringing some rents into the model.

The variables are w/p—the real wage; g—the growth rate; and x—productivity; adding this third equation, we have: g = g ( w / p, x ) , gw′ < 0, g′x > 0, assumed linear w / p = w ( g, x ) , wg′ > 0, wx′ > 0, assumed sigmoid in shape

x = x ( g,w / p ) , xg′ > xg′ g < 0, xw′ > 0 up to a point, then xw′ < 0 For a given real wage (nominal wage divided by the price level), w/p, it is assumed, plausibly enough, that there is some level of growth, g, beyond which productivity, x, will no longer increase. It is also assumed that, for a given g, at some level of the real wage x will reach a maximum and begin to decline. These assumptions effectively bound the level of x, and so ensure that the system of equations will have a solution. Given a few reasonable restrictions, it can be shown that these three behavioral equations have a unique, positive solution, which is stable by normal criteria.4 4

An example of a simple, linear version:

g = G − aw / p + hx

g = bw / p + jx

x = cg

where a, b, c, h, j > 0, and G is the maximum growth rate (the standard ratio). The solution is:

w / p = G (1 − jc ) /  a (1 − jc ) + b (1 − hc ) and it is sufficient for w/p > 0, that c, h, j < 1.

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This needs some explaining. How can a level of the real wage support a growing consumer demand, with higher levels supporting higher rates of growth? Higher wage levels can obviously support higher levels of spending, but higher rates of growth of spending? This should not be considered so surprising. Note the analogy with businesses, where each level of earnings is associated with a rate of growth of spending on capital goods. Higher earnings mean higher profits, resulting in a higher rate of profits, which gives rise to a higher rate of capital growth and therefore output. Analogous relationships hold here. Higher real wages allow for greater investment in selfimprovement—education, skills—and together, these permit greater access to credit, and so to still further investment. The real wage/growth of demand function tells us that for each level of the real wage there will be a corresponding level of investment in self-­improvement, leading to a (creditbased) corresponding rate of demand growth by households. (Note that in constructing this function we are holding capital technology constant—only improvements in worker skills are considered—so a higher wage rate will normally imply a higher wage share.) As households invest more and more heavily in self-improvement, they become increasingly eligible for credit and can increase their spending, particularly their spending on self-improvement. The function is economy-wide.

Summing up: at higher levels of the real wage there will be higher rates of demand growth, for two reasons: first, demand growth will be higher because each household may be able to sustain a larger investment in self-­ improvement, and second, because more households can be drawn into the effort to rise in the world.5 5 George was well aware of the importance of education and the improvement of skills in raising wages and living standards (provided the education was practical). Obviously, if some workers acquired skills and others did not, those with greater skills would do better in the market. But if wages rose and all workers became more educated and skillful, then it would be difficult to force wages down again. “Wherever the material condition of the laboring classes has been improved,” he writes, “improvement in their personal qualities has followed.… These qualities once attained (or … their concomitant—the improvement in the standard of comfort) offer a strong, and in many cases, a sufficient, resistance to the lowering of material condition” (309). So George sees higher wages leading to increases in education and skills and, in general, to a rise in living standards. Our addition to this is that such increases will make households more creditworthy, and thus lead to growth in consumer spending. George, however, argues that increases in wages normally cannot be sustained— indeed, will seldom occur—because improvements in productivity will be captured by rises in rents. But, as noted earlier, his analysis is defective, and the facts don’t support the claim.

(But that does not mean chap. 1 of book 6 should be rejected. The six “proposed remedies”

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We must be careful about the interpretation: the solution to these equations is not a long-period equilibrium—far from it. What the model shows is how things would work out, if everyone acted according to the prescribed formulas—and carried out their actions successfully. It shows how the variables interact. The reason that demand is growing is that families are trying to improve themselves and rise in the world. Innovation is taking place. On the other hand, it is not short-run; it covers a long-enough stretch for training and education to result in higher levels of productivity.

The time period might perhaps be a full business cycle.

If new innovations have been introduced simply because they reduce costs, we would expect them sometimes to be labor saving, sometimes to save on equipment and capital goods. Overall, there would seem to be no reason to expect any particular bias. In fact, there has been a very pronounced bias: technical development has been overwhelmingly labor saving but capital using. That is, machinery and equipment have been substituted for labor. The model can be used to suggest why, and also why labor has received little or no benefit from it. (George [1883, chap. 14] argued that labor failed to benefit because of the monopoly on land, which certainly could be a factor. But here it will be argued that the effect of innovation on wages depends principally on the wage-growth trade-off—a relationship that George overlooked.)

Start with a stripped-down version, leaving productivity growth to one side. Then consider Fig. 7.1, with the wage rate/growth of demand curve rising from the origin. As household investment takes place and wages go up, lifestyles will develop and the basic wage and expected standard of living will rise. The wage rate/growth of demand curve will shift out to the right. The wage will rise but the effect will be to lower the growth rate.

That is, when the wage rate increases, consumption increases at the same rate, and this leaves less profit available for investment. From the point of view of the individual firm, the rise in wages means lower profits. But this can be offset by replacing workers with machinery, if the technology is available or can be developed. If machinery is substituted for labor, not

for low wages and poverty are indeed “insufficient,” severally and together, to eliminate poverty, and for the reasons he advances. It’s just that they are not wholly insufficient: wages can and have advanced with productivity, living standards have risen, and poverty has been reduced. But it is still the case that progress—growth—reproduces poverty and drives rising inequality.)

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only will the rise in the wage lead to a lower decline in the growth rate but the substitution will also permit an even higher rise in the wage rate.

Alternatively, the shift to mechanization can be said to permit a larger increase in the real wage for a given decline in the growth rate. Household investment, leading to enhanced lifestyles, sets up continuing incentives for business to invest in mechanization, which in turn permits a higher rate of demand growth than would have been possible under the old techniques. Productivity increases will then continually shift the wage-­ accumulation lines up and out. Whether a given productivity shift has its principal impact on growth or on wages depends on where the wage-profit trade-off cuts the wage rate/growth of demand curve. If the intersection is in either the lower or the higher sections—both relatively flat—it will chiefly impact wages, but if it cuts the steep central section the main effect will be on the growth rate.

Household investment interacts with business capacity construction in more complex ways than this indicates, however. When household income expands and households undertake self-improvement, new markets for consumer goods are likely to emerge, especially when there have been innovations in consumer goods (e.g., time-saving household products).

But when there are new consumer goods to be supplied, there will have to be investment in the capital goods sector. An expansion of capital goods investment will require, first, investment in the capital goods sector itself, to build up the capacity it needs to supply the increased demand for capital goods from the consumer goods sector.6 New cost-cutting inventions in the capital goods sector will lead to a flurry of new investment, but it will be a once-for-all expansion. Much of this investment can be expected to create new differentials, and therefore to increase superprofit rents.

Bringing in Rents Now let’s introduce traditional land rents and their effects, incorporating them into the equations. The variables: g, the growth rate; w/p, the real wage; x, productivity growth; L, land/location, is fixed and will be multiplied by R, rents, giving, for example, rents per acre.

We now have five equations, the first three being the same as those above, but with a rent term added; and then we have two more equations: One for rents; and one to close the model.

6

See Lowe (1955, 1976), Nell (1976), Hagemann in Halevi, Laibman and Nell (1992).

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A1 : g y = g ( w / p, x, LR ) , g ′ ( w / p ) < 0; g ′ ( x ) > 0; g ′ ( LR ) < 0

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This is based on the inverse relation between profits and wages, and its dual, investment and consumption, combined to make a Joan Robinson– like wage-accumulation curve. This, in turn, will be higher and further out with higher productivity, and lower and inward when rents are higher.7 Higher rents lead to lower growth because the real estate sector does not generally invest in productivity-enhancing projects, preferring to put its profits into financial instruments.

A2 : gd = w ( w / p, x, LR ) , w′ ( w / p ) > 0; w′ ( x ) > 0; w′ ( LR ) < 0

This is an upward-rising sigmoid curve, showing how increases in the real wage raise the growth of demand (bringing in new classes of customers), shifting upward with productivity and downward with increases in rents.

A3 : x = x ( g y , w / p, LR ) , x ′ ( g ) > 0, x ′′ ( g ) < 0; x ′ ( w / p ) > 0 up to a point,

then < 0; x ′ ( LR ) < 0

Productivity growth rises with output growth at a diminishing rate, and rises (up to a point) with real wages, then flattens; it diminishes with a rise in rents.

A4 : Rn = Rn − I + ag (Yn − Yn − 1)

From the argument in Chaps. 2 and 3: A5 : g y = gd Notice that each of the first three equations connects the wage-price-­ profit side of the economy with the growth-consumption-size side. The first equation is the wage-accumulation curve, which, on the basis of the available evidence (Leontief 1987; Shaikh 2012; Nell 1998a), can be assumed to be linear or approximately linear. It will be negatively sloped 7 This equation is derived from the price-profit, growth-quantity equations (Sraffa 1960; Pasinetti 1977; Nell 1998a) and explains how firms with market power, following the growth of demand, will set prices to provide the profits that will support the investment needed to meet that growth of demand, thus giving rise to price-profit equations that can be formed into a wage-accumulation curve.

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and will shift with changes in productivity. The second is the wage rate/ growth of demand relationship, which is assumed to be sigmoid in shape.

A rise in the level of the real wage will increase the rate of demand growth, because higher incomes will raise new households into the middle class and set them on their way to establishing a new lifestyle, which will mean new basic expenditures and additional investment in human capital. At low-wage levels a rise will result in only a small increase in the rate of demand growth, but as the wage rises further this will speed up, and then finally slacken off, as the majority of eligible households will have moved.

The shape of the curve will therefore be sigmoid. With normal assumptions, we can therefore expect these two curves to intersect once in the positive quadrant.

The third equation is a Verdoorn-Kaldor relationship between productivity growth, output growth, and the real wage, showing that output growth tends to raise both productivity growth and the real wage, which, in turn, raises the intersection of the previous two curves. In each of these equations, traditional rent has been introduced appropriately.

The rental equation then follows from the previous discussion, and tends to shift all curves down (as George would have argued). Given reasonable assumptions, then, these equations are likely to have a unique positive solution, stable by normal criteria (Nell 1998a). When solving the equations including rents the magnitudes depend on the rental coefficients, but it is clear that higher growth means higher rents (and so lower wages and/or profit rates than would have been possible with the surplus implied by that set of production coefficients, so also lower consumption and growth). But the main point is that higher growth leads to new and larger differentials, and therefore to higher rents. It is important, however, to remember that this is a real-side structural model, not a predictive one.

It shows how things should work out, if activities are carried out as indicated—but without reference to the impact of finance.8 Rents depend on growth, but in what ways is growth affected by rents—for example, inversely, by reducing aggregate demand? We have 8 Finance might have an impact on “monopolization”—the development of positions of market power—through the investment policies of hedge funds and other financial companies: in order to spread risks investment policies typically invest widely, thus frequently ending up on both or all sides of a competitive market. Brisk competition will lead to some firms gaining, others losing, and this would be reflected in stock prices and earnings. But what if instead of competing, they all worked together, with the investing fund acting as coordinator? All would do well, and no one would make losses. Except the public.

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suggested that a rise in rents might reduce the rate of growth by shifting profits into the financial sector. George thought an increase in rents relative to other forms of income could have very deleterious effects, leading to increases in poverty, crime, and other social ills. And even if rents didn’t rise as much as he thought, they might still have a negative economic impact—for example, rents could plausibly reduce consumer demand, on which growth depends.

Yet this effect might be weak, and would likely be different in different periods. For example, growth will probably not be (much) affected by rents in the era of the craft economy, first, because many rents will be “Georgian,” meaning that average and marginal productivity rises and that differentials are created by innovation; and second—assuming rents are “Georgian,” so that average productivity rises—because the negative effects on the mostly working-class payers of rent, reducing their consumption spending, will be pretty much offset by the positive effects on the middle-class businesses and landlords that are the collectors of rent, or beneficiaries of innovation, who may raise their spending. It could easily be a wash. Moreover, in this era, many rents, especially in agriculture, will be “notional”; that is, owners of family farms will find their land values have gone up. This will not directly affect behavior much.

In the era of mass production (and mass consumption) family farms will be consolidated into much larger farms—but still mostly privately held— and again, rents will be notional. But now urban and suburban rents will be important, with real estate developers collecting rents or dealing in land values, and with working- and middle-class families paying the rents. The effect will be a transfer of purchasing power from those with a high ­propensity to consume to a wealthier class with a lower propensity to consume. This can be expected to impose a drag on the economy, though possibly a small one, but it will certainly be offset in part, if not eliminated, by the fact that wages and salaries are set to cover living costs, including rents, for all but those at the bottom of the scale. (Moreover, rent controls are popular with voters!) On the other hand, a general rise in land values could, if other conditions are right, set off a development boom, providing a strong stimulus to the economy—though very likely an unstable one. In general, while rents could in principle have a feedback effect, lowering aggregate demand, contributing to stagnation, they do not seem to have been a major factor. The overall effects could go either way, but for the most part seem to be small enough to ignore. But, as we shall see, this does not mean that rents are not important in the macroeconomic picture—far from it. That is the subject of Part III.

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Bibliography George, Henry. (1883) Social Problems. Chicago and New York: Belford, Clarke.

Hagemann, Harald. (1992) “Traverse Analysis in a Post-Classical Model.” In Beyond the Steady State, edited by Joseph D. Halevi, David Laibman, and Edward J. Nell. London: Macmillan.

Leontief, Wassily. (1987) “Input-Output Analysis” in The New Palgrave: A Dictionary of Economics. New York: Palgrave Macmillan.

Lowe, Adolph. (1955) “Structural Analysis of Real Capital Formation.” In Capital Formation and Economic Growth, edited by Moses Abramovitz. Princeton: Princeton University Press.

Nell, E J. (1976) “An Alternative Presentation of Lowe’s Basic Model.” In The Path of Economic Growth, by Adolph Lowe. Cambridge: Cambridge University Press.

Nell, E J. (1998a) The General Theory of Transformational Growth: Keynes after Sraffa. Cambridge: Cambridge University Press.

Nell, E J, ed. (1998b) Transformational Growth and the Business Cycle. London: Routledge.

Nell, E J. (2002) “Notes on the Transformational Growth of Demand.” In The Economics of Demand-Led Growth, edited by Mark Setterfield. Cheltenham: Edward Elgar.

Pasinetti, Luigi. (1977) Lectures on the Theory of Production. New York: Columbia University Press.

Schefold, Bertram. (1997) Normal Prices, Technical Change and Acculmulation, London: Macmillan.

Shaikh, Anwar. (2012) “The Empirical Linearity of Straffa’s Critical Output-­ Capital Ratios” in Gehrke, et al, op. cit.

Sraffa, Piero. (1960) Production of Commodities by Means of Commodities.

Cambridge: Cambridge University Press.

PART III

Rents, Real Estate Values, and Financialization

In the time of Henry George the stock market was relatively new and only a limited proportion of businesses were listed. Financial markets were small and grievously incomplete; the total of financial assets traded on all asset markets fell far short of the total value of real assets, most of which were owned directly by single proprietors or partnerships. By contrast, today, most real assets have their counterpart in equivalent financial assets: that is, financial assets are claims to real assets, or to the earnings of real assets. Their value finally depends on how the real assets are performing— ultimately, but certainly not immediately. For, as the economy has developed, a large divergence has emerged between real assets and their financial counterparts; they can move independently of each other, although in a crisis the real side of the economy will have to back up the financial side.

Unfortunately, the expansion and development of the financial side may have eroded the real side—we will explore this. In any case, the ties are no longer so close. But this is very similar to what George noticed in regard to land speculation: land values tended to lose touch with rents, and rents lost touch with earning power. Speculation drove up land values and land values dragged up rents, until rents were out of range of real earning power and the house of cards collapsed. The scale of speculation is vastly greater today, and the complexities can seem mind-bending, but the basic principles are largely the same.

In this part of the book we will develop an analysis of the growth of wealth today, in financial terms, with emphasis on access to liquid capital, eventually showing how this affects the setting of the wage—that is, demonstrating the role of relative wealth in setting relative wages and salaries. We will see

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how rents, once they have been securitized, provide a source of chronic instability in financial markets. The real story is transformational, rather than replicative, growth, and to fully appreciate this we need to pay special attention to the changing character and role of rents and real estate values.

CHAPTER 8

Real-Financial Linkages and Holding Securities

Speculators may do no harm as bubbles on a steady stream of enterprise.

But the position is different when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.

—John Maynard Keynes

Abstract A survey of the reasons for holding securities and the ways they are put together in portfolios will show that in normal conditions all securities issued will be held voluntarily.

Keywords Portfolio analysis • Stocks and bonds • Real-financial linkages • Holding securities • Markowitz portfolios The financial sector used to be (and still should be) the servant of the real side of the economy; instead, it has become the master, absorbing money and resources that could be invested in expanding real capacity but are now going into speculation. The modern financial sector has in effect become the monopoly supplier of money and credit. Yes, of course, money today is sovereign money, controlled by governments and administered by central banks, which also regulate the dispensation of credit. However, as

© The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_8

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anyone who watches the news or reads the papers knows, government control and regulation of the financial system is normally strictly vetted by the banks and financial institutions themselves, and is usually carried out by experts and administrators steeped in the ethos of that system. Its “monopoly character” is carefully protected.

“But!” our critics might cry at once. “The big banks all compete with one another, and there are many small, local, or specialized banks, and there is the nonbank ‘shadow’ system. All of them compete. At the very worst, it might be an oligopoly, but it’s certainly not a monopoly.” True enough. But real estate moguls compete too, as did the robber barons and the railroads in the late nineteenth century. When George spoke of the monopoly of the landowners, he meant that landowners as a class had a monopoly, just as banks and financiers, taken together as a group with common interests, have a monopoly today. In George’s time, he could speak of landowners primarily as a class of land-owning families, where the family patriarch would make decisions and manage (or at least monitor) the business; today, of course, we do still have large privately held fortunes that are passed on through inheritance. But the management of money—and real estate—is now handled by professionals working in a corporate setting. Money and finance, and now real estate too, have been professionalized, and are embedded in and managed by institutions rather than by private individuals and families.

And it is to this set of institutions that we—virtually anyone—must turn for money or credit. Even if someone “has money,” to mobilize liquidity, to make use of the money, it will usually be necessary to bring in a financial professional. If someone does not “have money” but needs it to start a business, or doesn’t have enough to finance an expansion, then the financial community will certainly be in the driver’s seat. To make a long—very long—story short, the transformational growth of the financial system has absorbed the real estate sector, and now the control of money and credit has replaced ownership of land as the barrier preventing the spread of the benefits of increased productivity. The US financial sector has grown from a single-digit share of the economy to almost one-fifth since the end of World War II.

The Question of Real-Financial Linkages The foundation of the financial sector consists of claims against the earnings of the real side of the private sector, or title to the real productive facilities and inventories of capital and consumption goods of that sector.

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These claims are traded in markets for financial assets. It makes intuitive sense to think that the value of the productive capacity of the private real sector should be the same as the total value of the claims in equilibrium to that capacity,1 a ratio known as Q :

Q = ( financial value of claims) / ( real value of productive assets ) = 1

In fact, Q generally does not equal 1, and we will be concerned to explain why and what the implications are. However, we will define our concepts somewhat differently from the way they appear in studies of Tobin’s Q , although we will continue to use the symbol “Q.” It should be clear that the financial sector is independent, on a day-to-­ day basis, from the “real” sector. The prices and quantities of stocks on the stock market are not closely tied to the operations of business. Put another way, the value of claims to a business does not directly depend on the degree of success of the current operations of that business—it may depend as much, or more, on the opinions of players in the stock market about what average market opinion regarding that business will be. It could be said that a key feature of the “post-George” financial system is that in day-­ to-­day operations it is strikingly independent of the real economy, and along with this, it is widely given to speculation. Of course, any investment involves making a gamble: for instance, betting on the success of a new technology (a matter of science); or that you can outcompete a rival (a matter of business acumen); or that consumers will love the new product (a matter of design). In each case, the bet involves building or developing something. Now compare this kind of investment to betting on stocks and shares, which involves not building, but buying paper claims based (as Keynes famously noted) “on what average opinion thinks average opinion will be,” or on what a statistical analysis says about the fluctuations of stock prices—in any case, nothing real, nothing that involves production or contributes to economic well-being, need be involved.

1 And what about government bonds? Should they be counted among the claims against private capital? Taxes on the output and income of the private sector pay the government’s debt servicing. Government output consists of public goods and services, for which we have no adequate measures. But as Henry George pointed out, government and goods services are necessary for growth (and its externalities may account for the equity premium). In any case, for our purposes here, it doesn’t matter which way we draw the accounts, so long as we draw them consistently: there will be a “normal” ratio of total claims to total real assets, and our analysis will describe the unstable and erratic fluctuations of Q around that normal ratio.

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It used to be that the purpose of the financial markets was to mobilize savings, and to package them so that firms could borrow them, or trade shares for them, to finance real-side investment or commercial activity. That is, banks and financial institutions and markets mobilized savings on a longterm basis to build productive capacity, or to set up department stores and shopping malls, or to establish marketing, transport, or advertising services, and in the short-term provided working capital. Now, however, this sort of thing is said to comprise about 15 percent of total financial sector activity.

The rest is competition for corporate control, or sheer speculation—especially speculation in real estate. As Adair Turner (2014) and Michael Hudson have shown, a very high proportion—ranging between 35 percent and 60 percent—of new bank lending is for the purpose of real estate dealing, not for investment in new enterprise or additional capacity.

The real sector—production, income payments, both household and business expenditure, and savings and investment—is usually, following Keynes, seen as connected to the financial sector through the long-term interest rate on loans to finance investment. This is much too simple, and is based on an inadequate conception of interest rates—e.g. spreads are sometimes as important as levels. Moreover, there have been many unsound ideas or poorly defined relationships suggested to explain how financial markets interact with the “real” economy. Keynes accepted the idea that interest rates influenced investment to a degree that does not seem to have been consistent with the evidence even then, let alone today.

Friedman famously claimed that the quantity of money directly affected demand—with an unexplained “variable lag”—and that the resulting impact of demand would affect both real income and the price level. The determinants of the split between the two were never clarified, but the price level effects were expected to morph into inflation. Patinkin maintained that “real balance effects” (where an overall fall in average prices during a downswing raises the value of money) could or would restore full employment (because money holdings would now be worth more, which should promote spending by households and business). But, contradicting this, with a general fall in prices the burden of debt is now greater, which should lead to belt-­tightening. In any case very little convincing evidence can be found for these claims. All these ideas were immensely influential but they were not well grounded in theory, nor were they clearly evident in statistics, as the endless disputes showed.

In elaborate models, there will also be effects running through short-­ term money market loans for working capital (Asada et al. 2010; Semmler 2017). “Tobin effects” come from the feedback into expectations for the

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next period or periods, resulting from the change in levels of activity in the current period. A rise in activity in the current period will often lead to expectations of further rises in the future. Such expectations for the real economy then lead to expectations of a rise in the value of stocks and shares. A rise in the stock market, in turn, is likely to stimulate further spending both by households and by businesses—a pattern of interaction that could become a self-sustaining bubble.2 Bubbles, indeed, appear to develop quite regularly. We know how bubbles work—that is, how they sustain themselves—but we have hardly any idea why they emerge in the first place. However, our analysis of rents may be able to shed some light on this matter.

But for now we must examine the working of today’s financial system.

How and why are stock and bonds issued, how and why are they held?

And what is the ratio between them, that is, what is the debt structure of the economy—and why does it matter?3 We will see that while debt/ equity (D/E) is a financial variable it requires real resources to establish and maintain it.

The Financial Sector: Portfolio Holdings of Securities To study the financial sector, we need to examine both the bond market and the stock market; we need to know how the ratio between the two— the debt/equity ratio—is determined, and whether and to what extent it is stable. To do this we need to show how the short-term market differs from the long. It has to be shown that portfolios will always be adjusted so that all securities properly issued will be held voluntarily. If this is not the case, the securities in question could fall to zero and the issuing firm might cease to exist, go bankrupt, or be reorganized.

2 George examines this kind of self-reinforcing expectation cycle with respect to land values in book 4, chap. 4, of Progress and Poverty.

3 Modigliani and Miller in a famous series of papers claim that capital structure does not matter and that an optimal debt-equity ratio does not exist. But their alleged “proof” of this assumes that, although there is uncertainty, markets are “perfect,” and all investors have the same full information and form the same expectations, including the shared expectation that all current profit streams will continue indefinitely, unchanged, that is, no defaults. In fact, markets fluctuate all the time, in waves of optimism and pessimism, and default risk is serious.

Moreover, equity is ownership, and the question of “diluting ownership” is important in deciding to issue stocks. M-M is divorced from reality.

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To explain the debt/equity ratio we can consider a firm in the market for funds for fixed capital, planning to invest and build capacity; it will be a borrower, an issuer of securities. On the other hand, there are portfolios that hold securities—that is, they are lenders as well. When interest rates are low compared to returns on equity, borrowers will want to issue debt; when generalized risk is low, issuers will be motivated to maximize leverage. Both these factors will promote the issue of bonds rather than equities, but as interest rates and risk increase, there will be a shift in preference in favor of equities. So, for issuers, the ratio of bonds to equities will fall as interest and risk increase. By contrast, portfolios, desiring earnings and being risk averse, will favor holding bonds when risk is high, shifting to equities as risk decreases. For portfolios, the desired ratio of bonds to equities will rise as interest and risk increase.

There is a relationship between the issuing of debt—borrowing—by private firms and the willingness to purchase and hold securities by portfolios to finance investment and other activities, including buybacks and other borrowing to rearrange holdings. As shown in Fig. 8.1, at low levels of interest relative to stock earnings4 the preference for debt will be high (the upper intercept on the vertical axis), but it is then likely to fall rapidly, as interest costs become a factor; however, even at interest rates that are

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Fig. 8.1 The issuing and holding of debt and equity 4 Under some circumstances interest rate differentials could lead firms to issue more debt in relation to equity. Suppose short-term interest rates were unusually low; a firm might choose to take advantage of this and increase its short-term borrowing, even if there were no clear advantage to debt in relation to equity.

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high compared to equity returns, issuers will not want to dilute ownership too greatly. If risk declines, firms will issue more debt, increasing their leverage. The shape will be an inverse sigmoid.

Now look at the holding of debt in private portfolios. The lower intercept on the vertical axis shows the debt-over-equity level that portfolios will hold regardless of the interest rate level. Portfolios will not accept much debt until interest rates rise significantly, at which point they will take it on rapidly, but even at very high rates they will still keep stocks.

Diversification will be important both for issuers and for holders of securities. If risk rises, portfolios will hold more bonds in relation to equity— since bonds are generally less risky than equity. Only in extreme conditions will portfolios exit both bonds and stocks for money, since money offers zero return (but also zero risk, in non-inflation periods).

In the long-term market the interaction between business issuers of securities and portfolio holders of securities will determine the ratio of private bonds to equities, and the ratio of private long-term interest to the equity return, subject to the levels of generalized risk—other things being equal, of course.5 Speculators will tend to bring these in line with one another. In the short market, private short rates and government short rates should differ only in risk.

These two equations together will solve for the D/E ratio and the ratio of long-term interest to equity return, subject to an acceptable level of risk. If risk rises above a critical level, portfolios will shift away from equity—that is, the lower sigmoid curve will shift up, showing that greater risk means a given ratio of long-term interest to expected equity return will be associated with a higher ratio of debt to equity.

The argument here is perfectly general. All of these calculations can be repeated for the short-term debt/revenue ratios of businesses, for the D/E ratios of financial companies, and for various other kinds of business.

Borrowers—issuers of securities—must make calculations of risk and reward; lenders—buyers of securities—have to make corresponding calculations from the opposite side. This then establishes the normal or target ratio of debt to equity. (In these equations, the price level cancels out, although if it is outside a normal range it may affect expectations.) We will see that such a D/E ratio plays a role in financial adjustments.

5 When we know the ratio of debt to equity, we can apply it to planned investment plus existing capital to get total debt, so that, given the long-term interest rate, we can calculate the present value of the stream of payments issuers will offer to portfolios.

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The Securitization of Rents Rents are flows of income, guaranteed by contracts. We commonly think of rents as monies paid to landlords, and many are. But business rents and, increasingly, those from family housing are paid to corporate entities in the real estate business. These corporate entities issue common stocks and bonds—claims to share in the rental incomes. In short, rents have become increasingly securitized.

Portfolios If we retain the assumption that interest is paid and debt is issued but that no dividends are paid, while stock prices rise to reflect the investment of retained earnings, then existing stock simply continues to be held. In the normal case, this was sufficient. If the stock was desirable in the past it will still be in the present, since nothing has changed.

This is certainly not the only plausible case when we consider market behavior. Conditions have, or may have, changed, and the stocks could be sold, so why do portfolios continue to hold them—perhaps they don’t want to buy bonds, but why do they hold on to stock? Portfolios could always sell the stocks and hold money instead. To show that securities are held in the desired ratios and amounts, it is necessary to show why securities are held instead of money. Money, of course, offers no return (except the “liquidity premium”), but in the absence of inflation it is safe, whereas securities have default and market risks. Government short securities, however, have utterly minimal risks, and may be considered a risk-free asset, although in the absence of inflation money is the most assuredly risk-free asset.

One answer would be that the entire portfolio should be considered in the light of the best available balance between risk and returns. Money is the safest, government securities next, then private bonds, then equity.

But equity will give the highest returns, and so on back down the list, to money, which yields no return. However, we must be careful talking about an “aggregate portfolio,” as if there were some identifiable decision makers who would determine the risk-return profile required to “hold” the aggregate of existing securities. Decisions are made that do result in the holding of all securities issued (or in not issuing securities that will not be held at an acceptable price). But an “aggregate portfolio” is misleading.

The aggregate is made up of two or more distinct groups of smaller

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­ ortfolios, designed with specific objectives in mind. Working capital must p be financed by short-run advances, while fixed capital (plant and equipment) and pensions must be financed by appropriately timed long-term securities—timed so that they will come due at the date when the old machines and workers retire.

Business borrowers need funds for working capital, which they turn over quickly. Firms need short-term advances, because they need to adjust their obligations to changes in the market. As demand changes, the need for working capital, especially funds for wages, will change accordingly.

Banks and money market institutions lend short term because they face potentially large liquidity demands. And, of course, they are an important part of the payments system. As for fixed capital, corporations and investment banks—as well as trust institutions and pension and other funds— hold corporate bonds and equities, and derivative instruments, as part of financing real investment. These lenders have definite needs that must be met at various dates in the future; failure to have funds on those dates may cost them much more than a financial setback—they may lose their competitive position in the real economy. This applies to borrowers as well: producers of fixed capital borrow funds to tide them over between widely spaced selling dates.

Note that long-term financial investors do not do a lot of short-term business, and money market institutions are careful about how deeply they delve into long-term investing. (Glass-Steagall in 1933 was designed precisely to keep these two apart, and the 1999 repeal has seen them come together again, with predictably unfortunate results.) Both sides have to be careful to avoid “maturity mismatches.” Matching maturity to requirements for funds avoids market risk. That is, capital losses due to market fluctuations cannot upset the payment schedules; the funds will be available in the right amounts on the due dates (subject still to default risk).

But if a long bond were replaced by a succession of short ones (rolled over), a rise in interest rate in the interim period could lead to a capital loss, creating a shortfall. Likewise, a short-term need covered by a long-­ term bond to be sold before maturity could be derailed by a collapse in bond prices. In each case, a bond falling due for the right amount at the right date avoids market risk.

But there are speculators and hedge funds that operate in both longand short-term markets, looking for arbitrage opportunities. These will tend to keep the two main sets of portfolios in line with each other.

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Indifference Curves Showing the Degree of Optimism in the Market Now let us examine the conditions for holding the whole aggregate of securities. This is a special construction for a special purpose. The generalized portfolio level of risk and the portfolio rate of return are not relevant to any of the other variables. The private long-term interest rate and the rate of return on equity (including the appreciation rate) are relevant, but then so too are the private short rate and the government rate. An aggregate average rate on the whole portfolio does not enter into anything— not into bank capital, nor real investment, nor equity growth. The only point of this construction is to show that all securities issued will be held, and if their yields are not high enough to justify holding them, then their prices will fall until they are.

We can imagine an aggregate “risk aversion” function (a kind of utility function) that shows the conventionally agreed-upon degree of risk aversion—that is, it exhibits the desired relationships between the safety of a portfolio of securities and the expected return, as understood by the market. It shows the relationships between safety and earnings that the market would consider reasonable; a portfolio manager would not be criticized for exhibiting these preferences. They can be expressed by indifference curves showing the trade-off between returns and risk that would leave investors satisfied.

The function U(…) can be displayed as a set of indifference curves, each of which exhibits the locus of combinations of returns and safety adjustment factors that will provide the same level of risk-adjusted expected earnings. This is not meant to be purely subjective; it is, rather, the consensus view of acceptable risk, and it depends on the general degree of optimism prevalent in markets. Along these indifference curves, successive unit decreases in safety (as estimated by market opinion) will have to be compensated for by increasing increments of earnings, in order to stay at the same level of expected earnings. Therefore, we can define the marginal rate of substitution; as risk increases, marginal earnings must rise to compensate.

Generalized optimism or pessimism can lead to a shift up or down in the indifference curves (or to a change in the curvature), and this can affect the whole complex of security yields. A rise in optimism leads to a willingness to take on more risk to pursue higher returns, and the curvature flattens out to the right. Larger increases in risk will be accepted in order to gain a given rise in returns. A rise in pessimism brings the opposite; only large increases in returns will justify accepting more risk.

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Markowitz Portfolios The objective is to show that the entire volume of existing securities will be held in portfolios—that is, interest rates and portfolio holdings must be adjusted so that all securities are held. Further, these portfolios must be “efficient”—that is, they cannot be profitably rearranged. (They are sometimes called “Markowitz portfolios.”) Such a portfolio shows the relationship between risk as conventionally measured and expected returns. The portfolio would be the complete set of securities under discussion: public short, public long, private short, and private long. For each level of risk there would be various combinations, one of which would be dominant; the locus of these dominant or efficient portfolios is the Markowitz set.

This construction can be shown as a curve rising from left to right at a diminishing rate—that is, as risk increases, expected returns increase but at a decreasing rate. So as risk increases, marginal earnings fall.

However, the idea of an aggregate portfolio is too great a stretch. We saw earlier that the working-capital/short-term market and the long-term fixed capital markets had good reason to stick with their maturity profiles.

Speculators could combine the two portfolios, each of which may also wish to hold risk-free assets or money. In that case, we can draw on models of capital asset pricing.

Combining the constructed portfolio with a set of indifference curves showing the generally accepted trade-off between risk and return, as defined by the degree of optimism in the market, then will allow us to argue that all securities issued would be held and that their prices would adjust to ensure their acceptability (Fig. 8.2). This means finding the point of tangency where the (rising) marginal rate of return on the indifference curve at that point equals the (falling) marginal rate of return on the Markowitz curve. This would appear to strike an optimal balance of risks and returns for the representative portfolio.

This determines the rate of return on the “marginal” portfolio, and the level of risk associated with that portfolio. But neither that rate of return nor that level of risk is of any actual interest here; the importance of market portfolio analysis is that we can show that all the securities issued will be held. That is, an examination of the overall holdings of all four categories of securities—short-term private and government, and long-term private and government—shows that all securities, existing and newly issued, will be absorbed by portfolios. Therefore, unlike in George’s era, land values and their associated rents are now incorporated into portfolios— that is, they are securitized.

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Fig. 8.2 All securities issued will be held

rate of return

market portfolio

risk rate of return

risk-free asset

risk

Fig. 8.3 The level of risk

Cautionary Note A Not so fast! There is an asset free of default risk: short-term government securities. Hence, a point can be identified on the rate-of-return axis where all funds are invested in the risk-free asset. A line from this point, with a slope equal to the risk-free interest rate, that is tangent to the efficient portfolio picks out the optimal point on that portfolio, and the line itself displays all the linear combinations of the risk-free asset and the optimal portfolio. This will be the chosen point, the equilibrium. Even though this line will in turn be tangent, at some point, to the indifference curve—indicating the best combination of securities, risky and risk-free, in light of the market’s general degree of optimism—that point is irrelevant. This is

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known as the “separation theorem”: the chosen point is independent of the indifference curves, that is, of the portfolio manager’s attitude to risk (Fig. 8.3).

Bibliography Asada, T, Chiarella, C, Flaschel, P and Franke, R. (2010) Monetary Macrodynamics, London: Routledge.

Semmler, Willi. (2017) “Destabilizing Effects of Bank Overleveraging on Real Activity,” Macroeconomic Dynamics.

Turner, Adair. (2014) “The Consequences of Money-Manger Capitalism,” Oct. 4, YouTube.com.

CHAPTER 9

Growth and Inequality in the Financial System

[A]s society grows, the disposition to continue previous social adjustments tends to lodge this collective power, as it arises, in hands of a portion of the community; and this unequal distribution of the wealth and power gained as society advances tends to produce greater inequality, since aggression grows by what it feeds upon, and the idea of justice is blurred by the habitual toleration of injustice.

—Henry George

Abstract Wealth will enable management-level employees to raise their earnings above what they would otherwise be. They will save more out of their earnings from work and out of the profits of their capital than ordinary workers will save out of their earnings from labor and their profits from their (much less) capital. These points can be put together into a simple model, which shows that the working of the financial system will steadily lead to greater and greater inequality. This will interact with the real side of the economy—the next chapter.

Keywords Wealth accumulation • Wealth inequality • Liquid capital Henry George argued strongly that progress, while raising productivity and improving technology, would tend to lead to rising income inequality and increasing poverty. He based this largely on his contention that rents © The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_9

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would absorb an increasing fraction of the surplus, squeezing out wages and profits. The claim that non-rental incomes must be squeezed is defective because it rests on unacceptable theories of the wage and interest—as we have seen. However, George’s claim extended to wealth inequality and was supported by his account of land speculation, where large-scale landlords reinvested their rents and acquired still more land, rents from which they also invested, acquiring still more, so that landholding became highly concentrated—more monopolized. There is a lesson here that needs to be explored in the context of today’s financial markets and the evident growth of wealth inequality.

Savings as they are placed in portfolios need to be examined more carefully. Investment, and other kinds of real-side spending, will determine the level of aggregate demand, and therefore of incomes; out of income there will be relatively reliable percentages saved, which are different for different social classes and categories of business. These savings ratios give us the level of savings out of money income, so liquid, and the funds saved will then be incorporated into portfolios. This process is often overlooked, but it has an important implication—namely, that some portfolios will expand faster than others, resulting in growing inequality. This will eventually react back on the real side. (Remember, the connection between the two sides of the economy is not tight.)

The Influence of Liquid Capital on Wages and Salaries, the Role of the Financial Sector, and Why This Phenomenon Was Not Seen Before Throughout most of the history of capitalism, pay for labor or work done was separate from and, ceteris paribus, varied inversely to the returns to capital. In other words, we had wages and salaries versus profits. Rich men (the rich have historically been men) owned firms and paid their top managers handsomely. Managers were still subordinates, and their pay depended on how well they pleased their employers. The distinction between owners and managers remained clear, until the time came when “ownership” became, for most investors, simply a matter of holding securities—shares and bonds. That is to say, “ownership” meant ownership of claims to income rather than command over labor and real resources.

Once this became established, the nature of the hierarchy of pay and position changed, and the way to move up in that hierarchy changed too.

When owners ran their companies, pay and promotion depended on winning the good opinion of your superiors, through good work or ­

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through many other, often less admirable, channels. This is the way things still work for the bottom 80 percent—perhaps 90 percent—of the labor force. But a significant fraction of total income at the top, a fraction that seems to be increasing, can now take a different route.

First, stock-owning managers, especially if they act together, are in a position to influence the stock market, and in effect (to some extent) to choose their “owners.” They may be able to arrange for investor groups to buy into the company on favorable terms, or to make favorable deals, joining forces with outside groups of investors. Second, they own enough capital that they have the option of using it individually to improve their position at work—in simple ways, like taking the time and spending the money to improve their skills or get an advanced degree; or in more complex ways, like resigning and setting up their own competing company, taking some of the business with them. Or, they can join an investor group that buys into the company, or make deals with executives of rival businesses. Having capital will bring them contacts and public positions, along with recognition, attention, and respect (whether deserved or not). These connections and appreciations will help them in many ways, unpredictably.

In some ways there is an analogy here to Henry George’s theory of the marginal wage, set by the earnings from setting up to farm on frontier land. A settler had to have the resources to get to the frontier, and to actually set up a farm—buying seed, tools, animals, being able and skilled enough to build a house and a barn—with a little help from friends, and so on. Plus there was risk; a farm could fail. But workers had to be paid more to keep them from moving West. Some managers would like to strike out on their own or with friends, and set up a new company, a start­up. They will need to establish a place of business, be master of the technology and able to acquire the necessary equipment, have associates to help with technical problems, have access to supplies and a way to bring goods to the market, and so on. Most start-ups fail, of course, but the ones that don’t frequently become major players, able to change the nature of the business. The best way to stop this is to give the potential innovator more autonomy, a larger salary, more responsibility and more security— keep the start-up from starting up. So the salaries of top managers will tend to reflect what it takes to keep them from setting up on their own.

And this will tend to pull up salaries across the board.

Besides these individual benefits conferred by capital ownership, there is the social, collective aspect: owners of capital share a common interest in its general profitability, in seeing that it is not taxed too heavily, nor

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regulated too strictly. In short, they can benefit from helping one another.

Notoriously, corporations find common cause in managing markets and suppressing competition at times; holders of financial assets are, if anything, even more likely to join together to find ways to enhance their wealth. One way is to establish a common, very high, standard for pay at the topmost executive levels in the corporate world. Top pay rates and individual cases both are generally vetted for boards of directors by outside consultants. Both boards of directors and consultants are made up of wealth holders, and tend to be sympathetic to increases in executive compensation. Earlier, of course, paying very high salaries to top executives could be seen as throwing away shareholders’ money; but since the 1980s, productivity has risen while working-class and middle-class pay has stagnated.1 There is, therefore, a margin available: the top pay to executives will come out of the savings on the pay of the bottom 90 percent.

A Simple Model of Wealth Accumulation and Inequality (with Linear Coefficients) Portfolios have further implications for saving and financial accumulation, assuming that the output-expenditure side of the economy continues to function smoothly at, or near, full employment. Real investment is assumed to be strong, so that there is steady growth from period to period, as shown in the growth model earlier. Investment will be financed in one of the ways just discussed, so that portfolios will have to adjust. Wages and salaries will be paid, and profits earned according to the norms and practices of the real economy. BUT wages and salaries and profits will be enhanced and affected by what happens in the financial side, along with the value of financial capital—and this is what we will look at now.

“Capitalists”—holders of claims to income from financial capital (stocks, bonds, options, securities, etc.)—earn what we shall call “profit” income, P, by which we mean income from holdings of financial capital, including real estate and real estate securities. Note that this may consist of money payments like dividends, interest, and rents, but it may also be capital gains from the increase in price of the assets. Further, however, recall that workers also save, and therefore have such capital income along with their principal income, wages, W. So capitalists save a large fraction of their profit, Pc , and a large fraction of their high salaries, Wc ; so their 1 In the 1960s top executive pay in the United States was about 30 times the average pay of production, non-supervisory workers. Today, it is about 300 times of that.

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saving is sc (Pc + Wc), where sc is capitalists’ propensity to save (assumed here, for simplicity, to be the same for both types of income). Workers save a much lower fraction (sw) of their wages, Ww and of their much smaller profit income, Pw , so their saving is sw (Ww + Pw). Besides workers and capitalists, as here defined, there will be a class of non-owners—a precarious class, with zero or negative net worth, and no job security (if they are employed at all). Any increase in financial wealth will increase inequality with respect to this class.

We know that the capitalist class has substantially more financial capital, f K, per capita than the working class; moreover, for this argument, which is about inequality between classes, we will include the value of holdings of land, office buildings, and rental property in the capital of the capitalist class, and the corresponding rents will be included in capitalist earnings from wealth. Worker capital will include pensions and owner-occupied housing, and their incomes will be adjusted for imputed rents. At the outset, in the initial period, there will be a large difference between capitalist wealth, so defined, and working-­class wealth, a difference expressed by the parameter a, which will increase from period to period. Therefore, capitalist earnings from (its managerial) work will be proportionally higher per capita than the earnings from the ordinary work of the working class.2 Further, if the capital of the capitalist class contains a larger fraction of rental securities and real estate than does the capital of the working class, then the capital of the capitalist will expand faster on its own, due to the rise in rents brought about by growth. This will tend to increase inequality by itself.

Let us set this last point aside for the moment. If the coefficients for the impact of wealth on earnings from work are the same, then wages per unit of financial capital will be the same for the two classes. This ratio will be w. Writing the equations with the subscripts c for capitalists, w for wage earners, L for labor (number of workers), and W for wage/salary income— remembering that a is the ratio between capitalist and working-class per capita wealth—we get: f

K c / Lc = a f K w / Lw , where a > 1,

and we will consider it constant during the period, though rising from period to period. For wages, we have 2 We could and should add that credit availability depends on wealth, so credit will be available to capitalists far more readily and far more cheaply than to workers. This will intensify all our conclusions, but we will not include this in order to keep the argument simple.

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Wc / Lc = aWw / Lw .

Combining these, a cancels, so

W = W= w. c /f Kc w /f K w

Now consider the implications for the growth of inequality. The respective financial incomes of the two classes are Yc = Pc + Wc and Yw = Pw + Ww .

Both P and W depend on f K here, that is, on the respective holdings of wealth by the two classes. We are not concerned at the moment with the real economy; we assume it is working well and that aggregate demand is such that the level of employment is satisfactory, and that revenues are such that wages, profits, and rents can be paid. Our concern is with the effects of growth on the holding of wealth, and with the consequent influence of these changed holdings on distribution. Growth of the holdings of the respective classes will depend on their savings. (We assume savings— demand for securities—to be immediately turned into new holding of securities: there is no problem of adequate supply of securities. This might reflect issuance of securities for investment equal to savings, or it might reflect the issuing of securities by financial firms—what used to be called “pyramiding.” Or both.)

Sc = sc ( Pc + Wc ) , and Sw = sw ( Pw + Ww )

Now divide both sides of the first equation by the financial capital of the capitalist class, and both sides of the second by the financial capital of the working class: gc = Sc / fK c = sc ( Pc + Wc ) / fK c = sc ( r + w ) , and gw = Sw / fK w = sw ( Pw + Ww ) / fK w = sw ( r + w ) . Hence,

gc / gw = sc / sw .

Based on the premises of this model, both profits and wages stand in fixed proportion to capital—r and w, respectively; therefore, the growth of capital holdings will raise profits and wages in proportion. Thus, the growth of capitalist financial income, Yc , will be given by gc , and the growth of working-class financial income, Yw , will be given by gw . Accordingly, Yc will

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grow faster than Yw . Inequality between capitalists and workers as measured by a, will, therefore, increase from period to period at the rate gc − gw , the difference between the growth rates. But we should remember that there is a large fraction of the population that has no net wealth at all, so any increase in financial wealth will increase inequality with regard to them.

Both capitalists and workers will increase their wealth at their respective growth rates compared to this underclass, which has no wealth and does not save.

Finally, as mentioned above, if the capitalist class has a higher fraction of real estate securities among its holdings, its wealth will tend to rise relative to the wealth of the working class for that reason alone.

Toward a More Complete Model Increases in inequality will tend to reduce the propensity to consume, weakening the multiplier and making it harder to sustain aggregate demand, slowing growth in the upswing and deepening recessions.

Rising inequality will also tend to shift investment and innovation toward luxuries and items for the extremely rich, as, for example, in the emerging field of space travel. The weakening of demand could make it more difficult to develop new products and new technologies that require enormous scale in production and need a mass market. This could bring on or intensify long-term stagnation, leading to a collapse of investment, whereupon the effort to keep up the supply of securities, through pyramiding and developing derivatives, will drive the valuation ratio to unreasonable heights and could ultimately lead to another breakdown of the financial system.

On the other hand, a political solution could emerge—taxing unearned income, perhaps even taxing wealth (or, as Henry George advocated, taxing rental income), but, most importantly, taxing financial earnings, at the same time providing a long-term stimulus to employment, including job retraining in the context of a system of public employment (preferably one that operates countercyclically, such as an employer of last resort).

These possibilities deserve careful attention, but they go beyond the objective here, which was to show how the saving-accumulation process, together with the effects of wealth on earned income, would tend, as George suggested, to generate greater, persistent, and regularly increasing income inequality.

CHAPTER 10

Rents and the Securities Markets

How speculative rent checks production may be seen not only in the valuable land withheld from use, but in the paroxysms of industrial depression which, originating in the speculative advance in land values, propagate themselves over the whole civilized world, everywhere paralyzing industry, and causing more waste and probably more suffering than would a general war. Taxation which would take rent for public uses would prevent all this.

—Henry George

Abstract Here the whole argument will be pulled together, developing a picture of a cyclical pattern of interaction between the real and financial sides of the economy, drawing on an unstable money supply system, most likely culminating in a crash. The cycle is sketched, showing the forces that generate an expansion, then the upturn of financial speculation, leading to excess, followed by the changes that bring about a downturn and a crash. The role of rent-based securities in the cycle is surprisingly important, and has not previously received the attention it deserves.

Keywords Business cycle • Financial speculation • Monetary instability • Increasing returns

© The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_10

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This is what we have been leading up to: growth of the economy leads to growth in rents, just as Henry George said, but now pushing up the value of rent-backed securities, which then drags up the value of other securities, creating pressures that have a strong tendency to turn into a self-­sustaining bubble. But such bubbles have to burst, though the timing cannot be predicted. As a result, the economy faces increased uncertainty and instability.

Let us again consider an “overall portfolio,” that is, an aggregate of portfolios, under stable and normal conditions, where holdings have been “optimized” in the light of risk and price/earnings (P/E) ratios, and investors are satisfied. All stocks and bonds that have been issued legitimately are held in portfolios voluntarily; no one is holding any securities because they were unable to find a market for them. Short-term securities, long-term securities, and rent-based securities are all settled in comfortably at the conclusion of a “period”—say, at the year’s end, when audits are taken everywhere.

In these circumstances, consider the impact of growth from one period to the next. To keep the story simple, let’s assume that growth in the real side of the economy is “balanced”: all sectors expand in the same proportions, C, I, and G all expand together, and wages and prices are steady, so that initially, at least, everything remains in equilibrium. This is not a “harmless” assumption; we make it only to focus at the outset on the impact of growth on securities, but we will have to abandon it right away.

In the Information Economy many, many processes and activities exhibit increasing returns to scale and/or scope, plus there are widespread “network” externalities. Earlier we saw that the cost structure of the Craft Economy reflected Diminishing Returns, while that of Mass Production showed Constant Costs. In the same way the Information Economy experiences widespread Increasing Returns; we will neglect these for now, but they will be important later. For simplicity, we can assume that profits are generally saved (except for some luxury consumption), while wages are chiefly consumed—workers also save, and therefore have wealth holdings.

Profits will be paid out as dividends and interest. Provisionally, we will adopt the convention that rents, held in higher income portfolios, are spent on luxury consumption. Savings and investment will be equal.

To examine the impact of this growth on the financial side, we have to analyze two cases, here taken as pure, but which obviously can be mixed together:

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First, balanced financial expansion—meaning that the new growth is financed with the same ratio of debt to equity as in the previous period, so that equity prices will be the same and interest rates will be unaffected, ensuring that bond prices will hold steady. Firms pay out all profits in interest and dividends, and then borrow back the funds by issuing new bonds and new stock certificates. Quantities of stocks and bonds will thus increase in exact proportion to the increases in real investment, but the ratio of stocks to bonds will not be affected. The P/E ratios of both stocks and bonds will also be unaffected.

This might seem a safe and desirable position, a financial equilibrium built on a real equilibrium, but as any reader of Henry George will know, that is not what we really have. Growth increases rents, and in equilibrium the portfolios all contain, or could contain, real estate–based securities, whose P/E ratios will have fallen. The portfolio balances will be upset; if they were in equilibrium before, they will have to be adjusted, since a large class of securities now has lower P/E ratios but (based on the premises of this model) unchanged risk. Holding more of these securities will be called for; portfolios can therefore be expected to sell off some of their other holdings to buy more rent-based securities. Also, such securities will be worth more as collateral; likewise, such securities held by banks will be worth more, thus increasing bank capital and permitting more loans. As a result, money for asset buying and selling will be increased.

But “adjusting portfolios” means selling off shares, and this will tend to depress share prices. This may be offset in part by new money coming into the market, but firms that do not want to see their shares fall will adopt strategies to prevent this, as we shall see.

Second, bonds and self-financing—meaning that firms would continue to issue debt as before, but instead of paying out dividends they would finance investment by retained earnings: no new shares would be issued, but profits would go directly to investment, in the expectation that existing shares would rise in price (“growth stocks”). Assuming that profits are the “right amount,” the increase in share value would mean that the overall debt/equity (D/E) ratio would remain unchanged. But the situation is not so simple; the existing shares would initially be unaffected, although they would constitute a fixed set of claims to a larger productive capacity—but still priced as before. This is equivalent to a lower P/E ratio. An appropriate rise in share value will mean that equity rises to keep pace with the new bonds; but for shares to rise in price to reflect the fact that they represent claims to increased productive capacity there will have to be market pressures, which means that portfolios will have to be adjusted.

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Again, the rent-based securities have experienced a rise in the underlying real earnings, so their P/E ratios are down. In short, this case is also an unstable position: both equity prices and rent-based security prices have to rise. But the equity is a claim to a larger or improved real asset, which should (eventually) result in higher earnings, assuming the expansion/improvements were wise; the real estate security is a claim to exactly the same real asset as before, although it is earning more now, right now.

Portfolio managers will typically look carefully at real investments, especially if they don’t know the business well, but when they see rents going up, if the location is good, they are likely to consider it a good sign. It is likely to be easier for real estate securities to rise than for growth stocks.

Portfolios will have to sell off securities or borrow against them to buy the securities with lower P/E ratios. This may cause turmoil. Banks, however, will eventually find themselves holding more-valuable securities, so they will be able to make more loans.

Could it be that these adjustments can be made quickly, moving to a new equilibrium? It is possible (unlikely, but possible) that the increases in productive capacity could be foreseen with accuracy—after all, the investment plans have been formed carefully, well in advance—so that a rational expectation could be formed of what the increased value of the claims to the new capacity should be. If everyone held the same expectations, then very little would be required in the way of market pressures to drive up share prices by the right amount. This is a fantasy, of course: everyone does not hold the same expectations, and there is no guarantee that the expectations will be correct. We wouldn’t invest in it if we didn’t expect the new technology to work—but very often it doesn’t. Even if it did, our forecasts of how profitable it will be may prove far from accurate.

Realistically, the adjustments cannot be made smoothly, and the fact that the rise in rent-based securities will increase both the value of collateral and the value of bank capital will threaten to set off a “positive feedback” cycle of asset price increases followed by bank lending expansion, followed by more asset price increases.

The point is, starting from an “equilibrium” balance between steady growth in the real economy and portfolio equilibrium on the financial side, a process of adjustment has to take place that will tend to generate destabilizing movements. The system cannot remain in equilibrium.

Look back at savings and investment: savings are made, investors issue stocks and shares—and bonds—to obtain the savings, and they then spend the saved funds on capital goods. So real investment—expansion of productive capacity—is matched by an increase in the amount of securities

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outstanding. There need be no rise in the prices of stocks and shares. But when real estate values go up, this is a pure asset price increase: the amount of land and the number of locations have not gone up. As a result, a rise in real estate values will tend to set off adjustments in portfolios, as well as encouraging an increase in bank lending for dealing in asset markets. This can easily develop into an asset-pricing boom.1 In fact, we have two destabilizing processes here. The first is the interaction between the real and financial sides of the economy arising from the effects of growth in generating rents, which in turn impact financial markets, with feedback effects on the real side. The second is the way the effects on financial markets can get swept up in a potentially runaway upward spiral—that is, a rise in asset prices leads to bank and monetary expansion, which leads to a further rise in asset prices. This can also turn down: a fall in asset prices tends to lead to bank and monetary contraction, bringing a further fall in asset prices. Each of these interaction processes strongly tends to be destabilizing. Looking more closely, for example, at what happens to the D/E ratios, let’s ask, if equity rises, will not debt rise also, to keep the D/E ratio constant? And will the combination drive Q (the valuation ratio) up?

First, the growth of output and real capital leads to a rise in rents, increasing the earnings of rent-backed securities, thus lowering their P/E ratios. This will lead to a rise in the demand for such securities, causing portfolios to alter their compositions by selling off other securities in order to bid for rent-backed securities. The securities being sold off will tend to drift down in price, unless otherwise supported.

Issuers of other securities will want to keep their prices up, to keep them competitive with real estate securities. (If a company’s stock prices are down, raising money through new issues will dilute earnings to a greater extent.) They will develop strategies to support their stocks, notably “buyback” purchases of their own stock.

This provides upward pressure in the markets for securities, which will tend to lower the D/E ratio—which would tend to encourage more ­borrowing, but the question here does not concern additional borrowing for building additional capacity. The issue is financing the purchase of securities. The rise in asset prices also has a dual effect on the banking system. On the one hand, it increases the value of potential collateral; on 1 See Kindleberger (1978), Minsky (1986), Nell (1998a, b), Nell and Errouaki (2013), Ch 12.

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the other, it increases the value of securities in the banks’ own portfolios.

Both of these effects tend to allow banks to increase their lending.

These additional loans amount to an increase in the money supply for asset buying and selling. A portfolio manager takes out a loan and buys.

The seller then uses the proceeds to buy further assets, but keeps a fraction of the funds for liquidity or precautionary purposes. In turn, the recipient of the funds passed on takes out a liquidity and precautionary fraction, and buys still further, and so on. This becomes a convergent series: if the liquidity/precautionary fraction is q, then the total spending will be the initial set of loans, multiplied by 1/(1 − q).

This asset price money multiplier, analogous to the (in)famous alleged money multiplier that supposedly operated in the real economy, will then engender a sequence of transactions that will drive up asset prices by more than the initial impact. So let’s look at how an asset price bubble develops.

At the outset, real growth leads to a rise in rents, which leads to an important sequence: • a rise in rent-backed asset prices (lowering the D/E ratio) will be followed by buybacks to bring up the prices of other assets; • collateral, along with bank capital, then increases in value; • the (apparently justified) expectation of rising prices encourages plans to make further purchases; • more loans are taken out (the D/E ratio is down, so more debt is permissible); • spending from the new loans drives up asset prices further (restoring the D/E ratio); • initial spending leads to respending from the receipts, drives up asset prices still further (via the asset price multiplier), and again lowers the D/E ratio; • the value of collateral and bank capital rises again, permitting more loans and strengthening expectations of rising prices; and • such rising value leads to yet another round of increases in asset prices, including more buybacks.

This spiral could be fixed in diameter, presumably depending largely on the D/E ratio, or it could expand (exploding) or contract (­converging) depending on a number of variables, not all of which can be explored here.

But it will certainly contract if perceived risk rises rapidly as asset prices increase—banks will not be willing to lend as much as their capital permits.

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If risk rises less rapidly than bank capital, however, they will lend to the full extent permitted (or even beyond), leading to a strong expansion, but sooner or later risk will tend to increase, and lending will be cut back.

Of course, there are other things that drive up rents and real estate values—they should be included too. But the impact of rising rents on security prices seems to be an unavoidable factor driving up real estate and other financial assets. Any such perpetual pressure is going to affect asset markets in ways that are likely to encourage speculation. Let’s consider this in more detail.

Real-Financial Instability At the outset of this process, we assume the real economy is experiencing balanced growth with steady wages, prices, and profits (but inequality is growing over time). (Later we will see that in a boom the economy may experience “jobless” growth as a result of increasing returns.) Productivity is growing, so the rise in rents need not lower profits or wages, unless rents rise more than proportionally. We also provisionally assume given and unchanging monetary policies. On the financial side, the new real capital is balanced by new issues, with a given D/E ratio; hence, the rate of profit is steady. With rising rents, the prices of real estate assets are also rising, leading, as described, to a general rise in financial assets, driven by the asset price cycle. So, as a consequence of securitized rents, real-side profits as a ratio to overall financial claims will fall. The real surplus will not be enough to provide a satisfactory rate of return on financial assets, creating pressure to drive wages down and force productivity up. This, combined with using part of profits in buybacks rather than in real investment, will tend to further weaken aggregate demand—already weakened by rising inequality—worsening the pressures.

This sets the stage for a terrible crisis: on the one hand, the growth-­ rent-­ portfolio-adjustment process tends to drive up financial assets, increasing inequality and leverage and indebtedness while raising the valuation ratio, yet at the same time creating pressure to push down wages and reduce employment through labor-saving innovation. On the other hand, higher inequality, lower wages, and higher debt increase financial fragility: the ratio of overindebted agents rises, leading to curtailed spending and, eventually, to deleveraging, so that a debt-deflation cycle may form—all of which tends to weaken aggregate demand. The feedback effects will include higher overall saving and therefore weaker markets, higher risk

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Fig. 10.1 Growth and the valuation ratio

premiums, and bigger spreads, raising costs to households and businesses, leading to weaker household, business, and investment spending and thus a more stagnant economy.2 As the real and financial sides of the economy pull further and further apart, both the economic links and the social fabric will begin to rupture—with consequences that cannot easily be predicted.

These steps in the cycle can be charted on a phase diagram (Fig. 10.1), plotting Q, non-derivative financial assets over aggregate real capital, on the vertical axis and the growth rate of output, g, on the horizontal. A rough account can be given as follows (there can be variations in several of these steps, but they all lead in the same direction): 2 This implies a valuation ratio above unity, Q > 1, which in conventional theory should lead to higher investment. But that theory was based on the idea that Q > 1 reflected higher expectation of profits in the future—raising equity prices—whereas in the circumstances described here the higher valuation ratio reflects the working of destabilizing processes. If Q > 1 did lead to higher investment, this would strengthen the boom and tend to keep Q from rising so much, or at least not as fast. It would be quite possible to imagine real investment tracking the changes in Q, lagging behind by a period. However, there are other important influences on real investment besides Q, chiefly the expected growth of markets— which will be hampered by the growth of inequality.

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• Starting below 1, as g rises, rents will rise, setting off a financial expansion, so that Q will rise also, from left to right, slowly at first, then faster, and finally much faster than g, which will tend to slow down as financial expansion cuts into the funding—and planning— for real investment. Ultimately we see Q rising vertically—at which time it will overshoot the vertical and turn back to the left, as the impact of the rapidly expanding financial system on the real economy turns negative, reducing growth. That is, the high level of asset prices—and the need for buybacks—will come to affect investment in the real economy negatively, by increasing the burden of debt and curtailing spending, so that the growth rate not only stops rising but begins to decrease. If as g rises, growth tends to become “jobless”, the wage bill will not rise fast enough and consumption will no longer keep pace, so stagnation will develop. This will add to the pressure for a downturn.

• At this point portfolios will begin to unload, and as asset prices start to fall, selling will rapidly increase, bringing a sharp downturn. This amounts to a fall in Q, at first slow but then becoming a vertical drop as deleveraging kicks in. Deleveraging will drive Q down below unity, dragging growth down at the same time; at the point where deleveraging is complete, Q will stop falling.

• But even in the slump real side investment will continue, at least for replacement, which will normally include improvements. As a result there will still be pressure capable of driving up rents. If rents are rising in a slump where everything else is stagnant, investment will take place in real estate as well as real estate securities, tending to bring about a construction upturn. So the real economy should begin to recover (although the timing cannot be predicted), and both g and Q will begin to rise again. Recovery is not automatic or assured; the economy could stagnate, unless a policy stimulus is provided.

This picture could be made into a precise model by introducing specific mathematical assumptions, for example, writing g as a function of Q and dQ/dt, and Q of g and dg/dt, with appropriate assumptions about borrowers and lenders, then finding an equilibrium point and deriving a specific cyclical pattern around that point. Doing this might be useful at a later stage. But for now it seems better to keep the discussion open; every one of these steps is plausible, but most of them could take place in more than one way. And the cycle could be one that expands from period to

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period, in wider and wider swings; or it might contract, tending to spiral in to a single point—or it might tend to just stay about the same. Or it might tend to expand at one time and contract another. The important point is that rents and real estate play a role in both the upswing and the downturn—the whole picture is realistic, although abstract. No “perfection” assumptions have been made, attributing impossible powers or knowledge to agents. Moreover, it is also open, allowing for the possibility of various different, but related, patterns of movement.

There do not seem to be any stabilizing features arising from the market to offset this plausible drift toward a spiraling vortex. Stabilization will have to come from government! The financial system is fragile, and it appears that the fragility will tend to increase over time, until it breaks apart! Unless there is an effective and well-executed intervention.

Policy Implications Monetary policy has been the approach of choice in recent decades, but evidence and experience have shown that while aggressive “quantitative adjustment”—buying securities to support their prices—might perhaps be able to mitigate the downswing in financial markets somewhat—unless the collapse is too extreme—it will not be able to prevent either the upswing or the downturn. Nor will it have much impact on the real side. Nor will it alone be able to generate a low-level upturn. Fiscal policy and regulation are also needed. As they used to say, “You can’t push on a string.”

Moreover trying to rely on monetary policy to control financial excess can be dangerous: Tight money cannot easily pop an asset price bubble without stopping the rising prices altogether—to slow them down, it seems they have to be stopped. But if they stop rising, or even rise only very slowly, they won’t make enough to meet their carrying costs—so it’s time to sell!—and this will bring about a crash.

As to fiscal policy, it should dampen the upswing and stimulate the downswing, so it is important that it should be “built-in”—deliver its impact automatically. An employer of last resort (ELR) policy should be considered. The basic idea is that public service jobs, and production of public goods, will be ratcheted up when the economy turns down, while in boom times, public service employment will be cut back or allowed to drop off, so as to supply experienced labor to the private sector.

An ELR policy fits well with important and widely accepted moral beliefs. It fulfills the work ethic, while providing opportunities both for

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work and for training to everyone. And it helps to ensure that no one who is able-bodied and competent need go without the basic necessities of life.

It keeps the abilities of the workforce active and up-to-date, so our human resources do not go to waste.

There are several variations of an ELR proposal. In some the government hires the workers itself; in others the government provides subsidies to firms to hire the workers. The proposals also vary in how workers are paid. In some all workers are paid the same minimum wage, regardless of the kind of work they are performing. In others the wage rate depends upon the kind of work being done and is set at the going market rate. But any kind of ELR makes the opportunity for employment universally available. It is not that everyone has “a right to a job”; if someone doesn’t do the work they can be fired. If they are not qualified and are unable to learn or refuse to learn, no one has to hire them. But the state has the duty to provide opportunity to everyone. Nor is this a new idea in the United States. It was a component of Roosevelt’s economic bill of rights, and it appears in the Universal Declaration of Human Rights, to which the United States is a signatory. By making the opportunity for employment an entitlement, this right becomes effective. It is a meeting of mutual responsibilities between the society and the individual—the former offers a job, the latter takes on the responsibilities of work. People are assured of the self-sufficiency and self-reliance that come with the dignity of a job.

Now that we are considering questions of policy, when we come to taxation where better to start than with taxation of rents (the Henry George Theorem)?

The tax upon land values is … the most just and equal of all taxes. It falls only upon those who receive from society a peculiar and valuable benefit, and upon them in proportion to the benefit they receive. It is the taking by the community for the use of the community of that value which is the creation of the community. It is the application of the common property to common uses. When all rent is taken by taxation for the needs of the ­community, then will the equality ordained by nature be attained. No citizen will have an advantage over any other citizen save as is given by his industry, skill and intelligence; and each will obtain what he fairly earns. (p. 353)

The “single tax” policy may not raise enough revenue to cover all of today’s government expenses, but it will certainly go a long way toward

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doing so. This is a tax that virtually all economists agree is non-distorting, and it falls on those who can afford it. Is it confiscatory? That depends on its specific design, but yes, to a certain extent it is and it should be—one objective is to eliminate speculation on land values. To do this, it is necessary to eliminate the possibility of gain from holding land. A major tax on rents is surely a step in the right direction for controlling and preventing the instability we have described and analyzed here. (cf. Goodhart and Hudson, (2019) for a proposal taxing land and using the proceeds to reduce the burdens of debt, drawing inspiration from the ancient custom of Jubilees canceling debts.)

But as we have seen, rents and real estate are now only part of the picture. It is no longer just land and rents that stand in the way of progress but the whole financial system—the servant has become the master. Finance is necessary, but a large “monopolized” sector of banks and hedge funds speculating furiously at levels that could sink the economy—again!—is certainly not necessary. A very good first step would be a “Tobin tax,” a tax on trading, on transactions, to diminish speculation—as Henry George often proposed. A stiff tax would be desirable and would provide significant revenue. It could be made more effective by reducing or voiding or reducing the tax if the securities have been held for a long-enough period of time.

To counteract other financial pressures and dangers will require defining other new taxes, designed to reduce speculation, especially on derivatives. Bear in mind that we want not only to reduce speculation, but also to reduce the financial system, reduce and even eliminate large parts of it.

It is a fifth or more of the economy, and it is both dangerous and almost wholly useless, in that only a very small part of its activity is devoted to its traditional tasks of financing real economic activities. Finance needs to be reconceptualized—but that is more, much more, than we can do here. A few suggestions, though.

New regulations, as well as new subsidies and new forms of insurance, will be needed to ensure that credit can be available to risky start-ups and proposed expansions of existing businesses. Promising innovation should be encouraged, and the public, which benefits from externalities, should bear some of the risk. An independently run, publicly funded agency could be created to provide venture capital to start-ups, at low rates. A similar agency could be created to provide low-cost liquidity to businesses, for example, loans for working capital. These should be non-profits; low-cost credit is a public good and should be made widely available. Many credit

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arrangements might usefully be converted to equity participations, reducing the risks of bankruptcies and lawsuits. What about the risks and especially the costs of failure? Bankruptcies will surely occur and what then?

Just throwing away the public’s money, our hard-earned taxes going to waste, and so on. Not a problem. The suggestion here is that the government creates money to finance such agencies; they should be carefully staffed and managed well, in which case they won’t lose much money, but they will promote innovation and competition. The money that is lost will be credit money the government agency created. The loss will not be felt by anyone, nor will it be a burden on the system as a whole.

This may well require designing new financial institutions, with a large public interest, and redefining property rights and credit systems to create a more equal system, and one that will work more smoothly, bubble-free!

A huge job lies ahead!

As to money itself, a case can be made that, in the digital age, it no longer makes sense to combine the medium of exchange—(essentially credit, as Henry George points out in his devastating criticism of Adam Smith on money)—with the liquid store of value. Credit can be created very cheaply and, with instantaneous information systems, can be continually vetted: it could easily be made widely and inexpensively available.

Current institutional arrangements basically serve the purpose of keeping credit and money scarce, yielding a monopoly profit. The store of value— being an asset—has to be earned, so by nature it will be “scarce.” But the medium of exchange does not have to be inherently valuable, and it will benefit the whole community if it is not scarce. Money needs to be reconceptualized.

International Implications Growth rates differ between countries, and the extent to which growth drives up rents also may differ between countries, or times and places generally. Hence, the pressures that changing rents and real estate values exert on the various financial sectors of the different nations will vary, and we can expect to see different patterns of boom and bust among them.

This has consequences on two levels. At the micro level, for example, it can upset cost calculations and such things as insurance plans that cover activities that cross borders. At the macro level, it can lead to movements in relative currency values, sudden appreciations or collapses, which need not reflect in any way changes in the real economy of the various countries

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(although the financial changes may bring about changes in the real economy, too). But changes in currency values can have such major consequences that it will be necessary to hedge against them.

Provisional Conclusions In the craft economy, rents, resulting in real estate values, were a straightforward transfer from the working class, broadly considered, to landlords, but because of similar propensities to consume and other reasons this transfer did not greatly affect aggregate demand—although, over time, it did seem to significantly change the income distribution. Rents did tend to lead to rising inequality, and eventually to divergent patterns of class behavior. Much the same can be said in the case of mass production, at least in the early stages, but once rents and real estate became securitized, they came to play a truly major, and dangerously destabilizing, role in the interaction between the real and financial sides of a growing economy.

Who would have thought that Ricardian rents, reconceptualized along lines suggested by George, Marx, and Sraffa, would provide a key to understanding the processes that are chronically destabilizing the modern global financial system?

Bibliography Kindleberger, Charles. (1978) Manias, Panics and Crashes: A History of Financial Crises. New York: Basic Books.

Minsky, Hyman P. (1986) Stabilizing an Unstable Economy, New Haven: Yale University Press.

Nell, E J. (1998a) The General Theory of Transformational Growth: Keynes after Sraffa. Cambridge: Cambridge University Press.

Nell, E J, ed. (1998b) Transformational Growth and the Business Cycle. London: Routledge.

Nell, E J and Errouaki, K. (2013) Rational Econometric Man. Cheltenham: Edward Elgar.

CHAPTER 11

Conclusions

Abstract Poverty and instability result from the working of the whole financial system, not just real estate. Henry George’s proposal for a single tax on rents should be expanded to a set of taxes on the financial system, especially on speculation, for example, Tobin taxes. The financial sector should be seriously reorganized and reduced in size and importance.

With taxes falling chiefly on rents and financial earnings, government spending should be used to manage aggregate demand and support innovation. These policy changes could break the link between Progress and Poverty.

Keywords Single tax • Tobin taxes • Progress • Poverty • Real estate Progress, in Henry George’s view, led to greater productivity and wealth, to improved education, technological development, and scientific advance; but it also led to greater inequality, poverty, and degradation. Progress brought poverty in its wake because progress drove up rents, until rents absorbed all the increased wealth. This had to be corrected by the ‘single tax’. But this claim depended on his argument that wages and profits would be prevented from rising during progress—wages because they were set on marginal land, which would become progressively poorer ­during growth, and profits because they depended on capital, which would © The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0_11

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also have to work on poorer land, and in many cases would be subject to monopolization. This last was surely true, but his earlier argument directly contradicts his account—his brilliant and ingenious account—of how rents arise in the first place, on the “unbounded savannah.” Remember: there, all land was equally fertile, so there was no reason to choose one plot over another. Hence, as progress took place, there was no movement to poorer land, because there was no poorer land. Rents depend on differentials, but differentials do not have to arise because of diminishing returns; in George’s account, the differentials emerged because division of labor and innovation took place and productivity rose in settled areas, which then became desirable and productive locations. In this story there is no reason to expect wages or profitability to diminish. Average and marginal productivity might very well rise rather than fall as development takes place. But rents will still tend to rise with progress, because new differentials will be created or old ones widened. And because progress offers opportunity for monopolies to emerge.

This tendency of rents to rise creates a special kind of pressure in the economy. George saw this and suggested that it could explain the value of land in a region or nation. Growth would increase output—GNP—but at the same time it would drive up rents. The value of land would be the capitalized value of the rents, and GNP the accumulated value of the increments of growth. These two would obviously move together, and if the capitalization factor were an interest rate equal or nearly equal to the rate of growth, the values would obviously be close. But many other factors and forces can intrude. This set of relationships has a close parallel in the modern world, in Q, the ratio of financial claims to real productive assets—two variables dependent on different forces and factors that nevertheless also have a tendency to move together and equal each other in appropriate circumstances.

But perhaps even more importantly, George saw that there would be a close connection between the total amount of rent in a region or nation and the costs of government in such an area. This would be due partly to the fact that improving government would advance progress, and so drive up rents; it would be due partly to the fact that progress, in driving up rents, creates conditions that require regulation and government attention, calling for spending on government. (Notice that if rents and costs of government move together there is no need for austerity; rents can be taxed to cover the costs of government—assuming landed interests don’t block the legislation.) In any case, total rents and the costs of government

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would tend to move together. If rents were heavily taxed, that might well pay for government. But it should not be rents alone; all of finance and monopoly should be subject to tax, to be set against the costs of today’s larger, and tomorrow’s much larger, government.

There is yet another aspect to the rise of rents. The process readily leads to concentration, and George saw this as driving the growth of inequality, also setting in motion land speculation, which further increased inequality.

He was convinced that progress would necessarily lead to increased inequality, bringing poverty in its wake. All of which, he hoped, could be rectified by the single tax. Some of his analysis and argument may have flaws, but the overall insight is surely on target. The effects of progress on rents need to be recast in terms of the macroeconomics of a modern economy, a financialized economy. In this context, we can see the pressures that will indeed lead to growing inequality—pressures, for example, of wealth on earning power, and of rising rents leading to concentration of land ownership. Likewise we are seeing a vast increase in debt, both for households and for business. But, following George, the argument here is that these dangerous developments can be curtailed with appropriately designed taxes, together with carefully designed ways of using the proceeds, among other things to reduce the burden of debt.

But concentration doesn’t happen only in land and land ownership. In a financialized economy, the availability of money and credit is controlled by the system, and the system is controlled by a smaller and smaller group of larger and larger banks and financial firms, as mergers and acquisitions increase concentration. The power to determine the allocation of credit resides in these institutions and is used for their benefit, not the benefit of the public, just as George pointed out that land and rents impoverished the general public. This is the new form of the danger that he so clearly saw and sought to confront. Accordingly, the taxes will have to hamper concentration and consolidation, regulation will have to prevent price-­ fixing, monopolizing of credit and other activities against the public interest, while taxation—Tobin taxes—will be needed to dampen and reduce speculation. And as a result of urbanization and the shift to mass production, the economy now faces weakness and instability in aggregate demand—so the Government Budget will have to take on the management of overall demand and employment—another topic altogether. And all this now faces the uncertain prospect of massive and widespread destruction of jobs by Artificial Intelligence and computer-run automation. (The uncertainty makes planning a response all the more difficult.)

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Finally, rents and real estate are securitized in the modern world, and this creates a whole new situation. In a financialized economy, some securities will increase in value even though there is no change in their underlying condition. The underlying real asset—land or location or social position— increases in value because its “rental” price has risen, in spite of the fact that there has been no investment or other change in it. Securities based on such assets will therefore tend to rise in value, so long as the economy as a whole is growing, even if weakly, in a slump.

This has a very significant implication: a growing financialized economy cannot grow in equilibrium. If some securities are rising in value and others are not, there will be a tendency to shift in favor of the rising securities.

The financial system will always have to rearrange its portfolio of securities, and it will have to put pressure on the real economy to support higher security prices. It will have to do this under conditions that will lead to difficult-to-control credit expansion, tending to spill over into a positive feedback spiral. The growth of rents tends to make the system unstable and liable to crisis. This, of course, interacts with the tendency toward increased inequality; progress may indeed bring us inexorably to poverty after all—unless policy-makers can rise to the occasion! And, as George understood very well, that depends on the development of a strong political force backing programs in the interest of the general public, the people as opposed to the profiteers! Why tax the rich? Because, as the NY bank robber famously said, that’s where the money is!

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Index1

A Accelerator, 86 Adjustment to demand fluctuations, in mass production economy, 76–82 Aggregate portfolio, 106, 109 Agricultural capital, 22 Anderson, James, 14 Andrews, P. W. S., 20 Arnott, R., 37n1 Atkinson, A., 37n1 B Balanced financial expansion, 123 Barter, 16 Beard, Charles, 21 Beard, Mary, 21 Block, Thorsten, 80n2 Bonds, 24, 31, 40, 41, 101n1, 103–107, 114, 116, 122–124 Business cycle, 62n7, 79, 80n2, 86, 91, 128, 129

C Capital, 12, 15, 17–23, 29, 30, 73, 74, 76, 135 agricultural, 22 controversy, 20 financial, 20, 33, 116–118 liquid, 97, 114–116 productivity, 22 real, 20 Capital accumulation, 61, 62, 76 golden rule of, 65n9 Capital and Credit (Morishima), 78n1 Capital and Growth (Hicks), 78n1 Classical view of rents, 17–18 Conference of the Eastern Economic Association (March 2017), 3 Consumption, 17, 18, 20, 21, 30, 31, 37, 38, 41, 59, 59n5, 60, 62, 64, 65n9, 72–76, 78, 80, 80n2, 82, 91, 93–95, 100, 122 Cooperation, 3–5, 21, 28–31, 37, 39, 41, 42, 52, 56, 88

Note: Page numbers followed by ‘n’ refer to notes.

1

© The Author(s) 2019 E. Nell, Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability, Palgrave Studies on Henry George for the 21st Century, https://doi.org/10.1007/978-3-030-18663-0

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INDEX

Costs of government, growth and, 42–45 Craft economy, 12, 19, 24, 51, 52, 56, 57, 59, 61–63, 73, 74, 81, 82, 95, 134 adjustment to demand fluctuations in, 58 Craft industry, 68 D D’Agata, Antonio, 57n1 D/E, see Debt/equity ratio Debt/equity (D/E) ratio, 103–105, 123, 125–127 Degree of optimism in market, 108 Demand pressure, 39–45, 64 Differentials, 3, 13, 15, 17, 21, 23, 28, 31, 41, 43, 89, 92, 94, 95, 104n4, 136 Diversification, 29, 105 Division of labor, 3, 5, 18, 21, 24, 28, 29, 31, 41, 42, 88, 136 E Economic growth, 6, 12, 27–33, 56 Economic policy, 2, 86 Economic rent, 15 ELR, see Employer of last resort policy Employer of last resort (ELR) policy, 119, 130, 131 Equality, 4, 67, 71–72, 131 Errouaki, K., 20n6, 125n1 F Factor markets, 18–20 Ferguson, C. E., 78n1 Feudal Europe, 11 Feudalism, 12 Financial capital, 20, 33, 116–118 Financialization, 68, 97–98, 137

Financial market, 40, 86, 97, 98, 102, 114, 125, 130 Financial speculation, 2, 132 Fixed-price economy, 77 Friedman, Milton, 102 Frontier thesis, 21 Full employment, 19, 62, 68, 72, 74, 75, 79, 102, 116 G Gaffney, Mason, 39n3 Garegnani, Pierangelo, 19n5 GDP, see Gross domestic product General Theory (Keynes), 72 George, Henry, 1–7, 3n1, 5n2, 9–12, 15, 17, 18, 20, 23, 28, 29, 32, 33, 36–38, 42–46, 51, 52, 56, 62, 67, 68, 71, 80, 82, 83, 85, 86, 88, 90n5, 91, 94, 95, 97, 100, 101n1, 103n2, 109, 113–115, 119, 122, 123, 132–137 Glass-Steagall Act of 1933, 107 Global financial crisis of 2008, 2 GNP, see Gross national product Gross domestic product (GDP), 45–48 Gross national product (GNP), 3, 6, 10, 14, 28, 32, 33, 51, 56, 82, 136 Growth analysis, 41–42 and costs of government, 42–45 of demand, 87, 88, 90–94 models, 13–17 of output, 66, 88, 125 of productivity, 88–89 rate, 30, 32, 38, 42, 60, 62–69, 87–92, 119, 128, 133, 136 and rents, relationship between, 42, 85–95 transformational, 13, 42–45, 86, 98, 100

INDEX

H Hagemann, Harald, 92n6 Halevi, Joseph D., 92n6 Hall, R., 20 Harcourt, G. C., 19n5, 65n9 Henry, George, 12–13 Henry George School of Social Science, 3n1 Henry George Theorem, 2, 36–48, 82, 131 demand pressure, 39–45 rent tax, 39–45 Revised 2016 GDP Accounts, 45–48 traditional case, 36–39 Hicks, John, 77, 78n1 Hitch, C. J., 20 Holding securities, 103–105, 114 Hudson, Michael, 102 I Imperfect markets, 37 Inequality, 2, 3, 7, 9, 23, 24, 91n5, 127, 128n2, 134, 135, 137 in financial system, 113–119 wealth, 62, 116–119 Innovation, 2–4, 6, 24, 28, 29, 31, 41, 43, 52, 57, 68, 73, 77, 86, 88, 91, 92, 95, 119, 127, 132, 133, 136 Innovative growth, 86 Interest, effects on saving and investment, 80–82 Investment, 6, 30, 31, 36–41, 52, 55–69, 72–82, 86, 87, 90–94, 101, 102, 104, 105n5, 106–108, 114, 116, 118, 119, 122–124, 127–129 K Kalecki, M., 6 Keynes, John Maynard, 6, 71–73, 76, 101, 102

145

Keynesian adjustment, 78–80 Keynesian model, 30 Kindleberger, Charles, 125n1 Kucera, David, 80n2 Kurz, Heinz, 17n4, 19n5, 20n6 L Labor, 12–17, 19, 20, 22, 29, 30 division of, 3, 5, 18, 21, 24, 28, 29, 31, 41, 42, 88, 136 market, 23, 72 movement, 21 productivity, 29 stored-up, 18 unpaid (non-monetized), 30 Laibman, David, 19n5, 92n6 Land, 12–17, 19–21, 24, 27–31, 33, 82–83 price, 29, 30 speculation, 68, 97, 114 value, 30 Land-backed securities, 33 Layoffs, 72, 74, 77, 86 Liquid capital, 97, 114–116 Liquidity premium, 106 Lowe, Adolph, 92n6 M Macroeconomics, 6, 51–52, 78, 79, 86, 137 Malthus, Thomas R., 14, 28 Marginal product, 9, 19, 20, 38, 61, 64, 72–75 Margin of production, 6, 57, 67 Marginal productivity, 2, 9, 14, 78, 95, 136 of labor, 71 theory, 18–20 Markovitz portfolios, 109–111 Marshall, Alfred, 18, 52 Marshallian technology, 56–61 Marx, Karl, 13, 76, 134

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INDEX

Mass production economy, adjustment to demand fluctuations in, 76–82 Mazzone, Andrew, 1–3, 3n1, 6, 7, 38n2, 39n3, 45–48 Meade, James, 78 Mill, John Stuart, 61 Miller, Merton, 103n3 Minsky, Hyman P., 125n1 Modigliani, Franco, 103n3 Monopolization, 67, 94n8, 136 Monopoly rent, 4, 10, 12, 39, 39n3, 44–46, 48, 71, 91, 99, 100, 132, 136 Morishima, Michio, 78n1 Multiplier, 38, 72–76, 79, 80n2, 119, 126 N NBC, see New Business Cycle Nell, E. J., 19n5, 20n6, 59n5, 65n9, 80n2, 88n2, 92n6, 125n1 Neoclassical models of rents, 14–15 Neoclassical Theory of Production and Distribution, The (Ferguson), 78n1 Neo-Ricardian approach, 14–15, 17 Network externalities, 20 New Business Cycle (NBC), 79n2 Non-basic good of type II, 15, 17 No-rent land, 14, 17, 57 O Old Business Cycle, 62n7 Oligopoly, 39, 52, 100 Order of fertility, 17 Ownership, 5, 5n2, 9, 30, 31, 41, 68, 100, 103n3, 105, 114, 115, 137 right to, 5

P P/E, see price/earnings ratio Petri, Fabio, 19n5 Phillips, Tom, 80n2 Portfolio analysis, 106–107, 109 Post-Keynesian approach, 14–15, 18 Poverty, 2, 5–7, 9, 12, 13, 23, 91n5, 95, 113, 135, 137 Price mechanism, 56–63 growth and, 61–63 growth rate, 63–69 Price/earnings (P/E) ratio, 122–125 Primitive accumulation, 21 Private land ownership, 9 Production function, 73–76 Productivity, 3, 5, 12, 17, 21, 22, 24, 28, 29, 41–44, 57, 61, 63n8, 65–67, 79, 89, 90n5, 91–94, 113, 116, 127, 135 capital, 22 growth of, 88–89 of labor, 29, 78, 79 marginal, 2, 9, 14, 18–20, 71, 78, 95, 136 Progress, 9, 12–13, 29, 52, 56, 85, 135–138 Progress and Poverty (George), 1, 2, 4, 28, 45, 56 Q Quadrio-Curzio, Alberto, 17n4 Quantitative adjustment, 130 R Real capital, 20 Real economy, rent in, 11–24 Real estate, 2, 6, 7, 12, 14, 23–24, 28, 31, 33, 39n3, 41, 45, 48, 51, 68, 93, 95, 98, 100, 102, 106, 116,

INDEX

117, 119, 123–127, 129, 132–134, 138 Real wage, 52, 58, 60, 61, 64–67, 71, 72, 74, 75, 79, 88–90, 92–94 Real-financial instability, 127–134 international implications, 133–134 policy implications, 130–133 Real-financial linkages, 100–103 Rent, 2, 3, 6, 7 growth and, 42 in real economy, 11–24 and securities markets, 122–134 securitization of, 12, 24, 33, 51, 98, 106–111, 127, 134, 138 tax, 36, 39–45 treatment of, 13–17 See also individual entries Rental assets, 51 Rent-seeking behavior, 15, 57n1 Revised 2016 GDP Accounts, 45–48 Ricardian theory of rent, 17, 28 Ricardo, David, 9, 14, 15, 17, 21–24, 28, 76 Right to ownership, 5 Rights to use, 5n2 Risk aversion, 104, 108 Robinson, Joan, 65n9, 88, 93 Ryan, Paul, 7 S Salvadori, Neri, 17n4, 19n5, 20n6, 57n1 Samuelson, Paul, 65n9 Savings, 23, 52, 55–69, 64n8, 79, 102, 114, 116, 118, 122, 124 Schefold, Bertram, 19n5, 88n3 Securities markets, rents and, 122–134 real-financial instability, 127–134 Securitization of rents, 12, 24, 33, 51, 98, 106–111, 127, 134, 138 degree of optimism in market, 108 Markovitz portfolios, 109–111 portfolios, 106–107

147

Self-financing, 123 Semmler, Willi, 125n1 Separation theorem, 111 Settlement, 3, 29, 32, 42, 43 expansion of, 29 Shaikh, Anwar, 20n6, 88n3 Short-run realistic adjustment, 19 Single tax, 2, 36, 45, 131 Smith, Adam, 14, 57n1, 133 Solow, Robert, 63n8, 65 Space, 2, 4, 9, 15, 20, 44 Sraffa, Piero, 15, 15n1, 16, 18, 19n5, 22, 57, 88n2, 134 Stiglitz, J., 37, 37n1 Stocks and bonds, 106 Stored-up labor, 18 Superprofits, 57, 58, 67, 68, 86, 89, 92 T Theory of Economic Growth (Morishima), 78n1 Theory of factor markets, 18 Theory of income distribution, 2 Theory of interest/profit, 22 Thomas, Stephanie, 80n2 Tobin effects, 102 Tobin tax, 132 Transformational growth, 13, 42–45, 86, 98, 100 Treatment of distribution, 21–23 Trump, Donald, 2, 7, 57n1 Turner, Adair, 102 Turner, Frederick Jackson, 21 U United Kingdom, 40 United States (US), 12, 17, 36, 40, 45, 46, 48, 116n1, 131 economy rents, 23 Universal Declaration of Human Rights, 131

148

INDEX

Unpaid (non-monetized) labor, 30 Urbanization, 44 US, see United States V Value and Capital (Hicks), 78n1 Verdoorn-Kaldor equation, 88, 89, 94 Victorian equilibrium, 67

W Wage-accumulation curve, 88, 92, 93, 93n7 Wage rate/growth of demand curve, 91–92 Wages of superintendence, 61, 62 Wealth accumulation, 116–119 Wealth inequality, 62, 116–119 West, Edward, 14