Why Georgists Correctly Predicted the Crisis
This essay, delivered during the February 27, 2009
session at the Eastern Economic Association meetings in New York
City was originally posted in an email March 23, 2009 by Dr.
Cleveland and is posted to the Association for Georgist Studies
website. Dr. Cleveland organized the session, "Why Georgists
Correctly Predicted the Crisis and Why (Almost) No One Took Them
Seriously. What Conventional Economics Can Learn from Them--and Vice
Versa." Panelists included Wellesley College Professor of
Economics Karl E. (Chip) Case, Univ. of Calif.-Riverside Economics
Professor Mason Gaffney, Knowledge and the Wealth of Nations author
David Warsh, Brendan (Dan) O?Flaherty of Columbia University, and
Prof. Fred Foldvary of Santa Clara University.
Land bubbles of varying severity and universality recur roughly
every eighteen to twenty years. Like Henry George, modern Georgists
attribute recessions and depressions to collapse of these bubbles. A
huge real estate bubble of the 1920's preceded the Depression of the
1930's. That bubble actually began to burst in 1926, three years
before the stock market crash of 1929. So when "house values"
exploded around the world during the last decade and then began to
decline in 2006, many of us predicted the worst.
A few prominent economists recognized the bubble's threat, notably
Karl Case and Robert Shiller of the Case-Shiller Home Price Index. But
most economists didn't see the crisis coming until it ran them over.
Why couldn't they see what Georgists saw? (Non-economists can skip to
the last paragraph.)
1. Like Adam Smith and other classical economists, Georgists assume a
three-factor world: land, labor and capital, earning economic rent,
wages and interest respectively. But starting in the early 20th
century, conventional economics merged land into capital. Land
disappeared so completely that Robert Solow could joke in 1955 that "if
God had meant there to be more than two factors of production, He
would have made it easier for us to draw three dimensional diagrams."
2. Conventional economics airbrushes out economic rent. The National
Income and Product Accounts omit or conceal rent. They exclude even
realized capital gains, let alone unrealized gains. They lump rent
received by business into profits. When I teach micro I have to
explain to students that those cute little triangles we label "consumer
surplus" and "producer surplus" are really economic
3. Conventional microeconomics is static. Textbooks incorporate
discounted present value poorly, or omit it altogether. In teaching
micro, I've had to write a special section on discounting--after all,
someday, students will buy houses and take out mortgages. Bubbles are
just unrealistic projections of rent, capitalized into the present.
Without discounting, how can we understand them? (Mind you, many
Georgists don't understand discounting either; they explain bubbles as
the work of "speculators." But at least they know bubbles
4. Conventional macroeconomics tosses out the good part of micro,
namely, marginal analysis. So in conventional macro, all taxes are
alike, all consumer spending is alike, all saving and investment is
alike. Economists can truly believe that it's good for the economy now
to borrow money (from whom?) and spend it on roads and bridges. How
can they understand that overspending on infrastructure stimulates
5. Conventional economics disregards a central Georgist assumption:
distribution of wealth matters. Moreover, the tax and subsidy system
is rigged to drive rent to the top of the heap. This very rigging of
the system also encourages bubbles. So the Georgist cure is to reverse
the rigging, capture the rent and redistribute it to society either in
the form of public goods, or directly as tax credits or grants. That's
a dangerously radical idea.
One hundred years ago, Georgists allied with Progressives to form a
powerful movement for political and fiscal reform. In The
Corruption of Economics,
Mason Gaffney argues that neoclassical economics assumed its blinkers
precisely to thwart that movement--leaving modern economists helpless.