Understanding the Cause
All kinds of explanations have been suggested for this destructive phenomenon, and remedy after remedy has been proposed and tried, yet at the end of the twentieth century these cycles still occur just as fiercely as they have for centuries.
One economic process has hardly been studied at all, and that is land speculation. Yet, as we will explain, it is the root cause of the problem.
The word "land" in the sense in which the word was used by classical economists and in which it is used in this pamphlet, means all natural resources. It means the ground on which everything stands, whether in town or country; the source from which all minerals are extracted, the soil in which everything grows. It does not include anything which is the work of man: buildings, roads, machinery, growing crops, drainage ditches, and so on.
Some types of speculation are good for the economy. When business people make speculative investments in new ideas and technical developments they ensure that progress and improvements take place in society. However when people speculate in land, the results are bad for society. It is the collective effect of this practice which we must understand and prevent. How then does all this bear on booms and slumps?
How the Economic Cycle Works
Let us start our analysis at the bottom of the slump. There is wide-spread unemployment, and land prices are relatively low.
Some people, nevertheless, buy land at the low prevailing prices, and other people continue to make discoveries and inventions which are the mainspring of future wealth production.
Gradually and painfully, the economy begins to improve. As order books pick up more jobs are created. People who had once been unemployed and living on the dole now receive wages, their demand for goods increases and further jobs are created to satisfy this demand. The Government's outlay on the dole is also reduced and can be put to better uses. At this point, the demand for land rises. People need land on which to extend factories, open shops, and for new and better homes which their improved circumstances make possible. But now, a very important difficulty begins to appear. What used to be called "the law of supply and demand" works in a totally different way with land from the way in which it works for everything else. When the demand for cabbages or cars or computers increases, people make more of these things, in order to satisfy the rising demand. When the demand for land rises, there is no way of increasing the quantity to satisfy the new demand.
As Mark Twain said long ago "They ain't making it no more!"
So land acquires a scarcity value. People who have got land already are able to raise the price. Not only that, but they anticipate further rises in a year or two, and so they hold it out of use, waiting for the price to rise. Thus rising demand actually reduces the quantity of land available at an affordable price.
All kinds of distortions now appear in the economy. More and more people begin to base their lives on the assumption that land prices will continue to rise. Building firms compete with each other to buy land, not for current use, but to hold in "land banks", on which they hope to draw at some later date.
Ordinary householders, who look in the windows of estate agents and see property like their own rising rapidly in value, begin to feel rich. In the boom of the late 1980s, some people saw the value of their "house" rise more in a year than the total salary they had received in that year. But what had risen so much in value? Not the bricks, timber and glass of which their house was made, but the land on which it stood. (See our Pamphlet No.4: 'Residential Roulette'). And so, in these boom conditions, people begin to buy expensive consumer goods which they would not normally purchase. More goods are produced to meet the new demand. All this pushes the boom further. People become less and less disposed to save and invest. Why should they save, when rising land values are doing the saving for them? If more people are eager to invest in land, interest rates get pushed up. The entrepreneur, who is willing to speculate usefully on technical developments, is caught in the pincer between high land rents and expensive capital.
In the end, of course, the bubble bursts. The boom collapses. People no longer feel rich. For the really unlucky businesses and people there are high debts to be repaid and seriously reduced income to do it with. Their demand for goods dries up, and so the people who were once making those goods become unemployed. Businesses fail. People are lumbered with land which they had purchased at a high price, but which they can no longer use. In the boom/slump cycle of the 1980s and early 1990s, this course of events did not just affect the simple and gullible, it affected experts as well. The phenomenon of "negative equity" brings this point out clearly. At the height of the boom of the 1980s, not only were ordinary house buyers prepared to take on huge loans, but building societies were prepared to advance those loans. In the end, building societies and householders alike were caught. Householders lost their savings, building societies found that they could not recover the money they had advanced if they decided to foreclose on bad debts. Estate agents burnt their fingers as well.
Remember the great number of offices which were opened in every High Street in the 1980s, and how many of these were forced to close when the boom ended? Shopkeepers and other businesses were all caught in the trap. Even some big companies were caught.
That was what happened in the most recent boom-slump cycle, but something essentially similar has marked other such cycles in the past. Unless people understand the lesson, the story will be repeated in the future.
It is necessary to recall the fundamental difference between the economic behaviour of land and the economic behaviour of other goods. This difference turns, as we have seen, on the fact that the quantity of land is fixed, while the quantity of most other goods can be increased at will. That fundamental difference should be reflected in our taxation system. Most of our taxes today fall on people performing useful activities. Income tax falls on people who work, VAT falls on people who buy goods and services. Taxes necessarily distort, and usually discourage, these useful activities and inhibit production. They also lead to infinite ingenuity in avoiding (or evading) the tax burden. What is needed is a different kind of tax, which should largely replace existing taxation. This is a tax on land values. By 'land' is meant the site alone, excluding the value of all improvements which the owner or his predecessors have introduced on that land. It would apply to all land everywere, urban or rural, vacant or in use.
How would this relate to the boom/slump cycle? As has been seen, the first sign of an approaching boom is useful economic activity, but the second sign is rising land values. With land value taxation (LVT for short), the increased land values would be collected automatically in tax. Without the prospect of gaining from the gradual increase in the value of land, speculation in land would become pointless. But speculative investment in ideas and progress would remain. Indeed it would be increased because people and institutions with money would have to invest in this more socially useful way. LVT would mean that nobody would have an inducement to hold land out of use, or to speculate on rising land values. Why hold land out of use when you are merely holding on to a tax liability?
So land would become much more freely available for use, and there would be no point in "investing" in speculative rises in land values, for those rises would be automatically mopped up in taxation. The artificial surge of booms would be replaced by steady growth. The crash in land speculation which produces slumps would disappear. Britain would enjoy a stable, full employment economy..