Sunday, March 2, 2014

Are landlords the future global plutocracy?

Karl Smith has two posts about land that I have been reading over and over for weeks. I'll start with this one. In response to recent work by Thomas Piketty, Smith argues that we should carefully distinguish between land and other forms of capital when talking about wealth. He starts with this chart from Piketty:


Smith's observation is that the surge in wealth of capital holders after the 1950s is driven primarily by housing (and, therefore, land). Using the example of Paris, he notes that legal restrictions on architecture and zoning render land extremely expensive, so "only those willing to pay the highest rents or mortgages can live in Paris and the rest are pushed to the suburbs." The value of Parisian land "does not stem from the creation of new structures, plant or equipment." It stems from severe supply constraints. It's hard to create more land. It's impossible to create more land in downtown Paris. 

Growing up in western Colorado, the richest people I knew were landowners. They came from old agricultural families that had been steadily selling off little chunks of land to movie stars, fashion moguls, and subdivision developers. Maybe other people think of rich guys as the ones who work in banking and drive a new Porsche, but the rich guys I knew drove 15-year-old pickups and wore cowboy hats. They were rich because the supply of private land near decent airports and skiing is fairly limited, and their parents had given them a chunk of that supply. What they haven't sold to Ralph Lauren will be passed on to their own children, who can sell a few more acres and pass on the rest. So Smith says, "irreproducibility and inheritance are the essential features of land in classical economics." And those who didn't inherit face ruthless pecuniary externalities.

Ryan Avent took issue with Smith's post, noting that US data look a bit different from French data. I think he makes a few good points to which I'll return, but Smith effectively rebuts him by noting that the data hint at fairly strong responses of capital wealth to capital returns, while land wealth just steadily grows. He uses the dot-com bust to illustrate that capital wealth is destroyed when it grows too big relative to national income--"this automatic correction mechanism is not an anomaly but a fundamental feature of capital." Smith ends with:

In the wake of the subprime crisis, I understand the temptation to rally against big banks and global finance. However, Lehman Brothers is dead. Sam Zell, founder and CEO of Equity Residential, is still alive. This is not an accident. The future does not belong to high flying titans. It belongs to dogged men and women who squirrel away rent checks when times are good, and buy [their] home when times are tight. This is the tyranny of land. Ignore it at your peril.

Now back to Avent. His argument is that land is more like productive capital than Smith allows, as the reason for its high demand in key locations is that it facilitates transactions, both within firms and between firms and workers. It "reduces the cost of exchange" because it allows workers to locate in productive cities. I like this heuristic, and to the extent that it's accurate Avent's point is reasonable. A good example that illustrates the point is Goldman Sachs, which has been moving an increasing share of its operations to Salt Lake City in a strategy that amounts to land price arbitrage. The cost of fragmenting production across regions is now low enough that the price of land in New York kills the advantages of locating workers near the main headquarters, at least for some tasks. You can work out the marginal consequences for New York landlords. More generally, even though land is a production factor with fixed supply, production functions have substitution elasticities. Skype can accomplish a lot of things that used to require physical presence; in that sense it is a substitute for city land, and substitution works against the notion that fixed factors must command a growing share of income over time (this is literally textbook macro; see Romer p. 42).

But I suspect it's not enough. There are reasons to believe that cities aren't going away and that where workers locate will continue to matter. Some jobs that used to be done only in New York can now be done elsewhere, but they must still be done in a city. And land is more than Avent suggests. It provides its users with collateral services and enters utility directly. It depreciates very slowly, more like human capital than physical capital, and it's easy to bequest. And Americans' taste for living space seems to be growing, so there's no reason to assume that demand for land is going to abate.

Avent also notes that breaking the policy grip of landlords will not necessarily result in giving workers a larger share of income. Rather, the gains would accrue to owners of intellectual property. Again, though, intellectual property is much less conducive to intergenerational wealth accumulation than is land.

Izabella Kaminska got in on the discussion as well, emphasizing the following:

In more established economies, however, land value is being increasingly determined by exclusive and finite access rights, and/or improvement restriction factors. Limits on how high you can build, how much of the green-belt can be urbanized, and so forth. 
This is what makes access-based land values so pernicious. There is no correction mechanism to offset the ever incremental returns.
What's really going on here is a complicated political economy tradeoff that no American politician will touch; but Eric Crampton points to some leaders Down Under who are being frank with voters. Australia's Matt Cowgill:

There's a trade-off at play here, one that can't be wished away or ignored. With a growing population, you can't restrict rising density in established suburbs, prevent sprawl on the urban fringes, and prevent housing from being unaffordable. Pick two of the three.

And New Zealand's Bill English:

So if Auckland wants to grow now, it has to grow out because you don't want it to grow up. Now that's a fair choice, but please don't stop it from growing out as well, otherwise we'll get another few years of 15% house price growth.

After you've recovered from the shock of seeing politicians tell voters that tradeoffs exist, solve for the equilibrium here. Apparently nobody likes sprawl and nobody likes density. Is there enough desire for low real estate prices to overcome these preferences? Cries for better zoning aren't going to come from incumbent land owners, are they?

East Coast dwellers may be unaware of another important factor in land values that will increasingly plague a few key US cities in the future: water. This was the dominant political issue in western Colorado. There is a perception--probably accurate--that cities have the political power to secure water, while rural areas don't. Phoenix, Las Vegas, and Los Angeles will always have water, a fact that will only supplement the forces that are drawing people into cities. Some of those places may not face the steep cost of living faced by the mid-Atlantic and Northeast, but give it a few years and they just might.

One last point is that real estate prices have asymmetric consequences. High prices are good for owners, but low prices may not provide a lot of benefits to non-owners. Remember that pecuniary externalities can bite in the presence of incomplete markets. Homeownership didn't surge when house prices collapsed. A lot of non-owners are credit constrained. Breaking into the landlord class isn't easy if prices only fall during credit crises.

I think the implication of Smith's argument is that we're marching the wrong way if we focus only on returns to owners of capital but ignore land. Capital accumulation has a way of self regulating, but land doesn't. If wealth concentration is pernicious, land wealth is more pernicious than capital because it is more likely to be durable. This supplements the standard list of reasons that Ramsey models typically imply high and low optimal taxes on land and capital, respectively, as Smith notes.

It is worth noting, though, that it has become increasingly easy to own small quantities of both land and capital, through REITs and stocks, and these holdings can be expanded gradually through tiny marginal investments. In my view, before we start trying to design a tax system to preempt Piketty's hunch about the future of capital's income share, we should see if there are ways to get more of the working class into land and capital ownership. For example, it seems to me that you can't believe both that returns to all forms of capital will continually outpace returns to labor in the future and that giving people the option to invest their Social Security accounts in equity securities is bad for them. This is not a call for policy, but if there are policy nudges that can make more regular people into owners of stuff, that may be a better way to go than to complicate the tax-and-transfer system further.

4 comments:

  1. I followed this discussion but missed your post. I noticed this with many relatives in coastal Andhra. I have both rich and relatively poor relatives from contractors to bus drivers. I find all of them who invested in some land, particularly small pieces of real estate in towns have prospered. Many also tend to keep some savings in gold. Those who remained in agriculture, generally two to ten acres of land, have not done well.

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  3. Hasn't the value of land as a percentage of total wealth been declining for a long time? I realize there is a chart at the top of this post that says the opposite, but "housing" includes structures, not just bare land, and it's no surprise that most of us don't live five families to a tenement any longer. And the return on capital is usually in the 12% range, but the return on housing tracks income. Over the long term, the value of land will inevitably decline versus capital. Sam Zell didn't get rich by cashing rent checks, he got rich by speculating, which is not a source of wealth except to the speculator.

    It's easy to look at old housing prices and think, man, if only I'd bought twenty years ago, I'd be rich. But if you actually go back and look at the compounded returns, the figure is usually in the single digits. That's not how you get rich. The rich own land, but owning land is not how to get rich.

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