15. Land Ownership and Mortgages
Last updated
Last updated
Something appears to be goofy with the housing market. The financial crisis of 2007/8 has widely been attributed to problems with housing, particularly in the US. At the same time massive over construction was going on in Spain and Ireland ultimately leading to ghost towns. Over the previous decade or so, homeowners in the UK were often earning more in house price appreciation then from going to work. All this time there was a mantra among the population that house prices could only ever go up. Meanwhile in Japan, they had their housing bubble in the early nineties where prices had been falling steadily ever since. All this time there was and still is a perception that the only possible reason house prices are the way they are is because of simple supply and demand with nothing more subtle going on. All this time the majority of the money lent by banks was for the purposes of buying houses. As we already know from chapter one, loans create money whilst repayments destroy money, which means that the majority of money that exists at any one time in the economy comes about through mortgage lending and any drop in the rate of new mortgage lending directly causes a fall in the money supply because existing mortgages continue to be repaid. This link results in a situation where the economy suffers terribly from a fall in the money supply every time there is a fall in the rate of new loans for purchasing houses. This leads to a situation where governments start employing tricks to artificially boost house prices at the slightest sign of a dip. In the UK with schemes like "help to buy", in the US with the "Mortgage Credit Certificate" scheme and in Australia with schemes like the "First Home Owner Grant". All of these things should be a clue that something is wrong with the way society organises housing.
In recent decades free market economists and politicians in the west have promoted the idea of mass home ownership. They often insisted that owning your own home was some sort of right, something that people should have the freedom to do. This chapter aims to show how the modern concept of mass home ownership in industrialised countries simply cannot be made to work in a way that is simultaneously equitable and economically stable without substantial modifications to our current system. To help illustrate exactly why this is so we shall need the help of some thought experiments, but before we get to that, we must first be clear about the main cost of housing in many modern economies.
The general public casually refer to the cost of "buying a house" as if the land were free and what they were paying for was the cost of the bricks, mortar and manpower required to built it. This view is however, mistaken. Consider the advertised price of a house located in the remote countryside and then compare that to an identically constructed house of the same size, in the middle of a major city like London. The difference could easily be five-fold. In big cities the cost of the bricks and mortar can be almost trivial compared to the cost of the land it sits on. One might imagine that professional economists are more sophisticated than the general public and think more deeply about the land component of house prices, but sadly with few exceptions, they don't. Land ownership is scarcely discussed by most economists, leading to some monumental problems, as we shall soon see. However, before we can get into the details we must first tease out some principles by means of some thought experiments.
Imagine that in the distant past, a large ship ran into rocks off a desert island and started sinking. Everyone jumped overboard and started swimming towards the nearest beach. Unfortunately a man armed with a gun, got to the island first, and then upon everyone else's arrival, the man pointed his gun at them and said: “I got here first, so this island is mine. You can't live here unless you pay me rent for using my land”. The swimmers have no choice and have to give the “landowner” part of their income forever more. This situation is obviously unjust. If you were one of the people having to pay rent you would no doubt be angry, and you would probably protest.
Years go by and a simple economy on the island develops. People are making things from wood and stone, whilst others are fishing or hunting. They use rare shells as a form of money and everyone has to pay 10% of their shells to the man with the gun for the privilege of living on the island. Let us now imagine the one of the islanders became relatively rich (as rich as one can be on a desert island), perhaps because they invented some new tool, or simply because they were very skilled in making some desirable produce. The rich person approaches the, now ageing, man with gun and says: "You must be fed up with all the aggravation of collecting rent and having everyone complaining about you the whole time. How about selling me the island and then you can then retire." The man with the gun agrees. Some of the other islanders observe this transaction and are wondering what is going to happen next. The rich man then makes an announcement: "For years you have all been paying rent to that thief who unjustly claimed this island but I have now purchased this land with my own, hard earned, money and without the use of force. I am now the rightful owner. So you can all pay rent to me, and quit complaining!".
If you were an islander, would you be happy with the situation now? At this point you may feel there is something strange going on here. Normally you do not begrudge ownership of items to people that have paid for them, but somehow this seems different. Why should you be paying anything at all for the privilege of living on the island? After all, none of the castaways should have any more claim to the land than any other. The resolution to the apparent paradox is as follows: the reason we have some innate feeling that the rich man does not deserve ownership, despite apparently having paid for it, is because A) the wrong people have received the payment and B) the wrong price has been paid. To see why this is so, consider a situation where two people contributed equally to the production of a sellable item, for example a knitted scarf. Say that both knitted exactly half. Now imagine that while one of them was distracted, the other sold it to a passer-by and pocketed the entirety of the money. Clearly an unfair situation. In general, the sale of an item is only fair, if everyone who is forgoing their rightful claim to that item, is being compensated for their loss and at a price is one that all interested parties have agreed. So in the case of someone wanting to purchase the island, a sale could only be said to be fair if everyone with a claim to the island was receiving a share of the purchase price, and that purchase price had been agreed by everyone. An additional complication in the case of land, and different to most items we think about buying or selling, is that land lasts forever. This means that the people that could rightfully make a claim to live on the land, include future generations! They are of course not available to take part in any sale agreements.
Let us continue the thought experiment... more years go by and the rich man dies, leaving the land to be divided equally between his children. Some of his children sell parts of their land to other islanders and so on. After a few more generations the land gradually becomes owned by more and more people. Say that we end up in a state where ten percent of the islanders own land, whilst the other ninety percent are tenants. How is the situation now? Should society forgive and forget the actions of the evil man-with-gun? Has the injustice become so diluted and distant that there is scarcely any injustice remaining? The answer is no, and to see why, consider the prospects for a new born child of parents that do not own any land. Unless that child becomes rich enough to become a landowner itself, they will have to pay a fraction of their income to other landowning islanders for their entire adult lives. This can not be fair. It is as if the crime were still continuing. Time and dilution of ownership do not fix the injustice. Instead, a kind of apartheid is created, with the non-landowning citizens having to supply a continuous stream of money to landowning ones in perpetuity. This is essentially the world we live in today. Even in the most advanced and civilised countries, most land ownership came about initially through force or the threat of force. So our current land ownership system should really be considered "handling stolen goods". This is all at the expense of the poor non-landowning classes.
It is a common idea among many economists that a free market ensures that the distribution of wealth between rich and poor is somehow automatically just and the rich only ever become that way through skill and hard work. These economists obviously have not included land in their calculations.
In order to discover a fairer way to distribute land, we must consider a variation on our thought experiment, this time without guns...
Consider a replay of the original thought experiment but this time nobody has a gun. The ship was filled exclusively with civilised, reasonable people. So when they arrive on the beach, they have a meeting to decide how they will distribute the land. Undoubtedly not everyone will have the same preferences. Some may love fishing and so want to live by the sea, others may like hill walking and want to live up a mountain, some may like sitting at home reading books and not really care much about how much space they get, others may simply want to live close to wherever their friends are. Let us examine a few options the islanders may discuss at their meeting...
Drawing lots
First of all, they may consider simply dividing the land into equal-sized areas and then get everyone to draw lots. At first glance this seems eminently fair. How could anyone complain? The problem is that it is a sub-optimal solution. The keen fisherman could, by chance, end up on the side of a hill while a keen hill-walker ends up by the sea. Another complication is that land is often very heterogeneous and some patches of land are undoubtedly going to be nicer than others. Do the islanders really want such an important aspect of their lives to be determined by the luck of the draw? Surely they can do better…
The committee
Another possible solution is to elect a committee who will distribute the land according to the people’s needs. This could be seen as the “communist” solution. If the members of the committee have a good grasp of the needs of all the individuals in the population, then they may stand a chance of coming up with reasonable decisions . But above a certain level of population size, it becomes infeasible for the members of the committee to truly know the people’s needs. What they will be forced to do then, is formulate sets of rules about who should get what pieces of land. This is where the trouble starts. Devising sets of rules about real-world human problems is fiendishly difficult. The number of factors to consider for each person is liable to be so large that a rule-based system is doomed to produce significant unfairness. Surely they can do better…
Free market renting
Keen free-marketeers might step in at this point and say, “Leave it to the free market. The free market is perfect for sorting out this kind of problem.” The idea is that people who are willing and able to pay the most should get the best land and people willing to pay the least should get the smaller or less desirable plots. But given that all the people were placed on the land at the same time, nobody owns any land to start with – so to whom could anyone pay any rent?
Indeed this problem would still exist to this day in the real world were it not for some sort of bootstrapping mechanism to get things started. Historically by far the most common way people got going with land ownership was to claim land by force, or at least the threat of force. But if we were to start over again with modern civilised people wishing to distribute land fairly without violence, how should we begin? Luckily there is a solution:
A free market solution would be the following:
Instigate “Desert Island Land Ltd”, a company that will own all the land on the island.
Make all the islanders equal shareholders.
Allow all the islanders to bid a rent for whatever plots of land they desire.
Rent each plot to whoever is willing to pay the highest rent.
The money received would be paid out equally among the shareholders via regular dividend payments.
This way everyone gets to have an equal share of the value of the land but the precise way the land gets distributed is then determined according to a combination of people’s desires and ability to pay rent.
An interesting consequence of this process would be that many people would get their land for free. If someone just happened to pay an amount for their plot that was equal to the average price, then their dividend payment from Desert Island Land Ltd would match their rent. People who bid more than average for the best bits of land would still be out of pocket; they would be net contributors. Those who bid less than the average and lived in the poorer quality or smaller patches of land would actually get paid to live on their patch!
At this point we can imagine some readers thinking to themselves that this is a crazy, mixed-up system. People being paid to live on certain patches of land? Surely some mistake!
Is the concept of some people being paid to live on their land really so strange? Some points to consider...
If it were just two families on a (very small) desert island, and there were clearly just two patches of land suitable for house building, one clearly nicer than the other, how would they resolve that between them without a fight? In that case it seems obvious that the family most keen to get the nicer plot would agree to give some sort of compensation to the other, perhaps some fish every now and then. This means that the family agreeing to live on the less desirable plot will essentially be being paid to live on their land. If this mechanism makes sense for two families, why not apply it to society as a whole?
Another thing to consider when pondering the seemingly odd concept of some people being paid to live on their land is the fact that even with our current real-world system, for some people land is a source of income rather than an expense. Anyone who owns lots of land can charge rent to others. Indeed in the real world the rate of flow of money being used to rent or buy land is exactly equal to the rate of flow of money being received by other people for renting/selling land. The difference between the status in the thought experiment and the status in the real world is that in the real world some private individuals are deemed to own land. It is individuals who can receive rent for any excess land beyond that required for their personal use.
Any land that happens to be owned by the state and rented out will earn money for the state and therefore subsidise tax income. Income from this rent is effectively being “paid” to everyone in society, in a way not too dissimilar to that described in the Desert Island Land company example.
Another way to think of the situation is to consider that the people on smaller plots of land are not so much being paid to live on their land, so much as they are being paid compensation for not using up their fair share of the land, or another way to think of it, is to consider the people living on small patches of land are in fact landlords. They have simply chosen not to use their full equitable share of land, but to live on a fraction of it and rent out the remainder to other people.
There are clear advantages of this system over the lottery and the committee: As long as they are willing and able to pay, the hill walkers can get their hillside land, the fishermen can get their land by the sea and so on. What’s more, if someone cares more about the ability to buy goods than having lots of land then they can opt for a small patch and be paid by the rest of the community for enabling them have more space. They can then use this income for whatever it is that they prefer to have, perhaps more food, wine, nicer clothes etc.
It should be noted that the rental system described here is just a crude outline. In practice there would need to be measures to allow for people to move from one place to another and to allow for population growth. Boundaries between plots of land may need to change occasionally, new homes built, old homes demolished etc. Indeed the cost of any buildings built on the land will add significant complications, but we are going to gloss over it for now and address this issue later. Imagine for the sake of argument for now, that people only ever live in tents, caravans or other temporary constructions.
It may be that the maximum achievable rent for any given plot of land fluctuates over time, so it is worth considering the question of how long a rental agreement should last. If it were too short a period then the tenants would be continuously stressed, worrying about whether their rent would go so high that they would be forced to move. An alternative might be to only set rents, via some bidding process, when a plot of land becomes available for a new tenant. A problem with this is that, assuming some inflation, long stay tenants could end up with a nice cheap rent but feel unable to move because everywhere else has become so much more expensive. This problem could be largely solved by having some automatic inflation adjustment built into rental agreements.
It may be that some people would prefer to own their land. Instead of paying a certain fraction of their produce or money on a continuous basis to Desert Island Land Ltd, they would prefer to pay a lump sum and then own that land outright, with nothing further to pay. One might think that this was a perfectly reasonable proposition because, unlike in the man-with-gun tale, the money for purchasing would go equally to all the other islanders. However, if purchasing is allowed, then it is almost inevitable that society will simply migrate to the landlord/tenant apartheid we have today. So what would seem quite reasonable in the short term, would slowly but surely lead to ever greater injustice as the years go by. A clue as to why the injustice gradually comes about, lies in the fact that when a purchase is made, not everyone with a claim to the land is actually being compensated; namely future generations. If a land purchase was made, only the current generation will receive payment. This is why the process is so insidious, the current generation is fooled into believing that everyone has been satisfied by the deal, but little do they notice that everyone yet to be born to non-landowning parents, has lost out.
Some eagle eyed readers may have spotted a potential flaw in this logic. They may point out that it is possible that the amount paid by an individual for a plot of land could be so great, that the real rate of return on that money could be of a greater or equal amount to the rental value of the land in perpetuity and therefore the deal could be a good one for society, without future generations losing out. However, it is unlikely that this large a sum would ever be paid. The problem is that lesser sums are likely to be too tempting. Consider the thought processes of whoever is running Desert Island Land Ltd. They will be faced with the dilemma of deciding whether to accept an offer of a lump sum in return for selling some land as opposed to renting it out. Say that the lump sum being offered falls a little short of that required (i.e. the interest alone falls short of expected rental value), the offer should be rejected... but if Desert Island Land Ltd consider using up some of the lump sum each year. This combined total (interest + part of the lump sum) could easily be greater than the current rental value, at least for a number of years before the lump sum is used up. The people in charge of Desert Island Land Ltd may say to themselves "Ok, so the lump sum may get used up in a few decades, but in the mean time we're getting a great income". The temptation to sell land too cheaply will be great because the downside may only become apparent over many years, even decades. It is likely that the downside will only really be felt by future generations.
With the desert island land rental model, if someone thinks to themselves, “I’m not greedy, I want a simple life. I’ll just work a few short hours per day (enough to cover my personal needs) and have a modest piece of land and a simple house”, then of course they will be able to do that. Their land will cost them nothing, or even less than nothing. They can do a small amount of work and live frugally. That plan may not be to everyone’s tastes, but some people do think that way and environmentally it’s good news – the more people think that way, the less of the earth’s resources we will consume and the less carbon we’ll put into the atmosphere.
Contrast this with what happens under our current system. A person with that exact same mindset is virtually barred from carrying out their plan. Under the current system, people born to non-landowning parents are born with precisely zero entitlement to any land at all. They are effectively born owing a lifetime’s rent to other private individuals for any land they want to live on. They are then compelled to earn the money to pay that rent by doing considerable amounts of work, consuming scarce resources and putting carbon into the atmosphere in the process. They will have to do this work throughout the major part of their entire lifespan. The environmental consequences are disastrous.
Indeed, the situation is even worse than this because not only does our frugally minded individual have to work to pay their landlord, but they also have to pay a land rent component of all the goods and services that they ever consume.
A key issue that has plagued many governments is that the gap between an unemployed persons income whilst on benefits, and their income when taking a low paid job, is too small. Sometime it can even be even be negative. This results in a lack of incentive to work. The "solution" to this issue has often been to force down unemployment benefits to inhumane levels. But consider what happens if we have the Land rent/Citizen’s dividend mechanism in place: For a start, net housing costs (land rent minus the dividend) for the poorest in society will be far lower than today, or could even be negative (i.e. your citizens income may be greater than your land rent + building costs), so any state benefits that needed to be paid to unemployed people would be much reduced or could even be zero. Secondly, because the citizens dividend is paid out regardless of employment status, the increase in income a person would gain by taking on work (even poorly paid work) would be very marked, resulting in a far greater incentive to work.
We have considered how land purchasing leads to unjust inequalities but what about homes built upon land? Do the same arguments still apply to them? Do we want a society in which buildings are not allowed to be purchased? Consider the following; if someone rented a barren patch of land, what would be their incentive to build a house on it? If they intended to live there for the rest of their lives then no doubt they will want to create a good quality, comfortable home but if they wanted the flexibility to change location after a year or two then we run into a problem. Building a house is a major effort / expense and if you simply had to abandon it when you moved away then the effort would scarcely be worth it. If buildings could not be sold then we may end up in a society where people lived in shabby, temporary buildings. To fix this problem, it appears we need some sort of hybrid system in which land is rented but the buildings upon it, can be bought and sold. Achieving this unusual sounding arrangement is not straight forward, but it is certainly possible:
Earlier in this chapter we discussed the duration of tenancy agreements and concluded that it may be a good idea that the level of rent payable for a plot of land be reassessed at the point where it comes on the market for a new tenant.
When the current occupier of a house intends to sell it, they will first of all approach Desert Island Land Ltd, who will then reassess the maximum rental value they think can be achieved for the raw land as if there were no house built on it. The house then can go on the market at whatever price for the building the current occupier can get for it. Anyone wanting to live in the house will of course have to pay the one-off selling price of the building as well as the ongoing rent to Desert Island Land Ltd.
At this point some people become concerned about the practicalities of estimating the correct rental. They may even say it is inherently impossible, or it will be arbitrary or open to political abuse. These accusations would indeed be true if there were no objective mechanism for judging how well the rent assessments were working but luckily there are. The goal should be that if someone lives in a house and maintains it well enough so that its condition at the end of their tenure is about the same as when they started then the selling price of the building should be neutral i.e. it should have risen about in line with inflation and no more. If the house was poorly maintained and was sold in a worse condition, then it should sell at a lower price (when adjusted for inflation) than when it was purchased. If the mechanism chosen for estimating land rents fails to achieve these objectives then you will know that the rent-setting formulas need to be modified.
The Desert Island Land Ltd idea can be considered in two parts: A) the collection of rents and B) the distribution of those rents back to the population. The most famous supporter of this concept was Henry George (1839-1897), but his chosen mechanism for part B, the distribution back to the people, took the form of funding of the government i.e. instead of income tax. One unfortunate side effect of using land rents to fund government is that the land rent collection will become labelled as a tax, namely Land Value Tax or LVT. This makes the idea difficult to popularise, because nobody likes taxes. Another problem with using land rent to fund government is that the poorest people in society may not get the full benefit of their share of the land rent. If you are unemployed, you will get nothing at all to live on. The government will then be forced to introduce additional schemes to prevent people becoming destitute. This will then put a stop to all the potential advantages in the section "relation to unemployment" earlier.
Another historical figure that supported collecting land rents and giving the money back to the public was Thomas Paine, though in his case, he supported the idea of giving the land rent more directly to the public in the form of a "Citizen's Dividend" or "Citizen's income".
Strangely, in recent times, the idea of collecting land rents (or Land Value Tax) and a that of having a citizen's income, appear to have become separated. There are groups campaigning for a citizen's dividend that do not relate it to the concept to land rent, whilst at the same time, there are supporters of Land Value Tax that are scarcely aware of the concept of a citizens dividend. The two groups appear not to realise that they are in fact two sides of the same coin. This is a political disaster because both groups leave themselves vulnerable to easy attack. The Land Value Tax supporters leave themselves open to attack from people that would say "how dare you tax us so much only to give it to the money-grabbing government" whilst the Citizen's Dividend groups leave themselves open to a rebuttal of "where on earth are you going to get the money from?"
It is not obvious what the best way if for society to make the transition from the current system to the desert island land model. No doubt an overnight switch would case chaos. There are just too many existing landowners and depriving all of them of their land would be politically unrealistic. but there are many ways in which a society could migrate towards it over a generation or so.
Widespread land ownership by private individuals is problematic in a wide variety of ways and would simply not happen in a true free market. The cheerleading and subsidising of mass home ownership by Margaret Thatcher, Ronald Reagan, George Bush and other (self-proclaimed) free marketeers was a significant contributor to the 2007/8 economic crisis.
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