1

The Old, The New and the Ugly

119th Annual Henry George Dinner

By Steven Spadijer

Georgist Insights Into Business Cycle: Some Empirical Evidence

Structure of The Presentation

• Section I: THE THEORY

A. Georgist Perspective B. Supplementary Perspectives - The Post-Keynesians and Institutionalists (Minsky, Veblen) - The Austrians (Schumpeter, Hayek)

• Section II: THE DATA

• What caused the 1970s Recession? - Not the 1970s Oil Shocks B. What caused the GFC? - The ‘GeoAustrian Synthesis’C. Why Are There no ‘Great Depressions’ anymore?

• Some Concluding Remarks and Predictions

THE THEORY: George observed...

“...the speculative advance in land values...is the main cause of those periodical industrial depressions [in] every civilized country... I do not mean to say that there are not other proximate causes. The growing complexity and interdependence of the machinery of production, which makes each shock or stoppage propagate itself through a widening circle; the essential defect of currencies which contract when most needed, and the tremendous alternations in volume that occur in the simpler forms of commercial credit...the protective tariffs which present artificial barriers to the interplay of productive forces... But land speculation is the ‘great initiatory cause...a fact..clearly evident in the United States. In each period of industrial activity land values have steadily risen, culminating in speculation which carried them up in great heights”.

Minsky on ‘euphoric expectations’...

“…Stability is destabilising…The natural starting place for analyzing the relation between debt and income is to take an economy with a cyclical past that is now doing well… As the period over which the economy does well lengthens, two things become evident in board rooms. Existing debts are easily validated and units that were heavily in debt prospered; it paid to lever… Such a financial system will be capable of both generating signals that induce an accelerating desire to invest and of financing that accelerating investment... It follows that the fundamental instability of a capitalist economy is upward. The tendency to transform doing well into a speculative investment boom is the basic instability in a capitalist economy; we have self-fullfilling expectations”

But 100 years before this George also said...

“... THERE IS ANOTHER CAUSE, not yet mentioned, that must be considered before we can fully explain the impact of progress on the distribution of wealth. It is the confident expectation that land values will increase in the future. The steady increase of rent in all growing countries leads to speculation - holding onto land for a higher price than it would otherwise bring at that time. ....With rapid advancement, the swift and steady increase of rent gives confidence to gives confidence to calculations of further increascalculations of further increase. It leads to land being withheld from use, as higher prices are expectedas higher prices are expected. Thus, the margin of production is forced out farther than required by the necessities of production. As landowners confidently expect rents to increase further, they demand more rent than the land would provide under current conditions”.

Schumpeter asks of business cycles...

“Why do entrepreneurs appear, not continuously, that is singly in every appropriately chosen interval, but in clusters? Exclusively because the appearance of one or a few entrepreneurs facilitates the appearance of others, and these the appearance of more, in ever-increasing numbers. For the new demand … is, directly and indirectly, chiefly a demand for labor. Therefore employment must first increase and with it the sum total of wages of labor, then the rate of pay and with it the income of the individual worker. It is from this rise in wages that the increased demand for consumption goods proceeds which results in the rise in the general price level…At the beginning of the boom costs rise in the old businesses; later their receipts are reduced, first in those businesses with which the innovation competes…”

Schumpeter...

but then in all old businesses, in so far as consumers' demand changes in favor of the innovation… outbreak of a crisis—panic, breakdown of the credit system, epidemics of bankruptcies, and its further consequences— …Subjectively, the turning point appears to producers, especially if they resist the unavoidable fall in prices, as an outbreak of hitherto latent overproduction, and the depression as its consequence. The unsaleableness of commodities already produced, still more of those producible, at prices which cover costs calls forth the well known further phenomenon of the tightness of money, possibly insolvency, which is so typical that every theory of the business cycle must be in a position to explain it…

Hang on... These ideas sound similar...

HG observed: “Distinct and independent industrial communities, [but which are] geographically or politically separated communities, blend and interlace their industrial organizations in different modes and varying measures... These seasons of depression are always preceded by seasons of activity and speculation, and on all hands the connection between the two is admitted—the depression being looked upon as the reaction from the speculation, as the headache of the morning is the reaction from the debauch of the night.... People want the things the manufacturer makes as much as ever, just as the operatives want the things the storekeeper has to sell. But they do not have as much to give for them. Production has somewhere been checked, and this reduction in the supply of some things has shown itself in cessation of demand for others...”

Hang on... These ideas sound similar...

“the check propagating itself through the whole framework of industry and exchange. Now, the industrial pyramid manifestly rests on the land... The primary and fundamental occupations, which create a demand for all others, are evidently those which extract wealth from nature, and, hence, if we trace from one exchange point to another, and from one occupation to another, this check to production, which shows itself in decreased purchasing power, we must ultimately find it in some obstacle which checks labour in expending itself on land...this explains the observation of overproduction and overconsumption”

General Propositions that can be distilled...

- Presumption in Favour of endogenous causes of business cycles: internal, not external causes of economic shocks

- Presumption that asset markets can affect commodity markets (and thus unemployment) in several ways: (1) high asset prices stimulate capital-intensive industries which increase the demand for commodities (e.g. building or construction equipment, through wealth effects, higher personal disposable income); (2) in a downturn complimentary industries collapse; (3) high vacancy rates, unsold goods and commodities precipitates bankruptcies

- Presumption of inequality amid prosperity: high debt and high rents belie the labour/working classes

Direct Impacts: Wealth Transfer EffectTheory: ‘Wealth transfer effect’ and ‘uncertainty effect’Reality: ‘Petro-dollars’ mostly rrecycled ecycled back in the US, UK

and Oz economy via new purchases in cars and real estate; surveys show indifference toward oil shock

• 8 billion went into purchasing “real estate and other assets in the UK and US alone” (Economic Report to the President, 1977)

• 25% increase in car exports after oil shock (Olson, 1988) • After oil shock general consumer surveys found

indifference, although irritation, on the impact of the oil shock; oil shock and I expenditure do not correlate

• March 1974 survey by the ABS found only 21% of Australians expected a recession (i.e. after oil shock)

• 500 000 new jobs in the US petroleum sector

SECTION II: SOME EMPIRICAL EVIDENCE

Cross Correlation of Real GNP WithVar. SD% x(t-5) x(t-4) x(t-3) x(t-2) x(t-1) x(t) x(t+1) x(t+2) x(t+3) x(t+4) x(t+5)

Real GNP 1.71 -0.03 0.15 0.38 0.63 0.85 1 0.85 0.63 0.38 0.15 -0.03

Consumption 1.25 0.25 0.41 0.56 0.71 0.81 .82 0.66 0.45 0.21 -0.02 -0.21

Nondurables 1.23 0.29 0.42 0.52 0.62 0.69 0.69 0.57 0.38 0.16 -0.05 -0.22

Services 0.63 0.03 0.25 0.46 0.63 0.73 0.71 0.6 0.49 0.39 0.23 0.07

Durables 4.99 0.25 0.38 0.5 0.64 0.74 0.77 0.6 0.37 0.1 -0.14 -0.32

Investment 8.3 0.04 0.19 0.39 0.6 0.79 0.91 0.75 0.5 0.21 -0.05 -0.26

Fixed Investment 5.38 0.09 0.25 0.44 0.64 0.83 0.9 0.81 0.6 0.35 0.08 -0.14

Nonresidential 5.18 -0.26 -0.13 0.05 0.31 0.57 0.8 0.88 0.83 0.68 0.46 0.23

Structures 4.75 -0.4 -0.31 -0.17 0.03 0.29 0.52 0.65 0.69 0.63 0.5 0.34

Equipment 6.21 -0.18 -0.04 0.14 0.39 0.65 0.85 0.9 0.81 0.62 0.38 0.15

Residential 10.89 0.42 0.56 0.66 0.73 0.73 0.62 0.37 0.1 -0.15 -0.34 -0.45

• All stronglypro-cyclical

• Leading• Lagging

Direct Impacts: Hamilton (1988)

Theory: Reduction in demand for oil-intensive consumer durables (particularly cars) caused output to fall

Reality: Durable consumption actually increased (e.g. Oz, UK) or were falling well before the oil shock (e.g. US)

Barsky and Killian (2002, 2005, 2009, 2010)

Indirect Impacts: Bernanke (1998)

Theory: Inflation caused by the oil shock forced the central bank to lift interest rates (IRs), halting growth

Reality: IRs were rising well beforebefore the oil shock hit and central banks were explicitly targeting asset (and not simply consumer/commodity price) inflation

Japan: Hit 7.25% in September from 5.25% from March ‘73, peaking in 1974 at 9% (BOJ cited ‘property bubble’)

UK: Reached 11.5% in Sept. 73 (BOE cited ‘property bubble’), peaking at 13% in October as the oil shock hit

US: Hit 12% before Oct 1973 and the Fed actually decreased decreased interest rates after oil shock (Burns was more worried about “commodities and real estate speculation”)

Aus: 4% to 9% from Jan to Sept 73 (Whitlam said of the rise in IR that he “hoped this would stop the speculative rush into land and property construction”)

Georgist: Oz, Japan, US and the UK

• Tax exemptions (Idle Land)• Deregulation • Population Growth• Technology and Infrastructure

Georgist Perspective: Role of Expectations

• Progress and Poverty: Land speculation as the “great initiatory cause” of business cycles/downturns...

Georgist: Kakuei Tanaka’s Plan For Japan• Commercial Land prices

http://www.imes.boj.or.jp/english/publication/mes/1989/me7-2-5.pdf

Georgist Perspectives

http://www.imes.boj.or.jp/english/publication/mes/1989/me7-2-5.pdf

Georgist Perspective

http://www.imes.boj.or.jp/english/publication/mes/1989/me7-2-5.pdf

Oz Construction Sector

• NEW BUILDING SUPPLY (SYDNEY CBD)

• Mainline Gearing ($m), Year to 30/6

Years No. Of new buildings Gross Floor area (sq. m)

1958-64

1965-70

1971-76

66

60

84

511 000

574 000

1 460 000

1969 1970 1971 1972 1973

Total Assets

Ext. Liabilities

Gearing (%)

4.8

4.0

83.3

16.7

13.0

77.8

26.9

17.8

66.1

34.1

25.1

73.6

65.6

50.5

77.0

Cambridge Credit…

• Cambridge Gearing ratios ($m), Year to 30/6

In November-December 1973, Cambridge had their real-estate assets re-valued and this suggested a surplus of $43 million after deducting intangible assets and providing for tax. The reality of the estimates depended upon Cambridge being able to realise and sell its land holdings, and at the value at which they were assessed in the books. In 1974, neither was possible. Their assets were illiquid. No one wanted to buy. Land values slumped.

Years Current Borrowing Long-Term Borrowing

1971

1972

1973

2.74:1

2.89:1

3.48:1

4.79:1

4.96:1

9.58:1

Cambridge Credit…

Cambridge Credit operated at a ridiculous gearing ratio. The ratio of stockholders and shareholder funds to liabilities was 1: 6.4 as early as 1968 and had grown 1:7.85 in 1972. At the time of its collapse, the ratio was 1:14.75. This extreme gearing appeared to be matched by a respectable swelling of assets over liabilities, the excess growing from $5.851 million in 1968 to $21 million in 1971. However, in addition to balance-sheet implications, Cambridge Credit had entered into guarantees on loans worth $56.4 million on 31 December 1973. There were, as well, enormous liabilities not listed on its balance-sheet arising out of joint ventures, and the Melbourne receiver claimed that $100 million of liabilities were cancelled from account in this way. Cambridge was engaged in some 650 individual projects, only eight percent of which were wholly owned by Cambridge.

Austrian Perspective: Hayek and Schumpeter

Hayek

• ‘cluster of business errors’ in ‘high order’ goods: e.g. construction goods (‘Round-aboutness’)

• A disequilibrium theory due to credit expansion; artificial, policy induced boom

• Role of the price signal

Schumpeter

• ‘Branching out’

• The Entrepreneur

• Complimentary sectors

• Oversupply, IRs

• Minsky and Schumpeter

Austrian: Overinvestment• Arthur Burns (Chairmen of the Fed) put it well in 1975:

• Sure enough there were was a huge ‘oversupply’ in commercial property. Vacancy rates were as extreme as: Oz (37% in Syd CBD); US (13-16 nationwide%); 35% UK

Austrian: Housing Output

Capacity Utilization…

Austrian: Residential & NR Investment

In Aus Fixed K investment collapsed the most

Austrian Perspective: Hayek and Schumpeter

Austrian Perspective: Hayek and Schumpeter

• Empirical evidence: BOE paper found that construction and complimentary, interrelated industries to housing sector were mainly affected during UK recessions:

http://www.bankofengland.co.uk/publications/quarterlybulletin/qb960302.pdf

GFC• Like the 1970s recession, GFC characterised by...

(a)High vacancy rates (15%+) and mass bankruptcies in the residential and commercial property sectors...

(b) Mass unemployment in construction and manufacturing sectors as well as and housing output....

(c) Exotic financial instruments

(d) World-wide real estate boom

Income and Employment Effects

• PDI did not fall for even one quarter; transfer payments exploded just as the economy started to “recover” (1975:II-IV)

Year (Quarterly)

Disposable Personal Income

(Billions)

Total Government Transfer Payment to

Individuals(Billions)

Government Transfer Payments ÷ Disposable

Personal Income (%)

1973

(1)

(2)

(3)

(4) Recession start*

866.6

891.7

914.1

939.9

110.0

111.9

114.5

117.5

12.69

12.55

12.53

12.50

1974

(1)

(2)

(3)

(4)

953.8

968.2

996.1

1015.9

123.5

130.7

138.4

145.5

12.95

13.50

13.89

14.43

1975

(1) End (Recovery)*

(2)

(3)

(4)

1024.0

1081.7

1087.1

1114.4

157.7

169.4

172.4

175.2

15.40

15.66

15.96

15.72

Income and Employment Effects• 83% of recipients of transfer payments (in 1974-75) were

either to the retired (old age) or disabled (Vets)

• Food stamps, education infrastructure building also exploded: quintessentially Keynesian ‘socialisation of investment’ response to the 1973-74 recession.

Income and Employment Effects

Cash-flow Effects: Watch the Profits!

Sectors and Their Compositions 1972 1973 1974 1975

Households

Disposable Personal Income

Personal Outlays

Personal Savings (Surplus)

Business

Gross Internal Funds

Gross Private Investment

Deficit or surplus

Government

Federal gov. deficits or surplus

State gov. deficit or surplus

Total gov. deficit or surplus

Total surpluses

Total deficits

Discrepancy

Household savings as % of disposable

personal income

Business deficits as % of gross private

investment

801.3

-751.9

+49.4

131.3

-179.2

-47.9

-17.3

13.7

-3.6

49.4

-51.5

-2.1

6.08

26.73

903.1

-830.4

+72.7

141.2

-220.2

-79.0

-6.9

12.9

+6.0

78.7

-79.0

-.3

8.05

35.88

983.6

-909.5

+74.0

141.6

-209.5

-67.8

-11.7

8.1

-3.6

74.0

-71.4

+3.6

7.52

32.4

1076.8

-987.2

+89.6

174.8

-196.3

-21.5

-73.4

10.0

-63.4

89.6

-84.9

+4.7

8.92

10.95

Sectoral Surpluses and Deficits, 1972-75 (Billions of Dollars)

Cash-flow Effects: A Form of Corporatism?

• The difference between the downturns is corporate profits; in 1929, 1930, 1933 they were 10.1, 6.6 billion and 1.7 billion respectively. In 1974, corporate profits were $83.6 billion, but in 1975 they rose to $95.9 billion!

• In 1930s the impact of government was not able to sustain profits and therefore investment, but 1970s it sustained profits!

1929 1930 1933 1974 1975

Gross Private InvestmentGovernment DeficitTotal

16.2-.9

15.3

10.1-.99.2

1.4+1.32.7

229+11240

206+69275

Year GNP Gross Private Investment

Federal Gov. Outlays

% of GNPPrivate Federal Gov.

192919331940195019551960196519701975

103.455.8100.0286.2400.0506.5691.1992.71549.2

16.21.4

13.153.868.475.9113.5144.2206.1

2.64.010.040.868.193.1123.8204.2356.6

15.72.513.118.817.115.016.414.513.3

2.57.2

10.014.317.018.417.920.623.0

Balance-Sheet Effects: Gov. Bonds

Sector 1972 1973 1974 1975Households

Non Financial CorporationsState & Local Governments

.6-2.4-3.4

20.4-1.8-.2

14.53.5-.1

-.916.1-5.8

Total NFS 1.6 18.8 18.1 21.1Commercial BankingSavings and Loans

Mutual Saving BanksCredit UnionsLife Insurance

Private Pension FundsState and Local Gov. Ret. Funds

Other Investment Co.

6.54.31.4.8.3

1.0-.6-.4

-1.3*

-.5.2.1.6.1-.1

1.03.3.1.2*

1.1.6-.3

30.311.13.61.91.35.41.7-1.0

Total Financial SectorTotal

13.615.2

-.418.4

6.724.9

57.178.1

Total Private Domestic Acquisition of U.S. Gov. Securities, 1972-75

Balance-Sheet Effects: Fiat Currency

Sectors and Their Compositions 1972 1973 1974 1975

Net acqs. Of financial assets

Demand deposits + currency

Total Bank Credit

Credit-market securities

U.S. Gov securities

Direct

Agency issues

Other securities + mortgages

S&L Obligations

Corporate Bonds

Home mortgages

Other mortgages

Other cr. Excl. Security

Consumer Credit

Bank Loans

Open-market paper

Corporate Equities

Security Credit

Vault cash / member bank reserves

Other interbank claims

Miscellaneous assets

78.3

.2

75.4

70.5

6.5

2.4

4.1

25.7

7.2

1.7

9.0

7.8

38.4

10.1

28.5

-.2

.1

4.8

-1.0

1.4

2.3

100.2

.3

83.3.

86.6

-1.3

-8.8

7.6

25.9

5.7

.5

11.0

8.8

62.0

10.6

52.1

-.8

.1

-3.4

3.5

6.0

7.2

83.9

-.2

62.2

54.6

1.0

-2.6

3.6

19.1

5.5

1.1

6.5

6.1

44.5

2.8

39.5

2.2

-

-2.4

-3

7.1

15.0

32.9

*

27.8

26.6

30.3

29.1

1.2

6.4

1.3

2.1

1.9

1.2

-10.1

-.6

-12.9

3.4

-

1.2

1.0

-5.4

9.5

Commercial Banking: Net Acquisition of Financial Assets, 1972-75 ($ billions)

Observation for Australia…

Industry GrowthGrowth Percent

Agriculture 20,503 5.7%

Mining 20,659 13.0%

Electricity -7,923 -5.5%

Construction 29,935 3.0%

Wholesale 11,759 3.0%

Retail -32,859 -2.7%

Accommodation & Food 49,279 6.9%

Transport -2,513 -0.4%

Information Technology -7,753 -3.5%

Finance -1,982 -0.5%

Real Estate 23,287 13.4%

Professional 78,640 10.4%

Administration 15,609 4.4%

Education 28,853 3.6%

Health 47,060 4.0%

Arts -13,156 -6.2%

Other Services 17,641 4.0%

Total Victoria 109,894 4.1%

Total Australia 158,710 2.1%

Victorian Employment Growth by Industry March-December 2009

Industry Growth Growth Percent

Agriculture 8,026 9.8%

Mining 978 9.4%

Electricity -5,953 -16.9%

Construction -8,366 -3.7%

Wholesale 5,029 4.4%

Retail 22,724 7.8%

Accommodation & Food 996 0.6%

Transport -6,782 -4.7%

Information Technology -1,236 -1.9%

Finance 21,275 22.4%

Real Estate -1,631 -4.6%

Professional 24,157 12.2%

Administration 7,456 8.5%

Education 14,673 7.4%

Health 13,718 4.8%

Arts -2,276 -3.6%

Other Services -704 -0.7%

Total Victoria 70,005 2.6%

Total Australia 62,953 0.8%

Construction...

Construction...

Construction...

Conclusion

• Don’t listen to neo-classicals…empirical data suggests there should be a presumption against the claim that exogenous ‘shocks’ are the primary cause of stagflation…‘Stag’ = collapse of property/debt bubble; ‘flation’ = due to big governments‘ attempt in stabilising output

• Keynesianism saved the day…even though, as Minsky puts it, ‘stagflation [was] the bitter price we pay to avoid a depression…’

• History of Economic Thought is a more viable in exploring the causes of stagflation…Perhaps a ‘synthesis’ between the Georgist, Austrian and Post-Keynesian schools is in order in analyzing the endogenous dynamics of stagflation…