Alternative Economic Review  No. 4: Will we all be Keynesians again?

Editorial:

Will we all be Keynesians again?

As a U.S. recession looks more and more like a done deal, many will argue that this is a great time for America to invest in public infrastructure: railways, bus services, roads, water supplies, underground electrical and communications cables, sewerage, drainage, schools and colleges, etc. Indeed, such investment not only employs men and machines that would otherwise be idle during the recession, but enhances the productive capacity of the economy, allowing faster inflation-free growth in the post-recession years.

Nevertheless, the financing of all such projects, from the smallest to the grandest, is subject to principles that remain valid regardless of the present state of the economy.

The market cannot value the benefit of infrastructure except through the price of access to the infrastructure; market value equals price of access. But the price of access has two components: the obvious one, namely the charges payable for actual use of the infrastructure (e.g. fares, tolls, waste-discharge tariffs); and the hidden one, namely the price of living or working in a location where the service provided by the infrastructure is available, as opposed to a location where it is not.

The value of a location is reflected in rents or prices of real estate in that location. More precisely, it is reflected in the rents or prices of sites — a site being a piece of ground or airspace, including location-dependent rights to build on that ground or into that airspace, but excluding any actual buildings or other artificial structures. A site has a unique location, hence a locational value, even if no buildings yet occupy it, whereas the value of a building in any location is limited by construction costs.

So the “hidden” component of the price of access to infrastructure is the uplift in site values caused by provision of the infrastructure. Moreover, the benefit of the infrastructure to the public (as distinct from the provider, which is assumed to be the government) is net of charges for actual use, and is therefore equal to the “hidden” component of the price of access. That is, the net benefit of infrastructure to the public is the total uplift in site values caused by the infrastructure.

Hence the economic cost/benefit ratio of an infrastructure project is simply the cost/uplift ratio. If the “cost” is understood as the cost to the provider, this is also net of charges for actual use, so that the cost/uplift ratio is the fraction of the uplift that must be recovered through the tax system in order to pay for the project. And if the project passes a cost-benefit test, this fraction is less than 100%.

(Note: Obviously costs and benefits may have lump-sum and annualized components, while uplifts may be expressed in terms of sale prices or rents. For the purpose of the foregoing argument, all terms must be converted to the same basis, e.g. present value or annuity.)

It follows that any infrastructure that passes an economic cost/benefit test can be financed by a tax collecting some fraction (less than 100%) of the uplift in site values caused by the infrastructure. The rest of the uplift is a net windfall for the site owners — who therefore should enthusiastically support the arrangement, as indeed they did in better-informed times.

More precisely, if a certain fraction of every uplift is reclaimed through the tax system, infrastructure projects whose cost/benefit ratios are equal to that fraction will be self-funding, while projects with lower cost/benefit ratios will be more than self-funding, yielding net contributions to revenue. These contributions may be spent on infrastructure projects with slightly higher cost/benefit ratios, or other services, or cuts in other taxes, or some combination thereof.

This arrangement does not mean that accommodation becomes less affordable; because the increase in site values is driven by quality, not demand or competition, it does not imply that accommodation of given quality becomes more expensive.

By creating a rational expectation of increasing site values due to improving infrastructure, this system of finance helps to reverse any slump in property values that may be in progress when the system is introduced. Equally well, by reclaiming a fraction of all uplifts in site values, the system reduces the attractiveness of capital gains relative to rental income (earned or saved), and therefore dampens the speculative motive that has inflated bubble after bubble in the property market. And if you don't blow bubbles, you don't have to endure the ensuing bursts and recessions.

Because this infrastructure-financing system provides the affected property owners with net windfalls that they would not otherwise get, a competent political party should be able to obtain a democratic mandate for it. The Chinese leadership, of course, does not need to concern itself with such niceties. Therefore, as long as China remains a one-party state, financing infrastructure out of the ensuing uplifts in site values is perhaps the only method by which the economies of developed democratic nations can stay ahead of China, and the only method by which the economies of developing democratic nations can catch up with China.

— Gavin R. Putland.

Contributions

At I, Me, Myself, Sidhusaaheb ponders India's economic future in “A few stray thoughts, on the eve of Diwali...” He notes that whereas most economies progress from agriculture through manufacturing to services, India has moved to services after comparatively little progress in manufacturing, hence little development of infrastructure. This premature concentration on services is due to offshoring by rich English-speaking countries, leaving India vulnerable to any recession in the USA or the UK — the more so because of likely competition from the massive English-speaking workforce in, of all places, China! The writer expresses the hope that recent progress in manufacturing will “promote the development of basic infrastructure”. The editor submits that pro-infrastructure tax reforms, along the lines suggested above, will also be needed. This post, by the way, dates from October 2006; it's old, but newly relevant.

The causes of America's economic woes are considered by Richard Pettinger in “What Went Wrong With the US Economy?” (January 15), posted at Economics Essays, and by Dob Bole [sic] in “The Time Is NOW!” (January 25), posted at FedUpAmerican.

Stirling Newberry at The Agonist, in a post dated January 8, predicts “The Coming Double Dip Recession” — a shallow recession this year, which will be ended by monetary expansion, and then a deeper recession caused by the monetary tightening that will be used to end the inflation.

Ian Welsh, also at The Agonist, apparently makes similar assumptions when he asks “Has the Dollar Hegemony's Tipping Point Been Passed?” (December 31).

Dollar hegemony and the threats thereto are further considered by Zé Cacetudo in “A Casus Belli For Iran” (October 2), posted at The Daily Hype.

The cheerleaders for neoclassical economics take every opportunity to extol tax cuts or tax concessions as “incentives”, but have no time for anyone who suggests that a tax cut or tax concession should be contingent on actually doing the thing for which it is allegedly an incentive. Doug Ragan at I'm A Pundit Too is not quite guilty of that. In “A Simple Fix For The US Economy”, although his first preference is simply “eliminating all corporate taxes”, he says by way of compromise: “Eliminate taxes for all corporations that pay 100% of all health care insurance for their employees.” Now that's an incentive. But it has a sting in its tail. For a corporation that takes up the offer, the total tax bill will obviously be reduced, but the marginal cost of hiring an additional worker will be higher — not only because of the insurance cost, but also because there is no longer any taxable income from which to deduct the worker's wages and insurance cost. Thus it becomes more expensive to hire and more attractive to fire.

How can the citizen recognize a recession before the official statisticians do? Some pundits recommend weighing the weekend edition of the local newspaper. Others recommend counting the cranes on the urban skyline; in Australia this method has been called the COSSI — the Cranes On Sydney Skyline Index. An important caveat for the crane-counters is that the completion of the world's tallest building has often coincided with a global recession; this observation is known as the “skyscraper index” (and also by a less polite name referring to the alleged symbolic significance of skyscrapers). But now “Head Pig” at Lipstick this Pig claims to have the ultimate answer: the Halloween Candy / Christmas Trash Theory of Economics (HCCTTE).

Finally, if the reader is in need of further comic relief at the expense of the financial sector, Ion Zwitter at Avant News obliges with... er... a futuristic look at the herd mentality.

Next edition

Articles for what is expected to be the final edition of Alternative Economic Review (published February 27, 2008) may be submitted via the carnival submission form. Guidelines for contributors may be found on the index page and homepage for this carnival.

[First published at grputland.blogspot.com. Edited Jan.31, 2008. Relocated Nov.13, 2009.]