I had a short argument with Greg Ransom a couple of months back. Greg won. But actually, I wasn't really arguing with him. I was on his side to begin with, though it did help me clarify my views.
Question. "What is the economic difference between capital and land?"
If you answered: "People made capital and God made land", you are wrong.
Economists have known that answer is wrong since 1871, when we discovered that bygones are forever bygones, and switched to the forward-looking marginalist theory of value. In 1871 we stopped saying that the value of goods is determined by what they cost to produce in the past. Instead we said the value of goods is determined by their marginal utility in the present and expected future. (OK, there are two blades of the Marshallian scissors, demand and supply, but both blades are made of the same stuff (Mark Blaug?), because marginal costs are really opportunity costs, and are the foregone marginal utility of the other goods we could make with the same resources.)
It doesn't matter whether people or God made stuff in the past, and what it cost to produce it. The only things that matter are: the present; and present expectations about the future. If archaeologists discovered that Prince Edward Island was an artificial island, rather than a geological formation, it shouldn't matter at all for the allocation of resources going forward. (OK, some geologists would have extra work to do, to revise their theories.)
What is the economic difference between the existing stock of capital goods and the existing stock of land? Nothing really. Except we will, probably, be producing more capital goods in the future, and we won't, probably, be producing more land in the future.
But even that is not quite right. And not just because the Dutch invest in producing more land. The capital goods we are making today aren't always exactly the same as the capital goods we made in the past. Technology changes. I doubt that anyone today is building a computer exactly like the one I'm using now.
Antique furniture is really land, economically speaking. So is my Mazda MX6. They don't make them like that any more. If we lost the blueprints, and couldn't reproduce any of the existing capital goods in future, they would all become land.
The best we can say is that we can and will be producing capital goods that are a much closer substitute for some existing goods than others.
If there's a very elastic supply curve of newly-produced goods that have a high cross-elasticity of demand for some existing goods then we can think of those existing goods as capital. If there's a very inelastic supply curve of newly-produced goods that have only a low cross-elasticity of demand for some existing goods then we can think of those existing goods as land.
Where am I going with all this? Here's where I'm going:
Some people today say that the current/recent recession was caused by past overinvestment. Or malinvestment, for the more sophisticated version. Especially in houses.
And I'm saying there's something logically peculiar about any sort of theory like that, if you approach economics from a praxeological, forward-looking basis. Bygones are supposed to be bygones. It didn't ought to matter how we got to where we are today. All that ought to matter is where we are today, and where we expect to be tomorrow.
Suppose that geologists discovered that we all had false memories of the last decade. The houses that appeared in the US are in fact a very recent geological feature. They just sprung up out of the ground. There wasn't any overinvestment in houses at all. God did it. God overinvested in land. Did God make us poorer by doing that? Would the recession suddenly disappear, when people learned the news?
There is something logically peculiar about the Austrian theory of recessions, as being caused by past overinvestment. Sure, the natural rate of interest would be lower, and the future pattern of investment would be different, if a lot of houses suddenly sprang up out of the ground. But isn't the market supposed to be able to handle things like that?
It's not just the Austrians. It's the Keynesians too, at least those who say we are stuck in a liquidity trap and can't get out.
Suppose we all wake up tomorrow and learn that all the economic statistics published over the last few years are totally wrong. And that our personal memories are false too. We have all been brainwashed by the Martians into believing inflation has been low and real growth low. In fact, Nominal GDP has been humming along quite nicely. Is there any reason to expect that it couldn't continue to hum along quite nicely in future?
True, a few workers seem to have forgotten who their employers are. And a few employers seem to have forgotten who their workers are. But given a few months they could search and find each other again. Or, at least, find new partners.
And the US Fed would be surprised to find its balance sheet is far too large, and it would need to do a very big open market operation to sell a lot of the assets it holds. And commercial banks would be surprised to find their reserves at the Fed were far too large, and the rest of their balance sheets too small.
And a lot of people and banks would discover they seem to have made some past loans at ridiculously low nominal interest rates, so they immediately raise interest rates on new loans.
And firms find their capital stocks seem to be far too small, so they do a lot of investing to get them back up to normal. And households find they are crammed into houses that are smaller than they need be, because there are a lot of houses sitting empty, but they soon sort that one out. And are driving old cars, and wearing old underwear, and so start investing in a lot of new stuff.
But otherwise, the economy could hum along quite happily on the new equilibrium NGDP path.
Suppose we all wake up tomorrow morning and learn that our memories of driving on the right are false. Everybody drives on the left in Canada. We are puzzled to find our steering wheels on the wrong side, and the road signs in the wrong places, but everyone switches to the new equilibrium and drives on the left.
If a change in our memories can switch us to a new equilibrium, why can't an announcement of the new equilbrium, an NGDP target, do the same?
When did economists forget that bygones are supposed to be bygones? (Not that they are, of course, totally).
Worthwhile Canadian Initiative 
J.V. Dubois
“That means that even if you wake up with total amnesia and somehow get to work (maybe you have the address of your employer in your phone), you would find that your production tools are damaged and you would have to wait for them to be replenished.”
But this makes no sense, as somebody else would have to be employed to repair them. (And it doesn’t explain why this is the case.) You can’t have general underemployment if this is the only problem.
And see the discussion I had with Greg Ransom about houses. Houses are a long production process because what is consumed is HOUSING (not houses as such) – but building the houses is actually a relatively short process – there aren’t lots of houses that can’t be completed. The problem is not real, it is purely financial.
Nick, how many industries and employment categories would be wrenched or wiped out if masses of houses cyclically appeared in a cascading fashion over a period of 5 or 10 years, and then suddenly halted, but but in unsystematic and unpredictable non-linear patterns.
Suddenly all sorts of workers and industries would hardly be needed, others suddenly would be needed. In systematic waves which no one planned for, prepared for or anticipated in advance.
I don’t want to do all of the work in picturing all of the steps in this story, which it shouldn’t be hard to do on your own.
But for starters, what would this do to the financial markets and the market for money and money substitutes?
Greg: OK. Any sudden unexpected real shock, like houses appearing out of the desert, would cause the economy to have to re-adjust. And that re-adjustment could be difficult. So, if we wanted to state/re-state ABCT in that light, we would say that the excess current stock of houses relative to the current stock of skilled builders is what causes the recession. What happened in the past is, by happenstance, what happened to have caused the excess stock of houses relative to builders, but plays no further role in the adjustment process.
Right. But houses alone are only one tiny slice of the whole net of relative prices & the web of interconnected consumption expectations, production processes taking different time lengths, and income stream expectations. Not to mention the sudden shock to shadow money asset values and near money liquidity.
The sudden unexpected real shock effects systematic directions every price and every income stream and every interconnected production and consumption node in the system. Not to mention liquidity, money, credit, debt, bankruptcy and other issues with a more conventional “money” dimension.
It’s a massively connectionist / parallel processing domino system with multiple cascades.
It’s not a mono-causal picture, it’s complex distributed system picture.
Housing and housing finance is simply the most prominent and pathological element in the system — the biggest causal domino with the largest number of connections and the mostly overly-determined causal element, with all of the various pathologies or “perfect storm” conditions exaggerating its causal significance. (And, contrary to Scott Sumner, there is a lot of empirical data showing the size of this element, and extending out from that node to dozens of others.)
Nick writes,
“Greg: OK. Any sudden unexpected real shock, like houses appearing out of the desert, would cause the economy to have to re-adjust. And that re-adjustment could be difficult. So, if we wanted to state/re-state ABCT in that light, we would say that the excess current stock of houses relative to the current stock of skilled builders is what causes the recession. What happened in the past is, by happenstance, what happened to have caused the excess stock of houses relative to builders, but plays no further role in the adjustment process.”
Sorry, make that:
“The sudden unexpected real shock systematically effects every price and every income stream and every interconnected production and consumption node in the system — cascading them in systematic directions .”
I’m not sure what you are saying here.
“we would say that the excess current stock of houses relative to the current stock of skilled builders is what causes the recession.”
If we suddenly have a massive supply of new houses out of no-where, we suddenly won’t have as much demand for new houses or the inputs to the production of new houses, e.g. we will no longer need the current supply of lumber and construction workers.
Leading to the same sorts of thing we witness today — hundreds of miles of mothballed lumber hauling rail cars and massive unemployment in the construction industry.
Greg: “I’m not sure what you are saying here.
“we would say that the excess current stock of houses relative to the current stock of skilled builders is what causes the recession.””
Nor do I. I said it wrong/unclearly. I meant the current stock of houses, and the current stock of builders, are wrong, relative to preferences and everything else.
If God suddenly switched bulldozers into houses, and also switched house builders into bulldozer builders at the same time, the economy could continue fine.
Nick writes,
“If God suddenly switched bulldozers into houses, and also switched house builders into bulldozer builders at the same time, the economy could continue fine.”
There is a lot assumed here — the implicit “given” of the example is that these items have equivalent production time profiles and labor input profiles. That is a fine Keynes’ style back of the pants stipulated “truth”, but it might be false.
Imagine that it isn’t true. Imagine that bulldozers last only 1 day and ordinarily take 3 days to build, while houses last 200 years and take 5 years to build. For simplicity, lets stick with the idea that both products require the same number of laborers, say 100.
We’ve now give up, say, 1,000 production goods that normally lasted only 1 day and take 3 days to build and we’ve gained production goods that last 200 years and take 10 years to build.
It looks to me like we’ve freed up some labor, and freed up some resources to be used for shorter production processes costing less time and interest. It will take some time to find remunerative uses for all of these inputs, many will have to be relocated to new places where they can be used, and some may have no place at all in the set of production plans going forward.
I’ve just scratched the surface, here, of course.
Patrick wrote:
Determinant: lots of very clever people have thought about really hard about this stuff. There is more to economic modelling than A-D. Off the top of my head as a rank amateur: try googling Barkley Rosser, also computation economics.
If you want to follow the advice of Sun Tzu:
http://cowles.econ.yale.edu/P/cm/m17/
It’s hard slogging to read closely (Bagehot is a Harlequin in comparison), but at least it’s not Hayek.
Thanks. I may do that.
My main point was that in a second-order system it clear and easy to explain why you cannot change the flows in the system instantaneously by looking at the math.
No infinite energy in an electrical circuit <=> Money is not infinite.
In the former you get circuit overloads and arcs, in the latter you get defaults.
I was trying to show why we are prisoners of our own construct.
That’s my line ..
“I was trying to show why we are prisoners of our own construct.”
But Greg/Nick the overhang of houses is not so great. The problem is the price of the LAND that the houses are built on. That mothballed building equipment is mothballed because house building is WAY below trend. Most of the extra debt was incurred not in buying new houses, but in buying existing houses. Essentially people have committed lots of future income to paying banks what is essentially rent on land. And the really bloated sector is the banking sector! Nick of all people, you should avoid this “money doesn’t matter trap”. This is more a asset price story than it is a real economy story.
And the real long term structural imbalance in the US economy is due to an out of whack exchange rate (which for some strange reason Austrians completely ignore) not inappropriate monetary policy (although the lending policies in the US from about 2005 were criminal – I think literally).
Greg Ransom
I agree housing is special – but it is because of volatile land prices and because almost every household (in most developed countries at least) owns some – and a lot of their net worth is tied up in it. The house itself is just a big consumer durable. The building boom (at the end of the house price boom – when existing houses became totally unaffordable) is a secondary phenomenon.
And surely folks, I’m not saying anything radical here. Anybody who actually looks at the real world knows all this. If its not in your models, then your models are incomplete.
This is also why I want Austrians to use something other than houses as an example – it is mixed up with land speculation and so is a dirty example. I repeat houses are just a big consumer durable. Consumer durables are known to be pro-cyclical. When people are feeling confident about the future they buy consumer durables, when they are not feeling confident about the future – they don’t. I think the Austrian argument is completely circular – essentially they are saying, if there are no economic cycles then there won’t be any cyclical industries. So? But the problem is there are, and always have been economic cycles.
Now I’m going to be provocative here. I’m making substantive points that are being mostly ignored. I think it is because my points can’t be addressed by your models. Show me I’m wrong!
“And the real long term structural imbalance in the US economy is due to an out of whack exchange rate (which for some strange reason Austrians completely ignore)”
Hayek didn’t ignore the potentionally large role of exchange rates in the trade cycle, see his Monetary Nationalism and International Stability.
And I’ve talked a bit about its role in the current situation.
You can’t say everything at once in a blog post comment …
I’m also aware of the land / housing issue, see particularly Thomas Sowell on this topic, and its relation to land use regulations.
Latest estimates are that 1/2 of all unemployed workers in 2008 were construction workers.
And how many times to I need to bang people over the head with the foundational economic concept that markets are interconnected, and a crash in housing effects all sorts of other markets in systematic ways.
If economists (trained to be math guys and think like math guys) can’t think economically, what hope is there?
Latest estimates are that 1/2 of all unemployed workers in 2008 were construction workers.
Can you document that – I find it hard to believe.
Oops
I missed something there – in 2008! i.e. You are just saying housing was the first sector hit. What does that prove?
“And how many times to I need to bang people over the head with the foundational economic concept that markets are interconnected, and a crash in housing effects all sorts of other markets in systematic ways.”
Can you find me a single economist who doesn’t think that? And surely a direct corollory is that it works in the other direction. (It is called the multiplier).
“reason” trolls,
“Can you find me a single economist who doesn’t think that?”
Yes — every economist who works with “K” or with single “representative agent” or with a 2-goods economy, or the direct linear causal interaction of government statistics aggregates and averages, or …
Oh hell, who am I kidding, you are “reason”, and it’s all about the trolling with “reason” ..
Every conversation is an opportunity for “reason” to invent a misunderstanding, or non-issue, or falsehood or stupidity to take the conversation into the weeds …
Greg,
the map is not the territory. Nobody believes a representative agent model is anything like reality. And cut the ad hominim it is beneath you.
Particularly as you are the biggest thread hijacker out there with your constant vague references to obliguely relevant old works by Austrian economists.
Look Greg – if you want to know why I don’t like the way you argue – this is typical
“”And the real long term structural imbalance in the US economy is due to an out of whack exchange rate (which for some strange reason Austrians completely ignore)”
Hayek didn’t ignore the potentionally large role of exchange rates in the trade cycle, see his Monetary Nationalism and International Stability.
And I’ve talked a bit about its role in the current situation.
You can’t say everything at once in a blog post comment …
I’m also aware of the land / housing issue, see particularly Thomas Sowell on this topic, and its relation to land use regulations.”
Unless I happen to be an expert on the books you mention – then you are not contributing a discussion – you are avoiding it. If you want to appeal to authorities then either quote them or summarise their arguments don’t refer vaguely to a whole book. I can’t answer unless I go away and read the book (and then find and read criticisms of it, for balance). I don’t have time for such distractions.
And don’t use specialised jargon – use normal english wherever possible.
And please Greg, if you want to relate your arguments to current circumstances, dehn to look at evidence. I found this
http://forecastchart.com/graph-housing-starts.html
and it allows you to look at the chart over 49 years. Now look at the 49 year chart. Is the level of building before the crash extraordinarily high – or is the level after extraordinarily low?
Now look at this:
The smoking gun points to housing prices not house building as the cause of the extraordinary problems we have now.
“reason” — take a course in critical thinking or informal logic, and leave me alone.
Greg
to be perfectly honest I think your problem with me is that I am critical. And yes in future I will just ignore you.
Just a small note about Austrian economists and the exchange rate (not addressed to Greg of course, but anybody else out there who is still reading) – in the current situation, I have seen Paul Krugman, Dean Baker and Andy Harless all emphasize the importance of the overvalued US dollar and the trade deficits to the problems that the US have. But I haven’t seen any Austrian economists emphasizing this – even though the trade deficit clearly shows that the international economy is not in structural balance (the Austrian solution is for US to deflate – with households massively in debt!).
reason: “..- even though the trade deficit clearly shows that the international economy is not in structural balance..”
Careful now. In equilibrium some countries export apples and import bananas. This makes sense, because countries are different. We don’t say that shows a structural imbalance. Similarly, in equilibrium some countries export goods this year, and import goods some time in the future. This too makes sense, because countries are different. It doesn’t mean there’s a structural imbalance.
If I lend to you, it doesn’t mean there’s a structural imbalance, that needs to be fixed.
Nick,
you know as well as I do that the US has had a massive trade deficit for a VERY long time now.
And Nick,
and you also know the bit about G-T + X-M + I-S = 0
So if X-M is massively negative then either G-T or I-S must be massively positive. It is hard for me to see how that persistently happening for a long doesn’t lead to financial problems.
That said, there is an argument that Saudi Arabia needs to save as much capital as it can now before its single massive cash cow runs out. But that doesn’t excuse the difference between say the USA and Germany. (And I really think people ought to pay more attention to the effect of VAT on effective exchange rates – VAT taxes imports but not exports and income tax vice-versa). The USA has deindustrialised. When the time comes for the USA to start exporting – what is it going to export?
reason: demographics last a long time.
Here’s my way of looking at it: if you see someone borrowing, it might be prudent, or it might be imprudent. It depends.
reason: “you know as well as I do that the US has had a massive trade deficit for a VERY long time now.”
The U. S. trade deficit used to bother me, until someone pointed out that in the 19th century Great Britain ran persistent trade deficits, without adverse effects. The basic point is that Britain was a superpower and perhaps the richest nation in the world at that time. It makes perfect sense for the richest nation to buy more from other nations than it sells to them. 🙂
But then Britain hit a wall eventually. Surely not a good example.
I think it has more to do with the distorting effects of having the reserve currency. It is sort of like a financial Dutch disease. I think there should be a managed international reserve currency independent of any one country’s central bank.