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Classical vs Neo-Classical Economists

Once you've spent a little time on this website, you might be led to wonder why you'd never heard of these ideas before, or why the child you're sending to a first-rate college or university has never had a class or textbook which paid more than passing attention to them. Is it because there is something wrong with these ideas? Or is there something else at work?

The story is an interesting one. You've come to the right place to find out.

Mason Gaffney: Land as a Distinctive Factor of Production

The classical economists treated land as distinct from capital: "land, labor and capital" were the three basic "factors of production."  They were mutually exclusive.  They were comprehensive, including all economic agents. Each was also "limitational," meaning at least some of each was needed for all economic activity (v.  A9, below)1 They made a coherent system, like Humboldt’s Cosmos, in the spirit of The Enlightenment that spawned them both.

Neo-classical economists denied the distinction and undertook to purge land from economese. 
  • Many of them, following John B. Clark and Frank Knight, still deny the distinction as I explain in The Corruption of Economics, a companion volume in this series. 
  • Many treat the matter by seizing on and stressing all similarities of land and capital, while ignoring all differences. 
  • Some invent gray areas that seem to fuse land and capital, present them as typical, and quickly move on. 
  • Many more simply ignore land, which has the effect of accepting the Clark-Knight verdict in practice. 
  • Others uneasily finesse and blur the issue by writing "land" in quotes, or trivializing its value, or referring vaguely to "quasi-rents" to comprehend a broad spectrum of incomes both from land and other factors.
What ever possessed the neo-classicals to leave such a mess?  One needs to know something of their times and politics.  J.B. Clark and E.R.A. Seligman of Columbia University were obsessed with deflecting proposals, strongly supported at the time and place they wrote, to focus taxation on land.  Henry George, after all, was nearly elected Mayor of New York City in 1886 and 1897.  Frank Knight, founder of The Chicago School, followed them closely.  That explains why some of the points made herein may seem obvious to readers who have been spared the formal conditioning imposed on graduate students in economics.  In graduate training, however, the obvious is obscured, silenced, or denied.  Hundreds of books on economic theory are published with "land" absent from the index.  Denial is reinforced by dominant figures using sophistical, pedantic cant, which students learn to ape to distinguish themselves from the laity and advance their careers.2 Read the whole article


Bill Batt: How the Railroads Got Us On the Wrong Economic Track
Professor Gaffney has for the first time shown how powerful economic interests in American society essentially bought the leading figures of the newly-established American Economics Association with all the blandishments that can be used to influence academicians. Leading scholars were induced to change definitions of terms so that special interests would be advantaged. What were those interests? Primarily the railroad industry, which at the time was probably the most powerful political force in America. By changing definitions and conflating the land factor into capital, it was no longer essential for land rent to be paid in taxes, and the railroads, holders of some of the most valuable land in the nation, were thereby able to escape their full duty. This is an astonishing story, one never fully spelled out until now, and it explains both how the academic community was beholden to powerful interests and how many of the social problems we see today could have been avoided.

The classical tradition of economic thought was ably synthesized and represented by one dominant figure of the age: Henry George. All but forgotten today, perhaps in good part due to the assiduous disparagement of his economic foes, one should note that he was more widely known in his time in America than anyone except Thomas Edison. His 1879 book, Progress and Poverty, sold more copies throughout the world than any book till that time except the Bible. Born in Philadelphia the son of a publisher of religious books, he travelled to California as a young man to make his fortune as a journalist. But what he saw in land speculation and the exploitation of labor soon led him to study the classical economists and to write his ideas down. Upon publication of his book he shortly became known throughout the world, and travelled and lectured widely as a social reformer for the rest of his life. By the time he died he had become so famous that he almost won the mayoralty of the city of New York. He ran twice, losing to Tammany Hall the first time in what was probably a corrupt election (but beating the third-place finisher, Theodore Roosevelt) in 1886, and died four days before a second election he might have won in 1897. As a spellbinding orator and lucid writer, he captivated the world with his vision of societies made more just by a proper understanding of economics. Gaffney shows that it was George, not Marx, that was the primary threat to dominant interests in end-of-century United States. He had to be stopped, and he was. ...

In classical economics, the definition of capital grew out of labor mixed with earlier capital. Land, by conventional definition, was not capital, nor was it a component of wealth. Rather land was its own category. Conflating land into capital allowed land rent to be hidden and diluted in ways so that the unearned increment arising from social improvements fell to speculators rather than being returned to society in rent.

The failure of society to recapture the appropriate level of land rent from titleholders led also to depression of labor wages at the margin, creating poverty and artificial scarcity of labor where otherwise it could be relieved. Hence the title of George's book, Progress and Poverty. George recognized that the value of any land parcel arose out of its social activity, not from anything which a titleholder might have done to it. He recognized that many, perhaps most, titleholders in land were speculators, reaping the benefit of others' investments, and selling out at last when their price was met. Hence it made sense that society had a right to a return on what it had brought about, as well as from the fact that those titles could never be other than leaseholds. That land rent, shortly confused by use of the words "single tax," was, to George, the rightful return to society.   ... read the whole article


Bill Batt: Who Says Cities are Poor? They Just Don't Know How to Tax Their Wealth!

The premises of discourse

What is most called for today is a return to basic analysis. Elementary economics starts with the recognition that there are three factors of production in the creation of social wealth. Each of those factors are mutually exclusive and, taken together, are jointly exhaustive of all sources of market value. The first of these is what classical economics from Adam Smith on called land. Land meant every aspect of nature to which industry can be applied; it meant not just locations of space but air, water, and mineral wealth. Today sunlight, radio waves, and even time, on occasion, would be added. The second factor of production is labor, referring quite simply to the effort applied by people's minds or bodies to land. The third factor is the product of past application of land and labor to current production: capital. Each factor in classical economics has its price, the product of which is the creation of wealth as we commonly understand it. The price of labor is wages; the price of capital is interest, and the price of land is rent. Rent, as understood in economics, is not payment for the use of property owned by others; it has, rather, a more technical meaning, one which will require greater explication below.

We have largely lost sight of these basic premises of economic thought, and it has led to our general inability to address the urban challenge of taxation with a perspective that offers an easy solution. Returning to these fundamental building blocks makes things much simpler and more comprehensible. Labor continues to be easily understood; its meaning has not changed in the course of a shift from classical to neoclassical economic thought. But capital, which had earlier encompassed only those creations that were the result of human enterprise— the product of labor and land, has now been redefined to include land. Land by itself in contemporary neoclassical economics has dropped out of the equation altogether, and so for the most part has the concept of economic rent.[4] Mathematical formulas in neoclassical economics are entirely changed.

There is good reason, however, to recover the use of the terms land and rent as they were employed in 19th century classical economics: rent is the surplus produced by the collective enterprise that can provide the necessary revenue to easily support public services, if it were only collected in the form of taxes.[5] In fact, by shifting taxes off labor and capital and onto land rent, the performance of markets would be made fully efficient and would be essentially painless to taxpayers. This is the thesis I am arguing here, and which is now possible to demonstrate with the advent of computer power and available data. It amplifies and validates what has been for a century only a plausible theoretical claim. We can now show that collecting economic rent can provide for all the services demanded of cities and avail themselves of the proper tax base that exceeds all others.[6] And unlike other taxes there is no downside impact; in fact it's positive. Economic rent is the surplus created by the community, and it circulates through the markets until it ultimately comes to settle on land sites.[7] The result of its accretion to land sites is to raise their market price. Economic rent is sometimes called land rent or ground rent for this reason, and comes about not through any titleholder's individual enterprise but by the consequence rather of society's collective effort. British political economist David Ricardo first conceived of land rent in terms of its relationship to agricultural production in the early 1800s, but its applicability today is understood far more easily with regard to the site values in cities. Whereas ground rent to Ricardo reflected the differential gifts of nature inherent in various land sites, it is today better understood as reflective of locational differentials in the capacities of communities. ...

One could argue that the failure to tax every bit of economic rent that accretes to land sites also has destructive consequences, although this is somewhat open to debate. Classical economists agree that rent collection ought to be at least the sum of inflation plus interest, otherwise the public is facilitating speculation in ways that distorts urban configurations even more than they constitute an inequity. But land sites frequently rise in market price far more than the rate of inflation, especially in times (as is perhaps true today) that a "bubble" in an economic cycle is in full flower. Some municipalities, especially on the east and west coasts of US, are today claiming to have increases in housing prices of as high as 20 percent per annum, a fever that surely will not last and will be especially destructive when it collapses.[19] Land values are what create that bubble; buildings are subject to continuing depreciation just like cars, computers, refrigerators or any other manufactured (capital) item. Recovering the economic rent reduces and perhaps even eliminates the speculative bubbles and swings that (some argue) account for economic cycles, fostering stability and regularity in economic planning and development that make for improved financial health to all.

This reality brings into stark relief the choices which local political leaders have. They may suggest increasing taxes on economic rent (i.e., on land value) or recognize that most property owners are counting on treating their homes and other property not as places to live and work so much as investments and then lament the poverty of their cities. Owners expect to reap a gain from their property when they sell, and they are often positioned to make any threat to that entitlement politically unpalatable. Farmers sometimes regard selling their farms as their retirement security. Homeowners sell with the expectation that this gain will provide them the means to enter long term end-of-life facilities if necessary. Heirs also oppose that recapture just as with a reverse mortgage. But for every long-term property owner that walks away with a lifetime's benefit of increased rent attached to a land title, there are just as many — if not more — young households or emerging businesses that are prohibited from acquiring a property because of the prohibitively expensive costs. In this sense, a title to a socially created stream of rental benefits constitutes a monopoly privilege to an unearned windfall gain for a lucky few. It is both unjust and is socially and economically destructive to the greater good.... read the whole article



Kris Feder: Progress and Poverty Today

As this book was written, the Industrial Revolution was transforming America and Europe at a breathless pace. In just a century, an economy that worked on wind, water, and muscular effort had become supercharged by steam, coal, and electricity. Canals, railroads, steamships and the telegraph were linking regional economies into a national and global network of exchange. The United States had stretched from coast to coast; the western frontier was evaporating.

American journalist and editor Henry George marveled at the stunning advance of technology, yet was alarmed by ominous trends. Why had not this unprecedented increase in productivity banished want and starvation from civilized countries, and lifted the working classes from poverty to prosperity? Instead, George saw that the division of labor, the widening of markets, and rapid urbanization had increased the dependence of the working poor upon forces beyond their control. The working poor were always, of course, the most vulnerable in depressions, and last to recover from them. Unemployment and pauperism had appeared in America, and indeed, were more prevalent in the developed East than in the aspiring West. It was "as though a great wedge were being forced, not underneath society, but through society. Those who are above the point of separation are elevated, but those who are below are crushed down." This, the "great enigma of our times," was the problem George set out to solve in Progress and Poverty.

Economists will recognize his analysis as a precursor to the modern marginal productivity theory of functional distribution. His story is framed in the language of what is today called classical political economy, though George was careful to avoid inconsistencies of definition and reasoning which, he showed, had led other economists astray.

A central feature of the British classical school was the classification of productive resources into three "factors of production" - labor, land, and capital. Most classical economists had conceived of these in terms of three great social classes (the workers, the landed aristocracy, and the capitalists). George, on the other hand, identified them as functional categories, distinguished by the conditions under which the factors are made available for production.

In a competitive economy, the earnings of the factors of production measure their separate contributions to the value of the product. Payments for the use of labor are called wages; payments for land are called rent; the income of capital is interest. In George's terms, the distress of the working classes had to do with a persistently low level of real wages. "Why," he asked, "in spite of increase in productive power, do wages tend to a minimum which will give but a bare living?"

The book proceeds systematically. First, George explores the prevailing scholarly and popular explanations, which relied principally on the famous population theory of Malthus, in combination with the "wage fund" theory of British political economy. Together these theories implied that the aggregate income of labor depends upon the amount of capital devoted to the payment of wages. An increase in wages required an increase in the amount of capital per worker. However, any rise in living standards above mere subsistence motivated workers to marry younger and bear more children, until population growth caused capital per worker - and, therefore, wages - to recede again.

Moreover, population growth diminished agricultural productivity by forcing recourse to inferior soils. Technological advance and capital accumulation might afford a period of relative prosperity - but ultimately, increasing applications of labor to a fixed amount of land could raise output only at a diminishing rate. In short, immutable laws of nature - the population principle and the law of diminishing returns to land - were widely believed to explain the persistence of poverty.

To George, the Malthusian analysis was abhorrent: It asserted that no institutional reform could fundamentally alter the pattern of income distribution, and that charitable support for the needy only compounded the problem - by lowering death rates and raising birth rates. ...

In his own analysis, George takes meticulous care to avoid inconsistencies of definition and reasoning. ...

Public debate about economic policy revolves today, as it always has, around a tension between two fundamental social goals. Economists and policymakers lament a perennial "trade-off between efficiency and equity."  ...

Most economists deem it their business to evaluate the efficiency of policy choices, but, claiming no special knowledge of ethics, they leave it to philosophers and the political process to evaluate questions of justice. Can it be true that society's arrangements to provide for common needs must always confront a divisive choice between equity and efficiency - between what is fair and what is feasible?

Henry George not only denied it; he asserted the reverse: Full recognition of economic rights and responsibilities would reveal the goals of equity and efficiency to be mutually reinforcing. Neither social justice nor a well-functioning free market system can long be enjoyed without the other. "The laws of the universe are harmonious," George proclaimed. His analysis showed that the root cause of widening inequality lies not in the laws of nature, but in social maladjustments which ignore them. Moreover, the breach of justice which underlies the problem of poverty is not merely incidental to economic development; it impedes development, leading to wider and wider inequality.

George emphasized that unequal distribution is itself wasteful of wealth.

Unemployment and underemployment of labor mean that energy and intelligence go untapped. ...

In short, an unjust system of privileges and entitlements tends to cause misallocation of resources, macroeconomic instability and stagnation, political corruption, and social conflict that ultimately may threaten whole civilizations. George's central contribution was to show that the distinction between individual property and common property forms a rational basis for distinguishing the domain of public activity from that of the private.  ...

George's insights have wide application to modern problems.  ...

Modern fiscal and monetary policies have not resolved the problem of macroeconomic fluctuations. Yet a half century before Keynes, George outlined a theory of boom and bust which explained the underlying instability of the market economy under present fiscal institutions. ...

Many American cities are plagued by the twin problems of urban decay and suburban sprawl. ...

Thus, George's synthesis informs a research program of remarkable breadth. Some writers understand Georgism to constitute a distinct paradigm of political economy, one which reconciles the contradictions between the two competing paradigms dominant in the world today - the mainstream neoclassical school, which tends to focus on the impressive efficiency properties of free markets, and Marxist socialism. Other Georgist writers believe that Georgism can and should be explained in the modern language of neoclassical economics. What is certain is that geoclassical thought bears crucially on some of the foremost controversies in America and the world today.  Read the whole article

Fred E. Foldvary — The Ultimate Tax Reform: Public Revenue from Land Rent

Land value taxation was viewed favorably by the classical economists, starting with Adam Smith, who wrote, “Ground-rents, and the ordinary rent of land, are, therefore, perhaps, the species of revenue which can best bear to have a particular tax imposed upon them. Ground-rents seem, in this respect, a more proper subject of particular taxation than even the ordinary rent of land.”14 ...

... There will always be critics who concoct a huge cost in getting assessments correct down to the last penny, or claim, without any evidence, that real estate is a trivial portion of the economy. Such critics date back to the days of Henry George, when the landed interests felt threatened by his ideas. Those opponents have been thoroughly rebutted in the book, Critics of Henry George (the latest edition edited in 2004 by Robert Andelson). The reasons for such attempts to falsify and trivialize rent-based public finance, and even to eliminate the land factor from economics, are chronicled and analyzed in The Corruption of Economics, especially in the chapter by Mason Gaffney, “Neo-classical Economics as a Stratagem against Henry George.” This negative viewpoint is perpetuated by academics who learn of land value taxation from misleading secondary sources, not bothering to dig any further. ... read the whole document

 


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