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Why did land disappear from some economic models?
In recent weeks, I've written a couple of articles about land tax and Henry George, the once-famous economist who advocated for better taxation of the economic rent of land and natural resources.
In last week's piece, I said there were reasons why Mr George had been largely forgotten by the mainstream but I didn't have time to elucidate them.
So let's do that today.
It will square off this little series, while referencing fascinating arguments about economic theory.
Why isn't Henry George a household name anymore?
The return of big questions
Last month, The Nation magazine published the audio of a great conversation with the US economist Marshall Steinbaum.
During the podcast, the host, Jeet Heer, said the economics profession had changed a lot in recent decades and he thought two hugely-popular books on economics were indicative of the shift.
He said one best-seller, Freakonomics, published in 2005, was associated, in his mind, with the "End of History" fad of the 1990s.
He said it was easy to see how the intellectual climate of the 1990s, which took for granted that the major ideological battle between Capitalism and Communism had been won, and big economic questions solved, leaving people to entertain themselves with trivialities, had led to the Freakonomics moment.
But then came the 2008-09 financial crisis, which reminded people that big economic questions hadn't, in fact, been solved.
He said that crisis gave birth to social movements like Occupy Wall Street, and a few years later we saw the publication of another best-selling economics book, Capital in the Twenty-First Century, by French economist Thomas Piketty, which spent hundreds of pages analysing the long-run drivers of wealth inequality, marking the return of "big questions" to the centre of the economic debate.
Mr Steinbaum said he agreed the global financial crisis was a transitional moment for economics, and it fitted uncomfortably with his personal history.
"This weighs heavily on me," he said.
"Because I started at the University of Chicago the fall that Lehman Brothers failed [in 2008], and I ended the spring that Capital in the Twenty-First Century was published [in 2014].
"And I basically felt like I didn't learn anything about how things actually work, over that six-year period, until I read Capital in the Twenty-First Century, basically after my thesis was accepted.
"After I'd done everything, got an entire PhD, I finally read a book that actually had something to say about how the economy worked," he said.
They couldn't have picked more different books to talk about.
Back in 2003, when the New York Times profiled Steven Levitt, the economist behind the Freakonomics phenomenon, it said this: "In Levitt's view, economics is a science with excellent tools for gaining answers but a serious shortage of interesting questions."
In contrast, Professor Piketty warned in Capital in the Twenty-First Century that if we allowed wealth inequality to keep growing, it would "radically" undermine democratic societies this century.
"The economists of the nineteenth century deserve immense credit for placing the distributional question at the heart of economic analysis and for seeking to study long-term trends," Piketty argued.
"Their answers were not always satisfactory, but at least they were asking the right questions.
"There is no fundamental reason why we should believe that economic growth is automatically balanced. It is long since past the time when we should have put the question of inequality back at the centre of economic analysis and begun asking questions first raised in the nineteenth century," he said.
Which brings us to Henry George and land.
The 'problem of economics'
When the Nobel Prize-winning economics Professor Angus Deaton criticised the economics profession last month, he alluded to inequality.
He said John Maynard Keynes (1883-1946) wrote that the problem of economics is to reconcile economic efficiency, social justice, and individual liberty, but "mainstream economics" today valorised efficiency over other ends and left social justice an afterthought.
But why is mainstream economics like that today?
Deaton said arguments over theory had pushed economics in the wrong direction, but he didn't get more specific.
But in Capital in the Twenty-First Century, Professor Piketty detailed specifically how the private ownership of land was connected to wealth accumulation, and how certain management of land (and the incomes that derive from it) can be a long-term driver of wealth inequality.
That was one of Henry George's main arguments.
When Mr George visited Australia in 1890, he gave dozens of lectures on the benefits of taxing land rents properly, saying such taxes would provide a more equitable outcome for the community than taxing workers' wages and business income.
In modern terms, he was arguing that proper taxation of land would solve the 'problem of economics' by reconciling economic efficiency, social justice, and liberty.
And his arguments were persuasive.
They helped to spark the Progressive Era in the United States and a worldwide social reform movement that existed well after his death in 1897.
So why have few Australians heard of him today?
Why was Henry George forgotten?
A number of reasons.
First, when Mr George arrived in Australia in 1890, the country was in the middle of a big political argument.
There were Protectionists on one side (with their stronghold in Victoria), and Free Traders on the other (with their stronghold in New South Wales), and they were warring over the direction that economic development should take.
Mr George was a strong supporter of free trade.
In lectures he gave to Victorian audiences, he happily told them why protection would hurt them. He often mocked them gently. In a public debate with William Trenwith MP, a vocal Protectionist, he made Trenwith so angry that he started to "fume" in front of his hometown crowd in Melbourne.
So in the minds of many Australians, Mr George's arguments about land taxation became linked with free trade, making it harder for him to convince Protectionists to listen to his arguments about land taxation with an open mind.
On top of that, lots of country folk with large landholdings were suspicious of his obsession with land.
So, there were socio-political reasons why "Georgism" didn't take off in Australia.
Second, there's the nature of how economic theory is constructed.
Today, some economists like to argue that contemporary economic models reflect the latest and best versions of economic theory and knowledge, and there's little we can learn from the past.
But the history of how some influential economic models were originally built raises questions about that assertion.
For example, in a fascinating book called The Corruption of Economics, Mason Gaffney and Fred Harrison catalogue the deliberate efforts of certain economists, in the late 1800s and early 1900s, to squeeze Henry George's focus on land out of mainstream economic reasoning.
They say classical economists like Adam Smith and John Stuart Mill described wealth as the product of three factors – land, labour and capital – and that was the tradition Henry George followed.
But the 'new' theorists who made an effort to push Mr George aside reduced those factors to two – labour and capital – by treating land as capital.
By erasing the classical distinction between land and capital, it undercut George's attack on landed property.
"The inevitable counterattack came to be called "neo-classical economics," Gaffney writes.
"Rent-taking had to be made to appear useful in functional economic terms. The classical underpinnings of George had to be undone in a fairly subtle way," he said.
Professor Gaffney said several major figures in the neo-classical revolution had personal contact with George, including John Bates Clark, Philip Wicksteed, Alfred Marshall, Edwin Seligman, and Francis Walker. He details their animosities.
He says Clark was especially determined to eradicate George's influence from public policy debates.
Circling back to land on land
But let's wrap things up.
In September last year, in a public speech in Melbourne, the eminent Australian economist Ross Garnaut discussed another element of the story of the theoretical treatment of land in mainstream models.
He said the influential US economist Paul Samuelson once developed an "elegant neo-classical model" that purported to present the famous "Australian case" for trade protection, but with one major problem.
"There was no land in the Samuelson model, yet the core of the Australian case was that protection operated as an indirect tax on land," Professor Garnaut said.
"Samuelson omitted land from his simple and elegant model because the algebra didn't work if you included a fixed factor of production."
He went on:
Samuelson was a colleague at the Massachusetts Institute of Technology of the young economist Bob Solow.
Solow was working on a theory of economic growth based on the Samuelson-type neo-classical model in which there was free movement of capital and labour, automatic adjustment of labour and capital to changes in wages and interest rates (and therefore no unemployment), and no land.
At exactly the same time in the 1950s, Trevor Swan at the Australian National University was working on growth models of a similar kind. Swan and Solow are recognised as having both developed the model that is the foundation of subsequent growth theory.
Swan tried to keep land in his model to make it more realistic. He recognised that economic growth would be associated with rising land rents and their effects on income distribution and the growth process.
Solow's model without concern for a fixed factor of production was simpler, more elegant, less realistic and won the Nobel Prize for Economic Science.
It set economics on a wrong course.
He then shared a personal story:
Half a dozen years ago, my close friend and colleague Max Cordon showed me a letter that he had just received from Bob Solow. Six decades after Solow's article, Bob [had written] to Max:
"We conventionally allocate all of the value added to either compensation of labour or return to capital, to capital as debt and equity. That would be fine if there were perfect competition. In reality there is a third component, monopoly rent. It gets allocated to labour and capital in unknown proportions. What one would like to see is a three-way breakdown in market return to labour, market return to capital and rent."
So, after more than 100 years of economic theorising, where does that leave us?
Did a once-famous nineteenth-century economist have ideas worth listening to, after all?