Tuesday, July 13, 2010

Why did neo-classical economists ignore resources?

We recently published an edition of Tax Justice Focus on the subject of land value taxation. Now Martin Wolf, the Financial Times economic commentator, has opened a fascinating online discussion on this very subject [we recommend you read Martin's comment and then read the largely well-informed discussion that follows it].

Martin kicks-off his discussion with an important observation about the study of economics:

"Something strange happened to economics about a century ago. In moving from classical to neo-classical economics — the dominant academic school today — economists expunged land — or natural resources. Neo-classical value theory — based on marginalism and subjective valuation — still makes a great deal of sense. Expunging natural resources from the way economists think about the world does not."

For this blogger, who took agricultural economics for his degree, economics was the study of resource use, and land was one of the three factors of production, alongside labour and capital. Not surprisingly, agricultural economists typically understand the relevance of land value taxation, whereas those schooled in neo-classical orthodoxies generally treat natural resources as capital. This tendency to lump land and capital together as a single factor of production is based on a rather questionable assumption: namely, that despite rising consumption and population growth, sustained technological change will overcome long-term tendencies to depletion of such as hydrocarbon fuels, phosphate fertilisers, uranium, not to mention the increased scarcity of fresh water and fertile agricultural land.

The assumptions of the twentieth century cannot be carried forward into the twenty first. As Martin Wolf notes, resource scarcity is an increasingly pressing issue:

"It shows up in concerns over pollution (including global warming), in the discussion of “peak oil” and so forth. The idea that diminishing returns will become a more significant factor in the next century than in the past two seems to me to be compelling, now that modern economic growth has spread across the globe. So we need to return to economic models that incorporate resources, as a matter of course."

It is time for economists -- and others -- to pay more attention to the enormous potential that land offers for raising public revenue in ways that do not inhibit innovation, or drive up the cost of labour. As Henry Law points out in an article in Tax Justice Focus:

Using land rent as public revenue has many advantages. It cannot be evaded or avoided. Parasitic speculation in the price of land titles becomes pointless, since land holding carries a liability to pay a charge proportionate to its actual present value. It inhibits corruption of the banking system through the trading of land titles, with consequential damage to the economy through boom-bust cycles.

From an economist's perspective, land value taxation has everything going for it. From the political perspective, however, resistance from powerful interests remains a bulwark against progress, as we have recently witnessed with the campaign by mining companies against the proposed profits super-tax in Australia.

Martin Wolf concludes as follows: "Thus, for both economic and political reasons, we should put natural resources into the heart of economics, thereby remedying a neoclassical mistake."

We wholeheartedly agree.


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