Archive for the ‘Uncategorized’ Category

Isolating ground rent

October 26, 2015

• Plots of land will be allotted into discrete locales within which ground rent per square foot is estimated as being approximately equal for a particular land-use with specific planning permission (eg on building height). All owners of real estate (ie improvements to the land) will be required to hold sufficient eligible land permits (LPs) for the current year. The public will maintain records of who owns real estate and who holds LPs.
• Ordinary land permits (OLPs) for every locale will be issued in standard denominations of square metres each year via public auction. Each Series of OLP is valid for a particular land-use/planning permission in the locale for one year commencing on the 15th anniversary of the auction. Single holdings in a Series will be limited to 10% in order to prevent market manipulation.
• On the date of the first issuance of OLPs (being post-dated), a batch of 15 Special Land Permits (SLPs), one for each of the first 15 years, will be registered with individual real estate lots in the name of their owners (disregarding the 10% limitation). This cushions incumbent real estate owners against the loss of residual value in the land. Any real estate sold within this initial 15-year period will be sold along with the remaining SLPs.
• Unlike SLPs, OLPs are alienable from particular real estate lots within the locale. This feature allows their auction to realise an approximation of ground rent as public revenue (more of which later). It also means that while being public instruments, OLPs are negotiable and can be privately traded on a (public) exchange.
• Real estate owners obtaining new planning permission would have their existing holdings of (up to 15) LPs upgraded to the new planning permission type, but additional OLPs would already have to be eligible on purchase. This avoids deterring development while also recognising the positive effect of upgraded planning permission on ground rent.
• As the combined area denoted by a Series of LPs is equal to the area of the land in the locale (with the given characteristics), at the start of each year any real estate owners without OLPs for that year will be granted an opportunity to purchase them. Necessarily, the only source of vesting OLPs comprises those who are holding them over without owning real estate in the locale. If the real estate owner makes the purchase, the price per square metre paid to the former holder of the OLPs would be set at the last open market transaction in that Series.
• Despite being able to top up their LPs each year on issuance, and therefore maintain 15 years’ security of tenure, giving real estate owners pre-emption purchase rights over OLPs exercisable when they vest prevents potential outbidders hoarding them in order subsequently to seize their real estate. At the same time this arrangement ensures anyone who acquires OLPs will receive fair value, whether as land-use or in exchange.
• If the real estate owner does not make the purchase, his real estate will be compulsorily auctioned along with the vesting OLP (whose previous holder would be free to bid). By setting aside the value of the OLPs (at their last market price) and paying this to their previous holder, the remainder of the combined proceeds of the auction represents the market value of the improvement to the land only. This amount will be returned to the former real estate owner as compensation for the sale of his real estate.
• As mentioned, the annual proceeds of the auctions of all the Series of OLPs will fetch a sum of ground rent for the public. This will be shared equally by the population, an annual citizen’s income described here as Ground Rental Entitlement (GRE).
• For an incumbent real estate owner, the effect of the policy is that (like the rest of the population) he immediately earns a new perpetual source of income (GRE); but set against this is his obligation to make ground rent payments after year 15 (noting that the value of remaining liability at any point in time is capped at the value of his real estate).
• What is notable with this policy is that GRE can be distributed to all from day one while protecting incumbent real estate owners’ tenure for 15 years. The universality and immediacy of GRE, along with the care taken not to penalise recent land buyers/upsizers, will both be essential in establishing general support for the policy.

Implementing location taxation

April 1, 2015

• Plots of land given over to a particular land-use will be allotted into discrete locales within which ground rent per square foot is estimated as being approximately equal. Annual land permits specifying land-use and locale, and accounting in aggregate for the total square footage of the plots, will be issued each year via a public auction. In this way each plot can be occupied by a registered permitholder, leaving no land permits unused.
• Ordinary Land Permits (OLP) will be auctioned annually from day one. These cannot be held by individuals in excess of [10%] of a locale in order to prevent market manipulation/extortion of would-be occupiers. OLP will be post-dated to [ten] years after issuance, and so an OLP issued at launch will only permit occupancy in the [11th] year, and so on. OLP can be privately traded at any time on a public exchange, provided ownership remains registered.
• The annual proceeds of the auction of OLP will fetch a sum of rent for the public to be shared equally by the population. This annual citizen’s income is described here as Ground Rental Entitlement (GRE).
• In parallel to the issuance of post-dated OLP, a batch of ten Special Land Permits (SLP) – one for each of the first [ten] years – will be vested with incumbent landowners on day one in order to cover their actual land holdings (disregarding the [10%] limitation by locale). These SLP must always be held by the actual landowner: so if a plot of land is sold in the first ten years, it must be accompanied by contribution of the remaining SLP.
• SLP are designed to cushion incumbent landowners from the loss of their freehold. The net effect of the policy is that incumbents receive ten SLP for the land they occupy, as well as annual GRE; but in return they forfeit the freehold land value, although not the cumulative improvement to the land ie buildings.
• For more sought-after plots, once SLP have run out on the [tenth] anniversary of the launch, the value of subsequent GRE may be insufficient to cover the cost of OLP to the incumbent owner: in this case the first ten years of GRE represent a bonus capable of subsidising the deficit.
• What is notable under this policy framework is that GRE will be collected and distributed to all from day one, and all the while without unfairly expropriating landowners (granted ten years’ incumbency). The universality and immediacy of GRE, along with the care taken not to penalise recent land buyers/upsizers, will both be essential in establishing general support for the policy.
• While being post-dated, OLP present value should be similar to future value: as ground rent tracks growth in output and population, it should therefore show correlation with the rate of interest used in discounting future income. Consequently, the public ought to be able to collect approximately the full value of ground rent over time.

A Wealth of Labour – Manifesto

July 25, 2014

A Note on Interest

March 17, 2014

Accumulating capital involves retention of an opportunity to consume in exchange for which surplus labour – labour whose subsistence needs are already funded – can be deployed as finance. Without finance being provided, any return on investment would not be realised, and this therefore confronts us with the following questions: how much of this gain is owed to holders of capital as interest, and what governs this?

In essence, a saver holding capital can provide finance by pledging a relatively liquid asset (typically money) in exchange for a relatively illiquid one (such as a receivable or equity). The shift from liquidity to illiquidity implies a cost measured by the delay (or the risk of economic loss on liquidation) that must be endured by the financier before being able to consume goods and services. This is offset by the gross gains made by the saver’s transaction counterparty, the investor, realised as greater future output.

Investing surplus labour means that consumption (principally workers’ subsistence) has been funded in advance of completion of the works. However, the full wages of labour still need to be paid (the consumption component owing to the provider of finance, which is thus repaid “at par”). Rent must also be discharged in full. The only basis for any excess remaining as a net investment return would be to cover interest charged by the provider of finance in satisfaction of the saver’s “time preference” for immediacy (liquidity).

In certain circumstances, the pure opportunity cost of deferred consumption may be zero, and if this could somehow sustain zero interest rates there would be no return on capital – allowing wages (including for intellectual property) and rent to absorb all the gains. (As intellectual property is diffused, rents take the lion’s share of gains; the biggest beneficiaries of antitrust laws are landlords.)

But savers do not just face a delay on consumption; in parallel, they face an opportunity cost measured as wages foregone by not investing in their own productivity. Zero interest rates would therefore imply an expectation of zero income gains to be made from investing (or else a monopoly on the expertise needed to achieve such gains).

Whereas for non-savers, surplus labour would need to be expended in raising productivity, savers already have the resources (surplus labour) with which to purchase equipment and thereafter enjoy higher wages (at least than would otherwise be the case). Accordingly, if the saver is instead to finance investment undertaken by someone else, in addition to receiving back par he should expect compensation for the loss of wages over the same period. This is a component of time preference and therefore interest.

Provided its fruits are not hoarded as goods – which would dampen aggregate consumption in proportion – but instead exchanged for the opportunity to consume (ie for capital in the form of debt, equity, rental receivables or money), surplus labour can be used to finance investment. Interest plays an essential role in this exchange, without which investment would be curtailed to the detriment of all.

Interest does not impinge upon the funds drawn on to pay wages. This is because wages (for generalised labour ie not “protected” by patented intellectual property) are constantly squeezed down towards the margin of cultivation, the socially-determined minimum return needed – after payment of rent – before labour will be supplied. The return on capital must, therefore, come out of what would otherwise have been drawn as rent. This exerts a stabilising influence on rents: in times of euphoria, higher interest offsets higher output; and vice versa.

A Note on Capital

March 9, 2014

Capital describes an opportunity for someone to consume a measure of goods now or in the future without having to expend labour. Assuming the goods to be consumed do not currently exist, labour will of course be expended to allow the opportunity to be taken. But this labour will be expended by others, to whom the capital under consideration will be distributed in order to elicit the goods.

So capital, in abstract terms, represents labour-time, namely the amount that must be expended to satisfy the opportunity to consume. Labour is the source of the only constraint on capital formation – it exerts the only fundamental cost on production – because, uniquely, human toil creates an additional subsistence need. Wages cannot fall below this margin of subsistence or else the labourer would not be able even to live.

The margin of subsistence must be capable of being met out of output or else the work is essentially non-productive. But workers may demand well in excess of this margin so as to save enough in anticipation of old age, when they will become decreasingly productive and eventually unable to work. Saving is precisely what motivates capital formation in the first place, and allows workers to create capital.

Whereas labour expended must consume part of its fruits, rent imposes no such constraint on capital formation: using the resources on which rent accrues does not imply additional consumption because land already exists, freely and in spite of human activity. It is this fact that actually defines rent, which is a key channel by which capital created is subsequently distributed.

It might appear that when high enough rent will constrain capital formation by leaving insufficient reward for the producer, thus removing the incentive to work. However this is a reversal of causality: rent does not constrain productivity but rather it is productivity that constrains rent. Far from being its nemesis, rent is a sign of productive opportunity: where land accrues no rent, this is because, at best, it scarcely yields enough to cover wages, and most likely is below the margin of cultivation dividing land that is in use from land that is idle.

By the same token, labour working on superior land does not automatically command higher wages, because rent absorbs any surplus over the margin of cultivation. This, Ricardo’s Law of Rent, is the consequence of competition over scarce resources (in this case location). As well as the significance of rent as a channel for distributing capital, this law is among the most important – and least prioritised – observations for economists. Socialising rights to rent, by taxing and remitting rent to all, is the only tool to combat poverty – and to democratise the use of capital.

Negative Rates

March 2, 2013

Negative rates on bank reserves acts as a fixed tax on the banking system. The only way for the banking system as a whole to reduce its impact is to expand by lending more, increasing the ratio of (untaxed) ‘bank money’ to (taxed) ‘base money’. Unlike conventional profit or transaction-based taxes, negative rates fall most heavily on the least active banks, those with the highest reserve ratios. Conventional taxes, since they discourage activity (lending), are passed from banks onto wider society in the shape of higher margins on loans and lower rates on deposits. Negative rates, on the other hand, cannot be passed on, since they force lending up – all of these additional loans will need funding, and so deposit-taking cannot be deterred by banks trashing rates to savers. Radical policy would replace conventional taxes on banks with a negative rate on reserves deposited at the central bank.

A Wealth of Labour – Manifesto

August 13, 2012
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Pay It Forward: Emergency Eurozone Liquidity Without Begging the ECB

November 24, 2011

The severity of the financial crisis is down to savers no longer “knowing”* what saving goods (especially bonds) are worth. While the crisis reflects major underlying problems, its immediate escalation is simply a draining away of liquidity from almost all saving goods. The one exception – so far – is money.

A holder of an Italian or Spanish government bond knows that it is backed by a promise made on behalf of million of taxpayers. Yes, both economies (as with all others in the developed world) are mired in difficulties of some description or other. But this diagnosis is not entirely new. Have Italian and Spanish workers all suddenly become less productive? No. Has the word of their sovereigns become questionable all of a sudden. No.

For all the theory directed towards macroeconomics, what causes a recession to occur after a period of growth is confidence. Factors of production – land, labour and capital – do not undergo sudden changes. Yes there are recurrent supply shocks, such as rising commodity prices, wars and natural disasters. But nobody is arguing that any of these is to blame for the current crisis.

Meanwhile, very many people recognise that confidence is key. Keynes talked of animal spirits, and this concept has recently made a comeback in the English language. Behavioural economics has never been more influential.

Yet this level of understanding among policymakers has not unlocked the present conundrum. The more savvy do realise that the key to de-escalating the Eurozone financial crisis is to furnish savers with a saving good whose worth they “know”*. So far, this has prompted calls for the provision of more money (ie ECB intervention). It is beyond the scope of this note to detail the difficulties of such a proposal – suffice to say there are major political impediments.

But as I argued recently (“Dear Mario: A Plan for Italy”**), formal ECB-driven quantitative easing (QE) is not required. No ECB intervention is needed for eurozone sovereigns to issue an instrument whose worth can never be in doubt. Previously this instrument was a government bond, although in this emergency savers now question whether distressed sovereigns are capable of honouring their promises. So a new instrument must be established.

This instrument is a Tax Credit. What distinguishes this from a conventional bond is that the worth of a Tax Credit (to a taxpayer in the year of exercise) is self-evident. This worth is independent of what other savers think or how they behave; it does not rely on a sovereign being in rude financial health in the future. A Tax Credit resembles money much more than it does a bond.

Whereas formal QE cannot be achieved by Italy or Spain (without abandoning the euro) – and might not even be feasible for the ECB given its political environment – Tax Credits can be issued by any sovereign unilaterally with immediate effect simply by offering to subscribe a sum of government bonds in exchange for another sum of Tax Credits exercisable in the future.

Whereas savers (who cannot know for sure what government bonds are worth) demand very high yields to hold bonds issued by distressed sovereigns, they would not have this concern about Tax Credits. Like money, their liquidity is as assured as taxes being levied. Consequently, the terms of the exchange would reflect a much lower (truly risk-free) rate of return: the opportunity cost of holding a Tax Credit (for the taxpayer) is the liquidity premium (on account of the delay before its exercise, at which date it is a cash equivalent).

The government would announce an auction/exchange date together with the sum of Tax Credits being offered (with different years of exercise). Using a risk-free rate of return to accrue value, a maximum exchange rate would be set. E.g. up to EUR110 of 10Y Tax Credits could be offered for EUR100 of 5Y bonds. (My previous note goes into more detail about pricing; the idea would be to offer Tax Credits whose present value corresponds with the surrendered bond par). Italy is running a primary surplus of around 1% of GDP – which, with debt of say 120% of GDP, suggests that paying average interest of 0.8% would mean the government would only need funding for bond repayment. While a yield of 80 basis points is probably ambitious, issuing Tax Credits holds out hope of reducing interest costs towards this breakeven level.

By staggering supply, the government could allow the price of Tax Credits to be bid higher as bondholders compete to exchange bonds for risk-free instruments. The higher the price of Tax Credits, the greater the saving for the sovereign. But by offering present value up to the bond par, this is achieved without imposing a haircut on bondholders, and without resorting to coercion or default. In this way, the sovereign sends a credible signal that it intends to honour its promises, which should encourage bonds to trade back up towards par. Conventional borrowing (bond issuance) would then fall back to affordable levels. (Returning to conventional bond issuance at some stage is desirable as it imposes greater discipline.)

Even with this level of generosity to bondholders (certainly in comparison to market prices), the sovereign would save itself a potentially considerable amount of interest over coming years – and also has the opportunity of postponing refinancing needs too. These two factors mean government – not bond vigilantes – can set the terms of necessary austerity. Restoring financial and economic health is not a given with such an emergency scheme – but by greatly boosting domestic liquidity and investor confidence while reducing interest costs, at least recovery would be back within governments’ sights.

*I use quotation marks in order to set aside wider questions of value and purchasing power, since these important ideas are not necessary in de-escalating the current crisis.

** Also available in the FT Long Room and at

Dear Mario (A Plan for Italy)

November 15, 2011

The nemesis of any nation’s public finances is the moment investors demand risk premia correspondent with fears of bond default. To go from this inflexion point to an actual credit event can be rapid, a matter of weeks or even days – not least because the shift upwards in perceptions of risk actually heightens risk i.e. excessive fears become self-fulfilling.

In such circumstances it is imperative to identify and deploy a “circuit-breaker” as soon as possible, a task that has proved extraordinarily difficult to achieve for distressed eurozone sovereigns, whose credibility is constrained, after all. In this post I outline just such a circuit-breaker.

So what can be done? Leaving aside the host of official eurozone proposals being bandied about, what options short of default can distressed sovereigns really enact themselves that would relieve the funding pressures arising from unaffordable risk premia?

Unlike other borrowers, sovereigns can raise taxes from their citizens. Of course this power does not exclude sovereigns from being viewed as risky; however, the obligation to pay tax does mean that an instrument created for the express purpose of meeting this obligation would, to the holder at least, bear zero credit risk. In normal circumstances, this instrument is money: in the eurozone, euros. However, eurozone sovereigns cannot issue euros, part of the reason they are hard to come by in certain markets. But eurozone sovereigns are not prohibited from issuing alternative instruments that they will accept in settlement of taxes levied on their populations.

In present circumstances, issuing Tax Credits may be the least worst if not the last available method for weak eurozone countries to manage their debt and access funding – two vital pillars in any austerity programme. Moreover, a Tax Credit being another name for currency, such a scheme would in effect promote much-needed monetary easing, helping to restore the economic activity on which austerity depends, namely investment.

To meet these objectives, distressed sovereigns have to infuse Tax Credits with credibility. Whereas convincing investors to hold its IOUs means Italy has to offer unaffordable rates of interest, convincing them to hold a Tax Credit that can be used to redeem future tax obligations ought not to come at such a heavy price. This is because unlike for the government bond, the value of a Tax Credit does not rely on the government meeting an increasingly unaffordable obligation; it relies on the government continuing to levy taxes, which (along with death) is unlikely to end any time soon.

What should investors be willing to concede to the sovereign in exchange for Italian Tax Credits, I wonder? Judging by the risk premia being charged, one answer is surely Italian government bonds.

The difference between the risk premium charged on new Italian government bonds (currently around 7%) and that on Tax Credits (a truly risk-free rate) represents a net saving for the sovereign extracted without coercion. The circa EUR2 trillion question is how to exploit this saving (but no more) in order to achieve the goals of sound public finances and economic growth. Fine-tuning the terms of the debt exchange should be about alleviating the debt ‘stock’ and funding ‘flow’ pressures on the sovereign, while minimising the fallout for investors, many of whom, after all, are domestic savers (pension funds, retail investors) and financial institutions critical for the nation’s revival. Even foreign investors, many comprising important elements in the eurozone financial system, may go on to provide vital funding in the future, provided they are treated fairly.

So to the details. In the case of Italy, the treasury would, in exchange for cancelling surrendered government bonds due in t years, offer Tax Credits exercisable in year t + n. (Tax Credits exercisable per year would be limited, say to [50]% of current collections, to ensure a minimum cash collection for non-debt service expenditures.) The exchange rate (r) offered by the treasury would represent the future value of the Tax Credit divided by the bond notional.

Subject to its terms, the scheme would boost Italy’s liquidity position i.e. its ability to run a budget surplus over the short term. However, liquidity comes at a cost for investors, who will therefore expect to be compensated at a risk-free rate of interest i over the corresponding term in return. As Tax Credits are not interest-bearing, i is implicit in r. That is, in quantifying the terms of the exchange (it is voluntary), investors will discount the future value of the Tax Credit (realised in t + n years) at a rate of interest i – using as a proxy some other benchmark such as the deposit rate at the central bank or yields on German government bonds with similar maturities – or maybe even domestic inflation.

In the case of Italy, with most of its public sector debt held by its own citizens, there is immediate scope to implement such a scheme (although foreign ownership is by no means incompatible with the basic premise as trading would repatriate most bonds). Italy, keen to preserve its status as a performing debtor rather than join the club of bailed-out states, will (unlike Greece, in a more perilous position) seek to avoid passing on economic loss to bondholders. This would be achieved by sizing r = (1 + i) ^ (t + n) for any bond being surrendered.

In discussion with investors, the treasury would have to select its own risk-free benchmark. If i = 1%, then for bonds surrendered with 5 years remaining Italy would offer Tax Credits exercisable in 5 + n years. With n = 5, the Tax Credits would be worth 110% of par. With a longer lag (say 10 years), r would rise to 116%. Yet despite no haircut, there is considerable saving for Italy owing to the difference in compounded risk premia over the period t + n. For a bond costing Italy 5% p.a., this amounts to a saving roughly of:

(1 + (5% – i)) ^ t during the term of the bond and the present value of (1 + (7% – i)) ^ n pending exercise of the Tax Credit (assuming bond yields stay around 7%).

This scheme could be offered immediately and should attract interest on all but the most short-dated bonds (of which bondholders might reasonably expect full repayment). For investors, counterparty risk is removed and there is no writedown of their investments. For the sovereign, cumulative debt service costs are slashed while some austerity is postponed, freeing up cash flow without undermining credibility.

Dear Mario, with such a scheme, Italy would have a reprieve – and the breathing space to commence on its programme of reforms as well as introducing some targeted growth-driven spending. There is a double saving: just as the break-even rate of growth necessary to restore sustainable debt dynamics would fall in line with funding costs, the prospects of securing this growth would also improve, both from the lightening of the fiscal adjustment and a de facto monetary loosening. Moreover the Italian yield curve would fall as bonds on all maturities trade up towards par, with investors heartened by having a concrete and credible exit in sight – and all without a cent of official support or ECB intervention!

Finally and crucially, the scheme acts as a circuit-breaker – more bullish investors might retain bonds in the hope of improved circumstances, whereas the more bearish would gladly surrender theirs. The composition of its investor base would migrate towards the more committed and away from speculators. Instead of escalating the crisis, periods of weakening investor sentiment (and there will doubtless be bumps along the way!) would give the sovereign more flexibility, not less as experienced presently.

Austerity, vital to reverse the deterioration in public finances, is not achieved by keeping productive resources idle – on the contrary, this is inexcusable waste. The scheme, unique among the raft of proposals for allowing for a controlled pro-growth stimulus within the confines of the single currency union, must be considered urgently if Italy – and indeed others – are to survive socially, politically and economically intact.

From a friend of Italy