Olly wants us to keep consuming the seed corn

Paul Walker takes the Standard’s authors to task for their economic understanding, which as he describes goes from woeful to ‘wisible’ – although, unlike Paul, I suspect their understanding (or lack thereof) is more to do with too much university-based economics raining rather than too little.

But such woefulness isn’t confined to the blogosphere.  Take dear old Olly Newland in yesterday’s Herald, in which he berates financial commentators who “regurgitate the hoary old theory that buying houses is ‘unproductive’ and [insist] instead we should be creating jobs and wealth by means other than investing in property.  Yet investing in property,” says Olly, “is one of the most productive enterprises in which a nation can engage… [Property] ownership automatically creates wealth by creating employment.”

Oh dear.  Apparently Mr Newland hasn’t been reading the papers for a year or two.  If what he says were true, then the United States should now “automatically” be wallowing in prosperity, since at the peak of America’s Greenspan-fuelled housing bubble some commentators suggest around forty percent of American employment – pretty much all the employment growth since 2001 -- was real-estate related.

What America and the world is now waking up to is that this was not at all productive.

Sure, Greenspan’s bubble “created employment,” for a while, but it did so by deluding home-owners that they had an increase in real wealth (i.e., in the goods and services that money income can buy) instead of just an increase in monetary value,  (a distinction first pointed out nearly two centuries ago by David Ricardo) encouraging them to consume their capital by using their houses like an ATM machine.  One could just as easily (and just as destructively) have “created employment” by paying people to fan out across the country and consume a nation’s seed corn.

Because that’s essentially what those employees were doing.

Let’s look at a basic distinction which Mr Newland seems to have missed.  The difference between a consumer good and an investment good (or a capital good, if you like) is a fairly simple one.  Capital is “wealth reproductively employed” – physical assets used in the self-sustaining production of more wealth.  Capital goods (or investment goods, which amounts to the same thing) produce from their own deployment the funds whereby to replace them, with (hopefully) a profit on top.  That’s how a country, year on year, builds a capital structure.

Consumer goods, by contrast, don’t pay for themselves out of their own production. Their replacement cost needs to be funded out of something else – in the case of too many so called “investment” properties it might have been your fifty-hour a week job (which is how so many NZers were trying to pay off their “investment property”). 

By this standard then, only some residential property constitutes a genuinely productive enterprise (that is, those that return more income than they consume) but most of it is no more an “investment” than any other durable good , like a fridge or a car or a spa pool. The primary reason people think property is different is because central-bank fuelled housing bubbles inflate the monetary value of houses, without inflating by quite so much the prices of these other durable consumer goods. 

But this isn’t an increase in real wealth, just an increase in monetary value.

Sure, some people for some years who bought “investment properties” on the basis of an expected “capital gain” did well – if they sold before the bubble popped.  But their gain wasn’t based on real productivity, it was based instead on a transfer of real wealth from production into consumption. It was based on the consumption of real capital – a consumption we’re all now paying for.

A shame Mr Newland doesn’t seem to realise that.