How and Why Does Land Have Value?
|January 9, 2007||Posted by Staff under Archive, Progress Report, The Progress Report|
Land Value, An In-Depth Treatment
How and Why Does Land Have Value?
Here is the second part of a three-installment exploration by David H. Chester, on the topic of land values and their economic characteristics.
by David H. Chester
The Basis for the Land Having Value
In common with items of goods which are produced by human exertion, the value of a site (that is created without direct labor), also is expressed by its market-value. This is determined by an equalization (or mutual agreement) between the demand-price provided by the buyer (on gaining the unconditional rights of access to the site), and the supply-cost required by the seller (on the loss of this opportunity). This action of exchange disregards the use for which the buyer intends to put the land, including that of speculation. Affirming that land has an exchange value however, does not actually explain how it arises in the first place. To do so, it is necessary to examine the role that the land plays within our macro-economic society.
2.1 What Creates the Utility of Land
Before anyone comes to live in a region, the land is useless, due to the absence of occasion or desire to exploit its bounty. (The richest lode of gold is worthless before its discovery, or even after it is known but remains inaccessible.) Once it is occupied however, the land is the natural resource that provides the means and opportunity for the production of goods and the supply of services. It is the common base for agricultural, industrial, commercial, recreational, residential and governmental activities. However, the natural resources offered by a site, is only one of two factors causing it to have utility, a characteristic that is subsequently expressed by its exchange-value, as noted above.
With population growth, a site’s usefulness increases, due to its improved capacity for access and communications. This opportunity is created without a particular site needing to be worked or any improvement being installed on it. Consequently, both the space and the place that it occupies are significant and the utility of the site is determined only when these two factors are combined. The necessary aspects of these general factors are shown in Tables 2a and 2b, with examples. When both kinds of the listed beneficial aspects are abundant, the site offers good opportunities for intensive utility, the collection of large ground-rents and premium class values of the land itself. These last two characteristics will be discussed in the subsequent Sections.
TABLE 2a THE “SPACE-FACTOR” ASPECTS OF SITE UTILITY a1] The Natural and Physical Properties of the Site
- (i) Geographic – the land size, shape, location and altitude.
(ii) Climatic – day and night temperatures, humidity, daily sunshine, rain-fall, hail, snow, high winds, heavy storms and the probability of natural disasters.
(iii) Adaptability – the amount of swamp, rocks, saltiness or acidity of the soil, necessitating labor to make the land useful for a specific purpose.
a2] The Natural Bounty Within the Site
- (i) Materialistic the extent of mineral deposits (solid, liquid or gaseous), botanical and zoological content at ground level (roughly). The intensity of the sunlight, quantity of fresh air, geothermal energy and space available above and below it.
a3] The Natural Topology of the Surrounding Region
- (i) The proximity of water – the distance to lakes, rivers, canals and the sea.
(ii) The slope and hillyness of the whole area and the ease of passage on it.
TABLE 2b THE “PLACE-FACTOR” ASPECTS OF SITE UTILITY b1] The Population and Communal Development Within the Region
- (i) Population density, age distribution, family size and labor fraction.
(ii) Quality of Life – general education, health standards, foreign-workers’ wages and unemployment, poverty, drug-addictions, accident and crime rates.
(iii) Communal Development due to investment by house-holders, producers, banks, traders, and the local and national government. It includes the proximity of markets and the availability and cost of using public utilities and facilities necessary for the production process, including the transport of goods and of workers between their work-place and their homes and to places of interest.
(iv) External Material Sources – need for and availability of raw materials (incapable of being prepared on-site) or of partly-made goods (from other producers).
(v) Artificial External Disadvantages disturbance from noise, pollution, cosmic radiation (due to ozone loss) and the possibility of terrorism, revolution or war.
b2] The Extent of Governmental Influence over the Region
- (i) Land Authority which planning permission is needed and its delay in being implemented. Regulations limiting the size of buildings or the use of heavy equipment and the amount of noise/pollution during construction and later use.
(ii) Local Economic Advantages – free-trade zone, simplified or abandoned licensing procedures. Amenability of the local authority to bribes for information about a planned development, or for directing it to certain places. Subsidized use of capital and consumer goods and services etc.
It is of interest to note that according to the Bible (Leviticus, Ch.27 vs. 16 – 26), the value of a field was determined according to the volume of barley needed to sow it, so as to obtain a full crop. A specific multiplication factor was then used for converting this quantity into a sum of money. Due allowance was subsequently made, for the proportion of time remaining before the next Jubilee, when in normal circumstances the access rights to the field would automatically return to its owner. That is to say, the lease-value (or total ground-rent of up to 49 years) was calculated according to the utility that a prospective lease-holder could reasonably expect. Parts of a field that were mortgaged (for purposes of contributing to the Temple sacrifices), were valued in the same way, but their redemption was more difficult. This early basis for determining the land-value has similarities with the method used here.
2.2 The Utility of Residential Land
The difference between industrial or commercial land and that used for residence is that no formal production process occurs in the last case. The residual land provides the space for housing, its primary economic role being to lodge the workers, thereby enabling them to recover their working strength. Most workers share their houses with dependants, whom they support. Their homes often contain additional rooms and grounds to allow for diverse and vital family activities to take place, which are regarded here as being enjoyable non-exchangeable consumer-services. The gratification of these human needs falls within the same class of economic functions as the provision of consumer goods, for which the utility of the land comprises an essential part. When all the residential land areas are considered, their optimal use is not a general requirement, although the making the most of one’s home-acre is a commonly taken attitude.
Instead of it arising directly from the production of goods, the criterion for determining the utility of residential land comes from social pressure and the satisfactory supply of the various home services. The more expensive and desirable residential sites are usually in well-developed localities away from noisy, crowded or polluted living conditions. These criteria are not fixed – the choice of the more fashionable (and potentially useful) places to live can vary with time, often moving away from the centers where former generations dwelt. Thus, the utility of the residential land varies from zero to the most expensive and it behaves similarly to land used in production. Residential sites require more municipal development around them than agricultural districts or industrial zones. Consequently these sites are more expensive per unit area, although their average population density is greater and they are seen here as being more productive.
2.3 The Utility of Public Land
There is no doubt that land used in this manner has utility too. The communal nature of the associated activities means that the locations of these sites are close to the centers of the population, in places where the use of the land for other purposes would certainly be advantageous. However, the only way to determine the utility here would be to consider a change in category of the land when it fulfills another urban role. But in any case the value of the public land is unimportant, since no ground-rent is collected in practice and its sale is usually prohibited by law.
2.4 Changes in the Utility Due to Investment
As seen from Tables 2a and 2b, the utility of a plot of land is independent of the amount of durable capital goods that has been established on it. However, one class of land exists that is not completely independent of prior investment. This is when poor agricultural sites can be improved to a limited extent by the local expenditure of labor directly on them. Then the productivity is raised by such pioneering actions as the clearing of stones and the draining of swamps. In this situation the investment of labor permanently excludes or rearranges unwanted natural elements. It is not building in the true constructive sense. The deficient land gains utility and it becomes equivalent to similar land that was not adversely affected. It is as if nature had previously invested a negative amount of capital in the low-productive sites. Within a region, land of equal utility per unit area, must be of equal economic value, regardless of how it was formed.
Except for this category of land, the introduction of durable capital (by using labor) on a specific site does not affect its basic potentiality for use. Care in definition is needed here. The raising of dikes to keep out floodwaters or the terracing of hillsides to trap the soil, are excluded from this category of land. Both of these kinds of investments are impermanent, for they will depreciate with time and require maintenance.
2.5 Ground-Rent – As an Expression of “Supra-Marginal” Utility
Within the prevailing macro-economic environment, the utility of the land is normally fully exploited by its user. He takes the greatest economic advantage that the site is able to offer, combining its productivity (in the most useful land status that local conditions allow), with optimal quantities of labor and “capital”. The latter are the durable goods, which are invested in the production facilities. In a micro-economic sense the capital can also consist of partly worked materials or input data, unless these are extracted, collected or generated directly. In this way, the land user makes the necessary effort in producing and distributing competitive and saleable goods or in supplying marketable services (sometimes in the form of output information).
To appreciate the relationship of utility to land-value, one must first introduce the concept the economic ground-rent. This is the regular sum that the owner of a plot of land can reasonably demand for its access rights, were a tenant prepared to make the best use of this opportunity. (Although we know that the market is not freely competitive and there is some land speculation, any discussion about the payment of smaller ground-rents for the sub-optimal use of monopolized sites is irrelevant, when trying to determine the land’s true value.) For economic activity to proceed, the tenant leases the land that he needs from its owner or the latter uses it directly. In both cases, the ground-rent is regularly returned to this land-lord, however in the second case the owner can be said to have leased it to himself. Then he absorbs the ground-rent within his own business (or as a living-expense in the case of a privately owned residence), since the direct use of the land saves him the need for leasing elsewhere.
Suppose that a worker decides to exploit the utility of a relatively infertile and remote site, to the best of his ability. The productivity of this site is so low that the monetary value of the few resulting goods only just covers their production costs of wages, hire-fees, depreciation and maintenance. (These being the returns for use of the other two factors of production, the labor and the durable capital goods invested on the site). After an additional payment for carrying the product to market and selling it, this site is incapable of generating any more income in the form of rent. Although it barely provides the worker with a living, the site has no micro-economic value, since in this mode of production nothing is left over. Hence, there will be no demand for the use of this land, which is regarded as being of marginal utility, according to Ricardo’s Law of Rent (Ricardo David. “Principles of Political Economy and Taxation”, London, 1817).
However not all land areas are so unproductive and the ground-rent varies with the quality of the natural resources available, and their relation to the centers of population. Consequently after the produce are sold, the ability to generate differing amounts of ground-rent is the measure of the “supra-marginal” utility of the various sites, when expressed in practical terms. The surplus income is continuously generated on properly used sites having productivity above the marginal level. This occurs even after returning the larger amounts of wages, hire-fees, depreciation and maintenance (to labor, capital and transport services), that are duly needed for obtaining these sites’ optimal utility. The added economic advantage to its user is thus expressed by the amount of ground-rent that the site generates, which increases progressively with the more productive land.
Because some or all of this rent is not collected (and sent elsewhere), it also contributes to the business net yield. In fact, it is this difference in ground-rent that provides the motivation for establishing the industry or commerce in prosperous regions, where it is more worthwhile to produce the goods or services. However, the amount of ground-rent that is charged for access to this land will reduce this economic advantage to the producer, especially if the actual utilization is less than optimum. After the sale of the produce and the return payments for the employment of labor and capital, it is the ability to generate ground-rent that endows the land with its utility-value, which offers a welcome opportunity to be explored by both the land-lord and the production manager.
Land that is used for commerce also falls within this class. Whether it is occupied by shops, offices, restaurants or other kinds of business, the advantage of its more-central location should be taken to obtain the full utility, with the optimum amounts of man-power and capital investment being employed. The same principle also applies to residential land as described above. Except in the public sector, for all other land classes, it is only by means of ground-rent, that supra-marginal utility is related to the land-value itself.
2.6 The Relationship between Ground-Rent and the Utility Land-Value
The utility value of the land area may be determined by comparing its ground-rent to the average yield obtainable from an equal money investment, put into durable goods acting as capital. This latter investment provides a dividend, after subtracting the rates of depreciation and maintenance from the business net yield. Alternatively, the comparison can be based on the dividend-rate obtainable from shares in public companies that efficiently use such goods. The numerical comparison is made by taking the ratio of the ground-rent and the associated land-value and equating it to the average dividend-rate on capital investment. Then the land-value equals its ground-rent divided by this dividend-rate (this will be seen in Table 3, line 5b). The utility land-values determined in this manner may be described as the “capitalized” ground-rents. Due to the dynamic nature of the macro-economy, fluctuations will occur in the rate of return on capital investment. These changes cause the relationship between the values of land and of shares in a productive process, to vary in a complicated manner. However, on average over a period of time, this method provides the best means for the accurate assessment of the land-value.
Locally, similar sites of equal size and utility are able to command roughly equal ground-rents and land-values, due the pressure of competition bringing them within a small range of differences. The slight advantage or disadvantage in utility of one site relative to the others ensures that the resulting price variations keep them all at a realistic level. This principle does not only apply to productive land, the utility value of residential land is also be regulated by this natural method of value-judgement.
Next week: The Comparison Between Ground-Rent and the Return on Capital, and Conclusion
Copyright 2002 by David Chester. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without the express written permission of David Chester.
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