How Large is Russia's Land Rent,
and How Will it be Used?

by Dr. Michael Hudson, ISLET ©
 

November 1999, gang8 letter

 

     In June, I travelled to Russia with Nicolaus Tideman to meet

with some of our Georgist counterparts and help create a program

for local communities to collect land rent.  We also wanted to

spell out the alternative. What would happen if the land were

privatized in such a way as to let its rent and price gains be

taken by absentee speculators (and the mortgage bankers lining

up behind them) to load this property down with debt?

 

     Our first task was to estimate the magnitude of local rental

and land values.  However, it soon became apparent that trying

to determine an economic price for Russian real estate was

premature.  Security of ownership is unclear in a political

environment that continues to be marked by corruption.

Real-estate taxes are not being paid, as owners collect rent but

avoid divulging their ownership to the tax authorities.  In the

absence of a legal system defining property rights, there is

scant basis for allocating changes in land values and rent rates

between the current users of properties, their localities, and

the national taxing authority in Moscow.

 

     Moscow and St. Petersburg are now ranked as the highest-cost

cities in the world to live, at least for foreigners.  A

Western-type hotel may charge $350 a night. To be sure, there

are very few such properties, which is why they are so

expensive.  The seedy hotel I stayed at in St. Petersburg was

mainly for native Russians, and cost just $35 a night.  Every

where I went, I found a similar double standard.  The Moscow art

museums charge foreigners $4, but Russians only have to pay 40

cents.  Lunch -- if one can find a restaurant -- costs about

$25; most Russians skip it altogether, or take it in their

company dining rooms.

 

     This double standard has a major effect on what Russians

believe their apartments and other properties to be worth.  The

typical Russian apartment is about four rooms, and is occupied

by numerous family members, often spanning two generations.

Such an apartment may be valued at about $80,000, and some

apartments indeed are changing hands at this price.  The typical

buyer is a foreign company with business in Russia, finding it

cheaper to pay this price than to put up its executives in one

of the foreign hotels.

 

But what are most apartments worth, or what would they be

worth if there was a free market in real estate? To

western-trained economists, property values are based on the

revenue they can generate.  This in turn reflects what renters

can afford to pay.  A rule of thumb is that residential tenants

are able to pay about 25% of their income as rent. Salaries for

skilled professionals in Moscow and St. Petersburg average only

about $100 a month.  This $1200 annual level suggests a maximum

rent-paying ability of about $300.  A household of four wage

earners could pay $1200.  Meanwhile, Russian interest rates are

widely advertised at 33 þ % per year for dollar-denominated

deposits immune from rouble inflation.  This indicates a

property value of only $3600 for a Russian apartment ($1200

divided by 1/3).

 

     How can one reconcile this calculation with prices in the

neighborhood of $80,000? How can a Russian family ever earn the

money to buy an apartment at these prices? Few Russians are able

to save any of their salary, their rouble-savings have been

wiped out by the hyperinflation, and foreign accounts are

illegal.  Many Russians are getting by only by selling assets in

the thriving market that has developed in family heirlooms.

 

     The explanation is to be found in the remarkable way

Russia's property rights were created.  At the time of the

revolution, most Russians simply were given the apartments they

occupied and the farms they worked.  Eager to extol the virtues

of privatization, President Yeltsin wanted to convince Russians

of something they wished to believe in any case: that they were

getting rich, at least on paper.  Some families exchanged large

apartments against smaller ones, providing a thin market from

which property values were able to take off.

 

     How can today's property values be supported out of

proportion to rental income? Part of the answer is that property

is becoming a hoarded good.  The Russians have learned to fear

their banking system.  The "vouchers" that each Russian worker

was given as equity in his or her company were worth only about

$25 each. The largest and most popular stock market vehicle --

the MMM mutual fund -- has gone bust.  Real property seems one

of the few investments worth having.

 

     For local authorities, how much tax can such properties be

expected to yield? Should they be assessed on their current

rental income, or on the largely unrealisable sales values their

holders imagine them to have?

 

      Obviously location plays a major role, but most Russians do

not seem to be very familiar with this concept.  Neighborhoods

in central St. Petersburg and Moscow remain most desirable, even

though high construction costs are needed to bring these

buildings up to western standards.  For most of the population,

prices in the $80,000 range are far out of proportion to

rent-yielding ability.  A typical salary of $1200 a year, with

four wage-earners per apartment (each paying a quarter of their

salary on rent), produces a price/rent ratio of $80,000/1200, or

61 times.  This means that it would take the Russian occupants a

lifetime -- over 66 years -- to buy their apartment, if they had

no other expenses.

 

     In this respect the Russian housing market has experienced

nearly as great a bubble as Japan.  For most countries,

Russian-style price/yield ratios would imply a speculative

market, as most speculation is funded by credit.  But there has

been almost no mortgage lending in Russia. What makes its case

even more unique is that the economy is so poor in absolute

terms, unlike Japan and America in the 1980s, Holland in the

late 17th century or England and France in the 1710s during the

South Sea and Mississippi bubbles.

 

     Suppose that a real-estate market would develop, enabling

Russian workers to take out mortgages on their apartments --

say, just half their value, or $40,000.  This is almost as much

as a Russian can make in a lifetime at today's wage levels.  Why

shouldn't he take the money and run, retire abroad or invest his

money at the going 33% rate of interest and use just a fraction

of that yield to pay rent somewhere else?

 

     Mortgage lenders are not so foolish as to lend under these

conditions. The result is that most Russians have little choice

but to stay put, for they are unable to change apartments in an

environment where nearly everyone has an inflated view of their

home values.  Indeed, I found that most Russians put an inflated

value on nearly every asset they have, from their apartments and

rugs down to their collections of phonograph records and family

heirlooms.  Many seem to be waiting for "the big kill," the

sucker who proverbally is born every minute, but whom a Russian

only needs to meet once in a lifetime to dump his assets at an

inflated price (something like the Rockefellers finally being

able to dump their money-losing Rockefeller Center on the

Japanese when the once-in-a-lifetime spike of New York

real-estate prices occurred in 1988).

 

     This does not suggest that Western mortgage lenders should

hold  their breath waiting to load down Russia's land with

interest charges.  There may indeed be local would-be Donald

Trumps eager to borrow money in exchange for pledging the land

as security.  But could they reap a high enough land-value gain

to pay off their creditors and keep a net balance for

themselves? If they buy land at today's prices, how much higher

can the pace be expected to rise from present levels?

 

     "Foreigners" also are making the market for Russian

factories, mines and other enterprises.  But in a country with

no working legal system, where there is no legal recourse

against fraud, embezzlement or other managerial misbehavior, it

is hard to attract foreign investors.  I suspect that when one

sees a foreign company putting in $10 million or more into a

Russian venture, it may well be holding as collateral the

foreign bank account of some Russian directly involved in the

operation.  An estimated $13 billion of Russian foreign exchange

reserves have simply disappeared, apparently into the hands of

the former bureaucracy, which is now drawing on this money to

fund its new operations within Russia.

 

     The upshot is that Russia has progressed far beyond the

United States in becoming a postindustrial society.  One only

can marvel that it offers the highest rate of return in the

world (the 33þ% rate is most commonly advertised), yet has few

consumer or capital-goods industries of its own, save for

Stolichnaya vodka.  When I visited Moscow's statistical agency

and asked how it was possible to compile retail sales statistics

in an economy dominated by sidewalk kiosks, I was told that the

figure was simply based on import estimates for that month!

Little domestic production is occurring except for raw

materials.  The Russians are surviving by selling off assets and

treating these sales as current revenue.

 

     This does not leave much room for a credit system to

develop.  Without credit, there is little way for real estate

values to be confirmed in the sense that we Americans are familiar.

 

     One must conclude that many Russians are being led to

confuse democracy and free enterprise with selling off their

land, natural resources and industry to foreigners and to the

former Soviet nomenclatura who got extremely rich at the very

outset of opening to the West.  Russians feel rich when they

look at the prices widely accepted for the real estate rights

they have been given, and see 33þ% being offered on

dollar-denominated savings. Some mutual funds have experienced a

remarkable bubble, with returns of 1000% per year being

promised, or at least reported if not actually "earned." But the

most popular bubbles already have burst.  Matters do not seem

likely to improve until more Russians recognize the difference

between earning money and simply receiving money for selling off

assets.  As they sink further into poverty, the danger of a land

and real estate crisis grows.

 

     This problem cannot be blamed entirely on communism as such.

 Nothing comparable is occurring in China, for instance.  While

Russian land paces in the large cities (and indeed, food prices

and most other prices) are nearly those of the United States,

China has kept its land prices and other domestic costs low.

Russia exports virtually nothing save raw materials, while China

is increasing its exportation of labor- and land-intensive

industrial manufactures.  China enjoys a major competitive

advantage in not having to factor high land-rents into these

products.  It is not hard to guess which economy will be better

placed to export its way out of foreign debt.  Land rents are an

important element of pricing, as are interest charges, taxes,

and the overhead of corruption.

 

     As Adam Smith warned, interest rates often are highest in

countries going most rapidly to ruin.  He also warned that

landlords love to reap where they have not sown.  His Wealth of

Nations is now being translated into Russian for the first time.

 Perhaps it will help alert Russians to the precariousness of

trying to create a rentier economy without a productive

foundation, living by selling its natural endowments and other

assets rather than the products of current labor and capital.

 

     To upgrade the productivity of its existing labor and

capital will require a credit system based not on lending

against land or other collateral that creditors can seize for

nonpayment, but against the new earning power that productive

credit may help finance.  This is the only way that

interest-bearing debt has been able to uplift economies.  A debt

overhead that leaves productivity untouched would be merely

parasitic, not productive.

 

 

Michael Hudson is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world’s first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was Dennis Kucinich’s Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the U.S., Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached via his website, mh@michael-hudson.com 

 

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