The Cantillon Effect: Tall Buildings As an Economic Indicator

Sometime in the very early 1800s, a Manhattan carpenter named Lozier came to the somewhat startling conclusion that the city in which he lived was dangerously lopsided and had too many taller buildings on its lower end. If any more structures went up, he warned the city, the island would sink into the Hudson River.

To head off this expected calamity, Lozier suggested to the city’s mayor that a chunk of Manhattan’s northern end be hacked off, towed down the Hudson, and then attached to the southern tip. This, Lozier explained, would redistribute the island’s weight and ensure no further sinking. Impressed with the scheme and with Lozier’s ingenuity, the mayor suggested Lozier commence at once, handing over to him from the City Treasury a good deal of cash to do so.

To help him, Lozier advertised for workers. Some 500 showed up one morning, shivering in the cold waiting for ‘the boss’ to show up. As the reader might already have guessed however, our carpenter Lozier was long gone; taking with him the city’s money intended to finance the project.

Over the years, New York City has had its fair share of real estate swindles. Another was thought to be in progress when a 50 metre high ‘superstructure’ was started on a six and a half metre plot of Broadway land, in the spring of 1887. The owner, a Manhattan realtor named John L. Stearns, actually owned the neighbouring plot as well, off lower Broadway in New Street. The front plot however, facing Broadway, had become so hemmed in that Stearns found it practically unsaleable except at a give-away price.

Frustrated, Stearns approached Bradford Lee Gilbert, a nearby architect for a possible way out. The solution, Bradford recalled in his reminiscences, was to build an iron bridge truss, but stand it on its end; a solution that took him a full six months to conceive and design he said later. In this way, the real structure of the building would start several stories above the curb and help produce the best design to maximize occupancy and rentals. The world’s first skyscraper, as the invention was later called, built of skeletal steel, was born.

So ingenious was the invention, utilizing the land space as never before, that the design enabled its owner to reap an additional $90,000 in rentals than would otherwise have been possible. A mania for tall buildings quickly developed; a phenomenon that continues to this day. Since then, the opening of successively taller, then tallest buildings have been in waves: the most remembered being The Empire State Building, which opened for business in May of 1931 to great fanfare, but practically empty.

I’ve given a name to this phenomenon – the Cantillon Effect: so named after Richard Cantillon (1680 – 1734), an Irish banker of the early 1700’s, generally credited today as the first economist to suggest that a change in the supply of money and credit will affect the economy by changing prices. Cantillon recognised that an increase in the availability of credit would result in economic expansion but that ultimately this would be overdone as prices rose and imports increased. His work pre-dates Adam Smith and was just as important, if not more so.

For maximum forecasting ability, however, the Cantillon effect should only be interpreted in conjunction with the real estate cycle, which is when the Cantillon effect will usually be at its most functional with easy credit conditions on display. (And when competition for the world’s tallest is sure to be at its height, pardon the pun.) The taller the building on the drawing boards; the more available and easier to procure is the bank created credit.

As it happens, the world’s tallest buildings have had a distinct and consistent habit of being completed right at the top of the real estate cycle. Since Gilbert’s first tower, there has not been an exception to this occurrence at each real estate peak, producing for us – at least so far – the most reliable indicator of an approaching real estate cycle top.

This is hardly surprising: as any decent architect could tell you, though rarely these days it seems, an economist, tall buildings are just built spaces to make the land pay. As a general rule, skyscrapers are a speculative project, built mostly by developers with other people’s money. Such buildings are going to be built only when credit conditions are easing or at their easiest, the time when developers are most flush with funds: hence the link with credit, and to Richard Cantillon.

Not with some irony did I notice that the Burj (tower) in Dubai was officially classed as the world’s tallest building on July 21st, 2007, very close to the day of the stock market high in New York from which all the recent credit troubles cascaded down ward. Richard Cantillon would indeed be pleased.

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