The Cantillon effect is a theory attributed to Richard Cantillon: an economic theorist from the turn of the seventeenth and eighteenth centuries, who was an Irishman with a Spanish surname living in France. The Cantillon effect is a distribution effect resulting from uneven changes in money supply. What does it mean? As we know, an increase in money supply brings, in consequence, an increase in market prices. If a wizard had once magically doubled the amount of money belonging to every person in the world and everyone was aware of it, soon the prices would have adapted to the increase in the amount of money. However, increasing money supply not only increases the overall price level – but also changes the price structure. How? In the real world, we do not have wizards with magic powers, and the increase in the money supply is caused by a money issuer, and nowadays the state apparatus and its central bank is – directly or indirectly – the money issuer. If the central bank decides to simply print new banknotes, money will not be spread evenly on the market like butter on a slice of bread, but will go to different recipients by different routes at different times, and the initial recipients will express the demand for specific goods, not for all goods available on market: prices will not only rise, but the ratio between them will also change. This is what the Cantillon effect is: a larger money supply causes price inflation, but unevenly, differently for different goods and services.
Modern monetary policy in most countries is based on subtler methods of creating money: the state does not have to print banknotes. It is enough to artificially lower nominal interest rates on the credit market below their market level. This will make taking loans cheaper, encourage the use of “easy money” and increase investment. As you know from the episode about business cycles: this leads to the first phase of the cycle – to economic boom.
Now: how does all of this relate to skyscrapers’ altitude records and the possible relationship between the construction of skyscrapers and economic crises?
Artificially low interest rates cause entrepreneurs not only to take advantage of unnaturally cheap investment loans, but also to look differently at the investments themselves. Businessmen are more and more willing to choose long-term investments – since the loan is cheap, and this suggests that capital is abundant, one can put money on investments that will last for many years or pay off after a long time. You don’t have to worry that the capital used for such long-term investments will be “frozen” for a long time – after all, thanks to low interest rates, we know that we now have the times of plenty, right?
First, the Cantillon effect affects land prices: with cheap loans, entrepreneurs can afford to buy land for development. This is a natural decision when planning long-range investments – good location is especially important. Since the demand for land used for development is growing, and the land itself cannot magically pop out of nowhere (where is this wizard with his magic powers when he is needed?!) – then, in accordance with the law of supply and demand, land prices must go up. And if the land becomes more expensive – it is becoming increasingly profitable and reasonable to build up in order to accommodate as much space as possible in the smallest area of purchased land. Higher land prices, especially in metropolitan centers, mean a reduction in the cost per floor in a tall building compared to the cost of a low but larger-in-surface building. This is a great incentive to erect buildings with more floors. This, finally, means: skyscrapers.
Second, we can see the Cantillon effect in the expansion of companies. Since interest rates are low and credit is cheap, entrepreneurs can invest in expensive capital, even if their own resources are insufficient. This is an incentive for the company to become more capital-intensive, to grow and, as a consequence, to benefit from economies of scale: a big one can do more than a small one. Thanks to all of the above production, distribution and transportation can become more specialized and cover larger and larger areas. Instead of using the services of Mr. Doe, who milks the cow and sells the milk – a large company can now invest in the best cattle, the best milking machines and new, improved ways of packing and distributing milk. Dairy production becomes more circular – but also more efficient. As part of an improved and more efficient production process, the company also invests more in its headquarters and marketing center. It increases the demand for office space, especially in the centers of large cities. And this means that building up becomes even more profitable – which, again, directs us to skyscrapers.
Third, there is the least obvious impact of the Cantillon effect: the opportunity to invest in new technology. Skyscrapers, especially the ones that break new height records, are not only investments – they are also a race of engineering and architectural achievements. Higher and higher skyscrapers require innovations and new, untested techniques in many areas, ranging from techniques of construction itself through issues of ventilation, heating, cooling, lighting, transport (elevators, stairs, parking lots), electricity, pipes and sewage systems to fire protection and security measures. And yet cheap credit is an incentive for entrepreneurs to choose more circular but more efficient production methods and to take greater risk with loaned money which are invested in innovations.
These three aspects of the Cantillon effect’s influence add up, complement each other and make investing in higher and higher skyscrapers more common and seemingly profitable during the boom, i.e. the first part of the business cycle.
But after each boom comes the second part of the cycle: the bust; Cheap loans, as it turns out now, had no coverage in actually accumulated capital and many investments turn out to be malinvestments – unsuccessful and erroneous. Companies need to deeply restructure themselves or collapse, which, in consequence, reduces the demand for office space – and therefore: demand for skyscrapers.
History of the first years of one of the most famous skyscrapers of all time – New York’s Empire State Building – is a sad confirmation of this phenomenon. Few know that the Empire State Building’s observation platform – place of numerous movie scenes, romantic moments … and suicide jumps – was not supposed to exist at all. The building was planned to be a “business temple” and no one intended to “profane” it by letting tourists on the roof for a small fee. Unfortunately, the completion of the skyscraper in 1931 coincided with the hardest phase of the Great Depression and there were few willing to rent the office space. To improve the profitability of the building (called the Empty State Building at that time – because the tower was literally empty), it was decided to open the viewing terraces on its 86th and 102th floor, which to this day, despite several dollar fees, enjoy unflagging popularity among tourists.
Should we be afraid of building skyscrapers? Of course not – but according to motto of the famous 19th-century economist and publicist Frederic Bastiat – it is worth looking not only at what is seen, but also at what is unseen. In this case: it is worth looking at the fact that subsequent waves of “mania on skyscrapers” and subsequent buildings breaking world height records do not necessarily mean a period of wealth and prosperity, but they can herald the opposite.