Unbalanced Growth and Land Overvaluation

Abstract

Historical trends suggest the decline in importance of land as a production factor but its continued importance as a store of value. Using an overlapping generations model with land and aggregate uncertainty, we theoretically study the long-run behavior of land prices and identify economic conditions under which land becomes overvalued on the long-run trend relative to the fundamentals defined by the present value of land rents. Unbalanced growth together with the elasticity of substitution between production factors plays a critical role. Around the trend, land prices exhibit recurrent stochastic fluctuations, with expansions and contractions in the size of land overvaluation.