The Impact of Economic Rent on Markets

Harry Pollard

[Reprinted from a Land-Theory online discussion, 22 June, 2005]

I most certainly am writing about principles. But, while we are pushing for political gains, we should not let our basic philosophy fall to the floor to be forgotten. The situation becomes fraught as, with school efforts at low ebb, we pick up land-value taxation friends and supporters who know nothing of our basic premises or our radical conclusions.

It seems to me that I should lay out the situation as I see it instead of our pecking away at each other, so here we go.

Conventions I adopt are capitalized words to mean our basic terms - even though I have made some changes to the way they are taught. We should be clear as to the subject of this post. It is about Economic Rent - a value which attaches to a location and is caused by the presence and access of the surrounding community."

Rent appears to be hormetic in nature. A few people don't appear to produce Rent. Yet, as a community grows Rent appears. I'll leave it others to pursue this point, but Rent probably appears when competition for locations begins to get serious.

Rent is a measure of Wealth production. When a producer uses a location with $10 Rent, it means that with the same application of Labor (and Capital) a producer will finish up with $10 more production than if he worked a zero location.

Rent is not a 'flow' of Wealth. It is a valuable adjunct to the exertion of Labor.

It's like a shovel. Without the shovel you can dig up 5 potatoes - with the shovel you will dig up 15 - with the same exertion. If you don't use the shovel, you won't get the extra 10 - if you don't use the location, you won't get the Rent.

Any income can be bought and sold which leads to a capitalized sales price. If the interest rate is 5% - when you invest $200 you would expect to earn $10 a year. Conversely, if you wanted to sell an income of $10, you would expect to get about $200.

It follows that if you owned the 10 location, you could sell it for 200, or thereabouts.

Well, we all know that.

Noah Alper said that George's understanding that Rent, Wages, and Interest, made up the whole product was his greatest contribution to the science.

When Rent, Wages, and Interest had been paid from the product, there was nothing left. The problem is that we treat these three as being equally important -- as if there is little difference between them.

In fact, Wages - the return to Labor - is the sole reason for production. Without Wages there would be no production. Wages is what Political Economy is all about.

In a free system, one unrestricted by privilege legislation, the market place determines the worth of the product. As the product of Labor is the Wages of Labor, it is evident that Wages are subject to the control of the price mechanism.

Wages are determined by the market.

In practice, labor has two costs of production. The first is interest -- the cost of borrowing capital.

Capital multiplies the effect of human exertion. It enables wages hugely to increase at a small cost. Why the small cost? Simply because interest also suffers the discipline of the market price mechanism. If labor is asked for too much interest when (say) he attempts to borrow a machine, he will go to another machine maker and borrow at a lower cost.

Interest is determined by the market.

So we get to rent.

Labor must have land on which to work, from which to gather his raw materials, on which he carries his products to market. Yet, much or all of this land may have rent value. If it is held by others they may require him to pay for the rent he enjoys. However, he is only paying for something he gets, so he is no worse off. If he pays $100, it is because he is getting $100 back. (This is true whether the payment is demanded by a private individual or by the community.)

However, a problem develops. The two necessary conditions of a free market are: there shall be no restriction on the production of goods; and there shall be no restriction on movement of goods to market. The efficiency of a free market depends on its ability to stimulate production and to draw it to the market.

Neither of these conditions apply to land. One cannot produce more land and no one can bring in cheap land from elsewhere to compete with expensive land. When the price of land in the marketplace goes up, the price mechanism cannot bring it down. So prices continue to rise. The net effect of their increase is to encourage land holders to hold out for the higher price, which in itself stimulates further increases.

Technically, the free market operates on negative feedback, with the price mechanism constantly bringing prices back to an equilibrium. The land market operates with a positive feedback mechanism constantly pushing prices higher.

Rent is not determined by the market.

For the tenant, it means the amount he is charged for his location also rises -- in step with the price rise, for they are linked by capitalization. A tenant enjoying a rent of 10 will find himself paying 15, then 20 and 25, perhaps 40 or 50.

This extra amount above the rent of the location can only come from one source -- the exertion of labor. In other words, this excess amount comes out of labor's wages which, necessarily, are reduced.

There is a natural limit to the amount that can be taken from wages, for labor must survive on what is left. When the uncollected wage reaches subsistence level, no more can be taken labor will die and nothing will be produced. This greatest exaction we can call rack-rent.

We can define it as: "the highest amount that can be exacted from a tenant while maintaining production".

Practically, "rent" is never collected. All tenants pay rack-rent.

Georgists may become confused over this. Sensibly, they want to collect rent. All they find are rack-rents, so they decide to collect rack-rents. Unfortunately, as everything above the Economic Rent has been taken from labor, their attempt to collect rent ends up with them collecting wages as well. Certainly not the intention of Henry George and definitely not the intention of Georgists.

Yet, there is so much more rack-rent than there is Rent, and we do need so much revenue (don't we?) for goodies that governments provide. Perhaps, we can be forgiven for going after the big bucks -- even though we would be taxing wages.

Or should we?

Though there is a natural limit to rack-rent, sales prices can continue to increase. This is being noticed as apartment sales prices no longer have a connection with their rentals. The apartments are being bought and sold at prices that cannot be covered by the rentals that can be collected.

The capitalization relationship breaks down as positive feedback continues to work on land prices. They may continue to climb in the same fashion as a collectible market -- hence my hypothesis that the land market is simply another collectible market.

I would expect that renting a home is much cheaper than buying one - or there will be a trend in that direction as the pace of building slows.

Two things to watch for.

When rack-rents push too high, businesses close. (Lease ends -- everything must be sold.)

When sales prices become collectible, look for more vacant and underused lots and "taxpayers".