The Meanings of Economic Rent

Harry Pollard

[Reprinted from a Land-Theory online discussion, September 2002]

I'm not in the habit of using the term "rack rent" myself, but I hesitate to recommend that sort of reticence to others. I would merely ask people to clarify the context in which they are using the term. One other meaning of rack rent, which I did not mention (because I was merely reporting on Lawrence Stone's work) is the idea that all capital improvements revert to the landlord at the end of a lease. That meant, in some historical situations, that when a lease was renewed, the landlord charged tenants rent on the improvements they had made during the previous lease. This would fit with the second definition of "rack rent" in the OED: excessive rent collection. In conclusion, if the term is going to be used in a pejorative sense, I think it is important to specify precisely how a rent is excessive. For English tenants of the 16th century, it appears that full economic rent was deemed excessive because it surpassed the ancient rents their ancestors had paid. CLIFFORD COBB

Some little while ago I defined four classes of location "land-value". This, because we seem to have lost our way in the discussion of Rent. We want Rent collection to replace present taxes and provide a kind of basic income to everyone, which self-inflicted pressure leads us in what I think are wrong directions.

INTRINSIC LAND VALUE

Two kinds of value attach to land. One is an intrinsic value that is in the land - to be extracted thereby diminishing this particular value. Several suggestions have been made to name that particular value - perhaps best is "Natural Rent". It ranges from fertility, to oil, to ores of many kinds.. The important point about it is that it may not be here tomorrow - as it disappears with use.

This is the substance of our island model in the Basic Course. It actually doesn't refer to population created values (although it uses a Malthusian increase in population to make its point).

In Southern California, we use the model to 'prove' Malthus' analysis. The island population increases until new settlers have nowhere to settle and must leave , or die.

Then we empty the island and wait for Lindy Davis to arrive with his family. Lindy knows that others will be coming to settle the island. The family plant their crops on the best land. Then, his 7 children - led by the oldest Eli, now 6'8" and built like a tank - get to work fencing all the best land.

When the next family arrives, their wages are already at subsistence for that's all they can get on the available land. So, we've created instant Malthus with only two families on the island.

"Natural Rent" - or whatever we call it - seems like a good source for state or national revenue.

EXTRINSIC RENT

The other Rent is our major topic of conversation. It attaches to a location but is produced from outside. It's an extrinsic value. This Rent is not used up with use, as is "Natural Rent".

I define location Rent as "the extrinsic community created value that attaches to a location". This is the Rent I always write with a capital R. Maybe we should be modern and call it the environmental value!

It is an amount we are morally allowed to collect. The community created it, they have a right to it based on the just ownership of what they produce.

RACK-RENT

You may not buy into my collectible market argument for land, but we know that with collectibles, the free market price mechanism doesn't work. Necessary to a free market is uninhibited production and its easy movement to the market. When market prices increase from equilibrium, in rushes production which drops prices back to equilibrium.

A collectible is something that cannot be reproduced. A collectible may be unique - or be one of a number. The crucial thing is that there "ain't going to be no more". So we are stuck with the six authenticated original Mona Lisas - or the three Rosalie beer cans, or with the land. There will be no more.

When opportunities are limited, or non-existent, labor endures an unhappy situation. When no worthwhile rent-free land is available for workers to make a living, competition for jobs pressures wages downward. The action of the free market is to raise quality and reduce costs. This applies also to labor.

Wages are reduced to subsistence - below which they can't go. When wages are deducted from production - the remainder is called rent. But it shouldn't be. It is not the value contributed to a site by the surrounding community. It is the highest amount that be squeezed from the worker, while keeping him alive (technically, alive and reproducing). This amount is rack-rent.

In practice, "rack-rent" is found this way. In the incredibly rich and fertile Mekong Delta rents reached to 90% of the crop. In less fertile situations, Rents will be lower. Stiglitz suggested that third world rents were 50% of the crop. In Taiwan, early land reform legislation forced a 25% drop in rents - to 37.5% of the crop. So, 50% may be a standard rent across much of the world.

However, this is hardly Rent, I would say, in the Georgist sense, or in my description above. This rent is the most that can be squeezed from a renter in the absence of a free market.

It is well called rack-rent.

So, Cliff, the usage restriction that inhibits dictionaries may have caused the OED confusion. The "rent" that is commonly paid throughout history and across the world is rack-rent. In real life, rent and rack-rent are the same thing. But not Rent.

LAND PRICE

Land has all the characteristics of a collectible. When land acts like a collectible, the tendency of its owner will be to hold it whether used or not. In fact, in many instances using it incurs expenses. If you have an antique desk with a collectible price, you wouldn't dream of using it for that might reduce its 'mint' condition and make it less valuable. The three Rosalie beer cans are worth almost $11,000 each because they are "perfect". If you have one, you wrap it in plastic and put it in a bedroom drawer. You wouldn't let the kid play with it.

In similar fashion, if a collector has a 5 acre vacant site in the city's downtown, he doesn't erect a building while awaiting the big sale. He leaves it vacant and primed for a skyscraper. If other expense - such as a property tax - weighs a little heavy, he may make it a parking lot. This is a minimum expense "taxpayer" that doesn't affect its potential as a skyscraper site.

In the suburbs, the best corner in town may sprout a service station. Again, its potential as a collectible isn't reduced. Cart away the pumps, pull the tanks out of the ground and the new S & L has a great HQ. These "temporary" taxpayers may for a year, or 5 years, or 20 years.

Ted Gwartney, Bret Barker, and I, video'd a downtown 5 acre site surrounded by skyscrapers. Ted said it had been a vacant lot for at least 25 years. It has now been "improved" to a parking lot, perhaps for another 25 years.

We call this land speculation - but it is actually collectors waiting for prices to rise even higher. In their minds, quite understandably, their $20,000 lot has risen to $2 million and will eventually provide them with perhaps a $5 million nest egg.

Collection involves a positive feedback mechanism. If a price rises, it induces a further price rise. If you have a $100,000 antique clock and you find a similar clock has fetched $120,000, you reset your sights to $120,000. In fact, as the clocks have apparently increased in value by $20,000, you expect further increases, perhaps to $140,000 - or $150,000.

Positive feedback doesn't much matter with clocks. It is a disaster when it applies to land.

You'll note that the free market is a negative feedback mechanism, rather like the thermostat on your living room wall. When the free market price rises or drops, the mechanism returns it to equilibrium. It hunts around a point, always returning to its equilibrium. (What determines the equilibrium is another unasked question - except with Georgists.

CAPITALIZED "RENT"

This is a value that doesn't exist except perhaps in the fevered minds of enthusiastic Georgists. Using the collectible land sales prices, they capitalize down to rent. This provides us with enormous amounts of cash with which we can pay for everything without the need for taxes and provide a Citizen's Dividend for everyone. Ed introduced a CD of $30,000 a head a few months ago.

Amazing! No, wonderful!!

"INCOME FROM CAPITALIZATION" LAND VALUE

The important part of capitalization in a free market situation is income. "What is my continuing return from this something that costs this much to buy?"

A collectible market is really not interested in income. We saw collectible thinking in the upper levels of the stock market in recent times as analysts bleated about price/earnings ratios. The "investors" were not interested in income, but rather in enjoying a positive feedback market that went only up.

Well.

This "estimated income from a collectible land price" is the one we use to estimate how much income we'll get from taxing land-values. It is imaginary.

Back in the days of prudent banking (there's a thought) banks would not lend on land because it was too volatile. Bring your land ownership proof along and maybe they would lend on your prospective house, or factory. But they wouldn't lend on land.

Imprudent banking has in recent times been particularly evident by US S&L's and Asian banking collapses.

As the banks found out, collectible markets can be somewhat ephemeral. Yet, said the Economist in a cover story, the economies of the world are held up by them.

Not exactly, they said that the economies of the world are being held up by the housing market. That's shorthand for the combination of house market and land market. The house market is pretty steady - the collectible land market is soaring.

Help!

Yesterday the LA Times announced that LA County median housing prices were up 15% from last year to $267,00. The similar increase for next door Orange County was 20% to $370,000.

With low mortgage rates, many young couples are investing in something that offers a profitable future. In fact, some have left the volatile stock market to invest in the "perceived safe harbor" of a home investment.

Double help! This is the situation across the world, says the Economist.

May someone have mercy on our souls!