Economic rent

In economics, economic rent is any payment to a factor of production in excess of the cost needed to bring that factor into production. In classical economics, economic rent is any payment made (including imputed value) or benefit received for non-produced inputs such as location (land) and for assets formed by creating official privilege over natural opportunities (e.g., patents). In neoclassical economics, economic rent also includes income gained by beneficiaries of other contrived exclusivity, such as labor guilds and unofficial corruption.

Economic rent should not be confused with producer surplus, or normal profit, both of which involve productive human action. Economic rent is also independent of opportunity cost, unlike economic profit, where opportunity cost is an essential component. Economic rent should be viewed as unearned revenue, whereas economic profit is a narrower term describing surplus income greater than the next best risk-adjusted alternative. Unlike economic profit, economic rent cannot be eliminated by competition, since all value from natural resources and locations yields economic rent.

In regard to labor, economic rent can be created by the existence of guilds or labor unions (e.g., higher pay for workers, where political action creates a scarcity of such workers). For a produced commodity, economic rent may also be due to the legal ownership of a patent (a politically enforced right to the use of a process or ingredient). For occupational licensing, it is the cost of permits and licenses that are politically controlled as to their number, regardless of the competence and willingness of those who wish to compete in the area being licensed. For most other production, including agriculture and extraction, economic rent is due to a scarcity of natural resources (e.g., land, oil, or minerals). When economic rent is privatized, the recipient of economic rent is referred to as a rentier.

By contrast, in production theory, if there is no exclusivity and there is perfect competition, there are no economic rents, as competition drives prices down to their floor.[1][2]

Economic rent is different from other unearned and passive income, including contract rent. This distinction has important implications for public revenue and tax policy.[3][4][5] As long as there is sufficient accounting profit, governments can collect a portion of economic rent for the purpose of public finance. For example, economic rent can be collected by a government as royalties or extraction fees in the case of resources such as minerals and oil and gas.

Historically, theories of rent have typically applied to rent received by different factor owners within a single economy. Hossein Mahdavy was the first to introduce the concept of "external rent", whereby one economy received rent from other economies.[6]

Definitions

According to Robert Tollison (1982), economic rents are "excess returns" above the "normal levels" that are generated in competitive markets. More specifically, a rent is "a return in excess of the resource owner's opportunity cost".[7]

Henry George, best known for his proposal for a single tax on land, defines rent as "the part of the produce that accrues to the owners of land (or other natural capabilities) by virtue of ownership" and as "the share of wealth given to landowners because they have an exclusive right to the use of those natural capabilities."[8]

The law professors Lucian Bebchuk and Jesse Fried define the term as "extra returns that firms or individuals obtain due to their positional advantages."[9]

In simple terms, economic rent is an excess where there is no enterprise or costs of production.

Classical rent (land rent)

In political economy, including physiocracy, classical economics, Georgism, and other schools of economic thought, land is recognized as an inelastic factor of production. Land, in this sense, means exclusive access rights to any natural opportunity. Rent is the share paid to freeholders for allowing production on the land they control.

As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land ....
— Adam Smith: The Wealth of Nations[10]

David Ricardo is credited with the first clear and comprehensive analysis of differential land rent and the associated economic relationships (Law of Rent).

Johann Heinrich von Thünen was influential in developing the spatial analysis of rents, which highlighted the importance of centrality and transport. Simply put, it was density of population, increasing the profitability of commerce and providing for the division and specialization of labor, that commanded higher municipal rents. These high rents determined that land in a central city would not be allocated to farming but be allocated instead to more profitable residential or commercial uses.

Observing that a tax on the unearned rent of land would not distort economic activities, Henry George proposed that publicly collected land rents (land value taxation) should be the primary (or only) source of public revenue, though he also advocated public ownership, taxation, and regulation of natural monopolies and monopolies of scale that cannot be eliminated by regulation.

Neoclassical Paretian rent

Neoclassical economics extends the concept of rent to include factors other than natural resource rents.

The labeling of this version of rent as "Paretian" may be a misnomer in that Vilfredo Pareto, the economist for whom this kind of rent was named, may or may not have proffered any conceptual formulation of rent.[14][15]

Monopoly rent

Some returns are associated with legally enforced monopolies like patents or copyrights. In addition, companies like Microsoft and Intel have important de facto monopolies that can be quite valuable. Some businesses, like public utilities, are by their nature monopolies.

Labour

The generalization of the concept of rent to include opportunity cost has served to highlight the role of political barriers in creating and privatizing rents. For example, a person seeking to become a member of a medieval guild makes a huge investment in training and education, which has limited potential application outside of that guild. In a competitive market, the wages of a member of the guild would be set so that the expected net return on the investment in training would be just enough to justify making the investment. In a sense, the required investment is a natural barrier to entry, discouraging some would-be members from making the necessary investment in training to enter the competitive market for the services of the guild. This is a natural "free market" self-limiting control on the number of guild members and/or the cost of training necessitated by certification. Some of those who would have opted for a particular guild may decide to join a different guild or occupation.

However, a political restriction on the number of people entering into the competitive market for services of the guild has the effect of raising the return on investments in the guild's training, especially for those already practicing, by creating an artificial scarcity of guild members. To the extent that a constraint on entrants to the guild actually increases the returns to guild members as opposed to ensuring competence, then the practice of limiting entrants to the field[16] is a rent-seeking activity, and the excess return realized by the guild members is economic rent.

The same model explains the high wages in some modern professions that have been able to both obtain legal protection from competition and limit their membership, notably medical doctors, actuaries, and lawyers. In countries where the creation of new universities is limited by legal charter, such as the UK, it also applies to professors. It may also apply to careers that are inherently competitive in the sense that there is a fixed number of slots, such as football league positions, music charts, or urban territory for illegal drug selling. These jobs are characterised by the existence of a small number of rich members of the guild, along with a much larger surrounding of poor people competing against each other under very poor conditions as they "pay their dues" to try to join the guild. (Reference: "Freakonomics: Why do drug dealers live with their Moms?").

Terminology relating to rent

Gross rent
Gross rent refers to the rent paid for the services of land and the capital invested on it. It consists of economic rent, interest on capital invested for improvement of land, and reward for the risk taken by the landlord in investing his or her capital.
Scarcity rent
Scarcity rent refers to the price paid for the use of homogeneous land when its supply is limited in relation to demand. If all units of land are homogeneous but demand exceeds supply, all land will earn economic rent by virtue of its scarcity.
Differential rent
Differential rent refers to the rent that arises owing to differences in fertility of land. The surplus that arises due to difference between the marginal and intra-marginal land is the differential rent. It is generally accrued under conditions of extensive land cultivation. The term was first proposed by David Ricardo.
Contract rent
Contract rent refers to rent that is mutually agreed upon between the landowner and the user. It may be equal to the economic rent of the factor.
Information rent
Information rent is rent an agent derives from having information not provided to the principal.

See also

References

  1. ↑ "Economics A-Z terms: rent". The Economist. The Economist Group.
  2. ↑ "What is economic rent?". wisegeek.com. wiseGEEK, Conjecture Corporation.
  3. ↑ Kittrell, Edward R. (July 1957). "Ricardo and the taxation of economic rents". The American Journal of Economics and Sociology. Wiley. 16 (4): 379–390. JSTOR 3484887. doi:10.1111/j.1536-7150.1957.tb00200.x.
  4. ↑ Goode, Richard B. (1984). "Taxation of exports and resources". In Goode, Richard B. Government finance in developing countries. Washington, D.C: Brookings Institution Press. p. 185. ISBN 9780815731955. Preview.
  5. ↑ Hammes, John K. (1985), "Economic rent considerations in international mineral development finance", in Tinsley, C. Richard; Emerson, Mark E., Finance for the minerals industry, New York, N.Y: Society of Mining Engineers of AIME, ISBN 9780895204356, archived from the original on 13 May 2014.
  6. ↑ Mahdavy, Hossein (1970), "Pattern and problems of economic development in rentier states: the Case of Iran", in Cook, Michael A., Studies in the economic history of the Middle East: from the rise of Islam to the present day, London, New York: OUP, pp. 428–467, ISBN 9780197135617.
  7. ↑ Tollison, Robert D. (November 1982). "Rent seeking: a survey". Kyklos. Wiley. 35 (4): 575–602. doi:10.1111/j.1467-6435.1982.tb00174.x.
  8. ↑ George, Henry (2006) [1879], "The law of rent", in Drake, Bob, Progress and poverty: why there are recessions and poverty amid plenty - and what to do about it, New York: Robert Schalkenbach Foundation, ISBN 9780911312980.
  9. ↑ Bebchuk, Lucian; Fried, Jesse (2004), "The managerial power perspective", in Bebchuk, Lucian; Fried, Jesse, Pay without performance: the unfulfilled promise of executive compensation, Cambridge, Massachusetts: Harvard University Press, p. 62, ISBN 9780674022287.
  10. ↑ Smith, Adam (1904), "Of the component parts of the price of commodities (book 1, chapter 6)", in Cannan, Edwin, An inquiry into the nature and causes of the wealth of nations (5th ed.), London: Methuen & Co., OCLC 494090. Text.
  11. ↑ Shepherd, A. Ross (October 1970). "Economic rent and the industry supply curve". Southern Economic Journal. Wiley. 37 (2): 209–211. doi:10.2307/1056131.
  12. ↑ "Economics A-Z terms: economic rent". The Economist. The Economist Group. Retrieved 27 May 2010.
  13. ↑ Morton, John; Goodman, Rae Jean B. (2003), "The story of economic rent: what do land, athletics and government have in common?", in Morton, John; Goodman, Rae Jean B., Advanced placement economics: teacher resource manual (3rd ed.), New York, N.Y: National Council on Economic Education, p. 266, ISBN 9781561835669. Preview.
  14. ↑ Bird, Ronald; Tarascio, Vincent J. (1999), "Paretian rent versus Pareto's rent theory: a clarification and correction", in Wood, John Cunningham; McLure, Michael, Vilfredo Pareto: critical assessments of leading economists, volume 2, London New York: Routledge, p. 474, ISBN 9780415185011. Preview.
  15. ↑ Foldvary, Fred E. (January 2008). "The marginalists who confronted land". The American Journal of Economics and Sociology. Wiley. 67 (1): 89–117. doi:10.1111/j.1536-7150.2007.00561.x.
  16. ↑ Friedersdorf, Conor (23 March 2015). "In an era of Uber and Lyft, one city's taxi regulations make no sense: Santa Monica's dysfunctional rules for cabs". The Atlantic. Atlantic Media. Retrieved 14 April 2015. Santa Monica's residents were being afforded too many choices... a population of 84,000 was served by 454 licensed taxis... City experts settled on a franchise system: Competition would be limited to five cab companies. The total number of taxis would be fixed at around 200. The biggest losers, besides the Santa Monica residents who had a tougher time finding a taxi, were the single proprietors who'd bought taxis and earned their livings in the city only to be told that they were no longer welcome there.

Further reading

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