Capitalism

Virtuous Rent: a Rudder That Can Transform Our Economy

How to create a bottom-up stimulus machine in which the people rather than the government do the spending.

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By Peter Barnes

THE LONDON UNDERGROUND abounds with warnings to “mind the gap,” referring to the space between station platforms and train doors. In our larger society similar warnings could be issued for the gaps between rich and poor and between humans and nature. These gaps must not only be minded, they must also be narrowed. The persistent question is how to do this, and I con­tend that a form of rent may be the best possible tool. But before we get to that, we must first become familiar with rent.

The term was first used by classical economists, including Adam Smith, to describe money paid to landowners. It was one of three income streams in the early years of capitalism, the others being wages paid to labor and interest paid to capital.

In Smith’s view, landlords benefited from land’s unique ability to enrich its owners “independent of any plan or project of their own.” This ability arises from the fact that the supply of good land is limited, while the demand for it steadily rises. The effect of landowners’ collection of rent, he concluded, isn’t to increase society’s wealth but to take money away from labor and capital. In other words, land rent is an extractor of wealth rather than a contributor to it.

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A century later, a widely-read American economist named Henry George (his magnum opus, Progress and Poverty, sold over two million copies) enlarged Smith’s insight substantially. At a time when Karl Marx was blaming capital­ists for expropriating surplus value from workers, George blamed landlords for expropriating rent from everyone. Such ­rent­ extraction operated like “an immense wedge being forced, not underneath society, but through society. Those who are above the point of separation are elevated, but those who are below are crushed down.” George’s proposed remedy was a steep tax on land that would recapture for society most of landowners’ parasitic gains.

More recently, the concept of rent was expanded to include mono­poly pro­fits, the extra income a company reaps by quashing com­pe­tition and raising prices. Smith had written about this form of wealth extraction too, though he didn’t call it rent. “The interest of any particular branch of trade or manufac­tures is always to widen the market and to narrow the competition…To widen the market may frequently be agreeable enough to the interest of the public; but to narrow the competition must always be against it, and can only serve to enable the dealers, by raising their profits above what they naturally would be, to levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens.”

It’s important to recognize that the tax Smith spoke of isn’t the kind we pay to government; rather, it’s the kind we pay, much less visibly, to businesses with power. That’s because prices in capitalism are driven by four factors: supply, demand, market power and politi­cal power. The first two, which are omnipresent in economics texts, deter­mine what might be called fair market value; the last two, which are prevalent in the real world, determine rent. Actual prices charged are the sum of fair market value and rent. Another way to say this is that rent is the extra money people pay above what they’d pay in truly com­pe­titive markets.

More recently, the term has been further extended to include income from privileges granted by government—import quotas, mining rights, subsidies, tax loop­holes and so on. Many econo­mists use the term “rent-seeking” to describe the multiple ways special interests use govern­ment to enrich them­selves at the expense of others. If you’re wondering why Washington, D.C. and its envi­rons have grown so prosperous in recent decades, it’s not because govern­ment itself has become gargantuan, it’s because rent-seeking has.

In short, traditional rent is income received not because of anything a person or business produces, but because of rights or power a person or business possesses. It con­sists of takings from the larger whole rather than additions to it. It redis­tributes wealth within an econ­omy but doesn’t add any. As British economist John Kay put it in the Financial Times, “When the appropriation of the wealth of others is illegal, it’s called theft or fraud. When it’s legal, it’s called rent.”

BECAUSE RENT ISNT LISTED separately on any price tag or corpor­ate in­come statement, we don’t know exactly how much of it there is, but it’s likely there’s quite a lot. Consider, for example, health care in America, about one-sixth of our economy. There are many reasons the U.S. spends 80 percent more per capita on health care than does Canada, while achieving no better results, but one of the biggest is that Canada has wrung huge amounts of rent out of its health care system and we haven’t. Every Canadian is covered by non-profit rather than profit-maximizing health insurance, and pharmaceuti­cal prices are tightly controlled. By contrast, in the U.S., drug companies overcharge because of patents, Medicare is barred from bargaining for lower drug prices, and private insurers add many costs and inefficiencies.

Or consider our financial sector. Commercial banks, the kind that take depo­sits and make loans, receive an immensely valuable gift from the federal gov­ernment: the right to create money. They’re allowed to do this through what’s called fractional reserve bank­ing, which lets them lend, with interest, about ten times more than they have on deposit. This gift alone is worth billions.

Then there are commercial banks’ cousins, investment banks, which are in the business of trading securities. They can’t mint money the way commercial banks do, but they have tricks of their own. For one, they charge hefty fees for taking private companies public, thus seizing part of the liquidity pre­mium public trading creates. For another, they make lofty sums by creat­ing, and then manipulating, hyper-complex financial “products” that are, in effect, bets on bets. This pumps up the casino economy and extracts capital that could otherwise benefit the real economy.

We could wander through other major industries—energy, tele­com­muni­ca­tions, broadcasting, agriculture—and find similar ex­tractions of rent. What percentage of our economy, then, consists of rent? This is a question you’d think economists would explore, but few do. To my knowledge, the only prominent economist who has even raised it is Joseph Stiglitz, a Nobel laureate at Columbia University, and he hasn’t answered it quantitatively.

The amount of rent in the U.S. economy, Stiglitz says, is “hard to quantify (but) clearly enormous.” Moreover, “to a significant degree,” it “redistributes money from those at the bottom to those at the top.” Further, it not only adds no value to the economy, it “distorts resource allocation and makes the econ­omy weaker.” 

SO FAR I’VE DESCRIBED rent as a negative force in our economy. Now I want to introduce the concept of virtuous rent, a form of rent that would have distinctly positive effects.

A perfect example of virtuous rent is the money paid to Alaskans by the Alaska Permanent Fund. Since 1980, the Permanent Fund has distributed equal yearly divi­­dends to every person who resides in Alaska for one year or more. The divi­dends—which have ranged from $1,000 to $3,269 per person —come from a giant mutual fund whose beneficiaries are all the people of Alas­­ka, present and future. The fund is capitalized by earnings from Alaska’s oil, a commonly owned resource. Given the steady flow of cash to its entire pop­u­la­tion, it’s not surprising that Alaska has the highest median income and one of the lowest pover­ty rates of any state in the nation.

Broadly speaking, virtuous rent would be any flow of money that starts by raising the cost of harmful or extractive activity and ends by increasing the incomes of all members of society. Another way to think of it is as rent that we, as collective co-owners, charge for private use of our common assets. Think, for example, of charging polluters for using our common atmosphere and then sharing the proceeds equally.

There are two key differences between traditional and virtuous rent. The first has to do with how the rent is collected, the second with how it’s distributed.

Traditional rent is collected by businesses whose market and/or political power enables them to charge higher-than-competitive prices. It leads to higher prices that serve no economic, social or ecological function. Virtuous rent, by con­trast, would be collected by not-for-profit trusts that represent all mem­bers of a polity equally. It would be generated by charging private busi­nesses for using common assets that most of the time they use for free. Such rent would also lead to higher prices, but for good reasons: to make business­es pay costs they currently shift to society, nature and future genera­tions, and to offset traditional rent.

The second difference is distributional. Traditional rent flows upward to the small minority that owns most of the stock of rent-extracting businesses. Virtuous rent would flow to everyone equally.

When collection and distribution are merged, the effects of traditional rent are doubly negative: it diminishes the efficiency of our economy and the in­comes of all those who pay it but don’t get any. The effects of virtuous rent, by con­trast, are doubly positive: it increases the health and fairness of our economy and the security of our middle class.

At this moment, of course, traditional rent totals trillions of dollars a year, while virtuous rent (out­side of Alaska) is more of a concept than a reality. But virtuous rent can and should grow. To understand how this could hap­pen, it’s necessary to ex­plore two other concepts: common wealth and exter­nalities.

Common wealth has several components. One consists of gifts of nature we inherit together: our atmosphere and oceans, water­sheds and wetlands, forests and fertile plains, and so on. In almost all cases, we overuse these gifts because there’s no cost attached to using them.

Another component is wealth created by our ancestors: sciences and techno­lo­gies, legal and political systems, our financial infra­structure, and much more. These confer enormous benefits on all of us, but a small minority reaps far more financial gain from them than do most of us.

Yet another chunk of common wealth is what might be called “wealth of the whole”—the value added by the scale and syner­gies of our economy itself. The notion of “wealth of the whole” dates back to Adam Smith’s insight two-and-a-half centuries ago that labor specialization and the exchange of goods —pervasive features of a whole system—are what make nations rich. Beyond that, it’s obvious that no business can prosper by itself: all busi­nesses need cus­­tomers, suppliers, distributors, highways, money and a web of comple­men­tary products (cars need fuel, software needs hardware, and so forth). So the economy as a whole is not only greater than the sum of its parts, it’s an asset without which the parts would have almost no value at all.

The sum of wealth created by nature, our ancestors and our econ­omy as a whole is what I here call common wealth. Several things can be said about our common wealth. First, it’s the goose that lays almost all the eggs of private wealth. Second, it’s extremely large but also (like the dark matter of the universe) mostly invisible. Third, because it’s not cre­ated by any indivi­dual or business, it belongs to all of us jointly. And fourth, because no one has a greater claim to it than anyone else, it belongs to all of us equally, or as close to equally as we can arrange.

The big, rarely asked question about our current economy is who gets the benefits of common wealth? No one disputes that private wealth creators are entitled to the wealth they create, but who is entitled to the wealth we share is an entirely different question. My contention is that the rich are rich not so much because they create wealth, but because they capture a much larger share of common wealth than they’re entitled to. Another way to say this is that the rich are as rich as they are—and the rest of us are poorer than we should be—because extracted rent far exceeds virtuous rent. If that’s the truth of the matter, the solution is to diminish the first kind of rent and increase the second kind. 

EXTERNALITIES are a better-known concept than common wealth. They’re the costs businesses impose on others—workers, communities, nature and fu­ture generations—but don’t pay themselves. The classic example is pollution.

Almost all economists accept the need to “internalize externalities,” by which they mean making businesses pay the full costs of their activities. What they don’t often discuss are the cash flows that would arise if we actually did this. If businesses pay more money, how much more, and to whom should the checks be made out?

These aren’t trivial questions. In fact, they’re among the most momentous questions we must address in the twenty-first century. The sums involved can, and indeed should, be very large—after all, to diminish harms to nature and society, we must internalize as many unpaid costs as possible. But how should we collect the money, and whose money is it?

One way to collect the money was proposed nearly a century ago by British economist Arthur Pigou, a colleague of Keynes’ at Cam­bridge. When the price of a piece of nature is too low, Pigou said, government should impose a tax on using it. Such a tax would reduce our usage while raising revenue for government.

In theory Pigou’s idea makes sense; the trouble with it lies in imple­mentation. No western government wants to get into the business of price-setting; that’s a job best left to markets. And even if politicians tried to adjust prices with taxes, there’s little chance they’d get them “right” from nature’s perspective. Far more likely would be tax rates driven by the very corporations that domi­nate government and overuse nature now.

An alternative is to bring some non-governmental entities into play; after all, the reason we have externalities in the first place is that no one represents stakeholders harmed by shifted costs. But if those stakeholders were repre­sent­ed by legally accountable agents, that problem could be fixed. The void into which externalities now flow would be filled by trustees of common wealth. And those trustees would charge rent.

As for whose money it is, it follows from the above that payments for most externalities—and in particular, for costs imposed on living creatures present and future—should flow to all of us together as beneficiaries of common wealth. They certainly shouldn’t flow to the companies that impose the exter­nalities; that would defeat the purpose of internalizing them. But neither should they flow to government, as Pigou suggested.

In my mind, there’s nothing wrong with government taxing our individual shares of common wealth rent, just as it taxes other personal income, but government shouldn’t get first dibs on it. The proper first claimants are we, the people. One could even argue, as economist Dallas Burtraw has, that government capture of this income may be an unconstitutional taking of pri­vate property.

THIS BRINGS US BACK to virtuous rent. There are several points that can be made about this sort of rent.

First, paying virtuous rent to ourselves has a very different effect than paying extractive rent to Wall Street, Microsoft or Saudi princes. In addition to dis­couraging overuse of nature, it returns the money we pay in higher prices to where it does our families and economy the most good: our own pockets. From there we can spend it on food, housing or anything else we choose. Such spending not only helps us; it also helps businesses and their employees. It’s like a bottom-up stimulus machine in which the people rather than the government do the spending. This is no trivial virtue at a time when fiscal and monetary policy have both lost their potency.

VIRTUOUS RENT

Screen Shot 2016-08-09 at 9.52.58 PM

Second, virtuous rent isn’t a set of government policies that can be changed when political winds shift. Rather, it’s a set of pipes within the market that, once in place, will circulate money indefinitely, thereby sustaining a large middle class and a healthier planet even as politicians and their policies come and go.

And third, though virtuous rent requires government action to get started, it has the political virtue of avoiding the bigger/smaller government tug-of-war that paralyzes Washington today. It thus can appeal to voters and politicians in the center, left and right.

A TRIM TAB is a tiny flap on a ship or airplane’s rudder. The designer Buck­minster Fuller often noted that moving a trim tab slightly turns a ship or a plane dramatically. If we think of our economy as a moving vessel, the same metaphor can be applied to rent. Depending on how much of it is collected and whether it flows to a few or to many, rent can steer an economy toward extreme inequality or a large middle class. It can also guide an economy toward excessive use of nature or a safe level of use. In other words, in addi­tion to being a wedge (as Henry George put it), rent can also be a rudder. An economy’s outcomes depend on how we turn the rudder.

Think about the board game Monopoly. The object is to squeeze so much rent out of other players that you wind up with all their money. You do this by acquiring monopolies and building hotels on them. However, there’s another feature of the game that offsets this extracting of rent: all players get a cash payment when they pass Go. This can be thought of as virtuous rent.

As Monopoly is designed, the rent extracted through monopoly power greatly exceeds the virtuous rent players receive when pass­ing Go. The result is that the game always ends the same way: one player gets all the money. But sup­pose we tip the scale the other way. Suppose we decrease the extracted rent and increase the virtuous kind. For example, we could pay players five times as much for passing Go and reduce hotel rents by half. What then happens?

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Instead of flowing upward and concentrating in the hands of a single winner, rent flows more evenly. Instead of the game ending when one winner takes all, the game continues with many players remaining.

The point I wish to make is that different rent flows can steer a game—and more importantly, an economy—toward different outcomes. Among the out­comes that can be affected by differing rent flows are the levels of wealth co­n­centration, pollution and real investment as opposed to specu­lation.

Rent, in other words, is a powerful tool. And it’s also something we can fiddle with. Do we want less extracted rent? More virtuous rent? If so, it’s up to us to build the pipes and turn the valves.

2016 August 10


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  • anotherneighborhoodactivist

    Who wrote the headline ending with “Use it to Fuel Growth”? Growth is not discussed in the article, and endless growth is incompatible with long term equity and sustainability. Cf.

    • robertmkadar

      Growth is implied throughout the article. You are thinking about “GDP” growth. Different meaning.

  • Rick Derris

    >>>By contrast, in the U.S., drug companies overcharge because of patents

    No, they overcharge because the American consumer is subsidizing the costs of the drugs paid by consumers in other nations and because of the FDA approval process. The patent is a temporary monopoly grant. Drug companies also must go through other regulatory hurdles; that’s really how Shkreli made his ill-gotten gains – the drug he sold was off-patent for decades.

    >>>>>
    Commercial banks, the kind that take depo­sits and make loans, receive an immensely valuable gift from the federal gov­ernment: the right to create money. They’re allowed to do this through what’s called fractional reserve bank­ing, which lets them lend, with interest, about ten times more than they have on deposit.
    >>>>>

    And consider the regulatory and statutory compliance that they must comply with in order to operate as banks.

    >>>>>
    Then there are commercial banks’ cousins, investment banks, which are in the business of trading securities. … For one, they charge hefty fees for taking private companies public, thus seizing part of the liquidity pre­mium public trading creates.
    >>>>>

    And do not forget that they’re also offering services to comply with the 1933 Securities Act and the 1934 Securities Exchange Act. Those laws were enacted to protect the public but the compliance costs are a large factor that contribute to the existence of investment banks.

    >>>>>
    We could wander through other major industries—energy, tele­com­muni­ca­tions, broadcasting, agriculture—and find similar ex­tractions of rent
    >>>>>

    Yes, and one of the biggest rent extractors is Elon (DOUCHE) Musk. Tesla would be broke if not for environmental subsidies. A hybrid car is most likely less polluting than his overpriced virtue-signalling ugly wagons.

    But a GREAT article! I think I’ll order Capitalism 3.0.

    • John M Legge

      Big Pharma spends more on sales, marketing and lobbying than on R&D; and in any case most of the underlying scientific breakthroughs occur at the NIH and in the major research universities and are passed to Big Pharma for nothing. The only people who would suffer if Medicare was allowed to use its monopsony to negotiate drug prices would be politicians losing a lucrative stream of donations.

  • John M Legge

    One major flaw in the article is the assumption/assertion that competition lowers prices. The normal demonstration in elementary economics textbooks (monopoly price leads to MR=MC; competitive price to P=MC) incorporates a basic mathematical error. Even under the textbook assumptions the price will tend to the monopoly level irrespective of the level of competition. Once economies of scale are considered the joint profit maximising price set by an oligopoly will be well below any possible “competitive” price. As Schumpeter noted, “the corner grocer cannot compete with the supermarket, which sells for less than the cost to him of buying.”
    Large companies are certainly good at extracting rent through lobbying (and for some, outright corruption when they think that they can get away with it). They also profit from unrequited externalities: it is not simply justice but essential for the survival of humanity that such profits are taxed, or rented, away.

  • Many conceptual malapropisms in this article. For example:

    “Commercial banks, the kind that take depo­sits and make loans, receive an immensely valuable gift from the federal gov­ernment: the right to create money. They’re allowed to do this through what’s called fractional reserve bank­ing, which lets them lend, with interest, about ten times more than they have on deposit.”

    That is not at all what fractional reserve banking is (See https://en.wikipedia.org/wiki/Fractional-reserve_banking). Banks can lend more than they have in reserves, not what they have on deposit. If a reserve requirement was 5%. The Bank could lend 95 cents of every dollar deposited, retaining the rest as a reserve. The only sense in which money is created is that the depositor counts the deposit as “money” and so does the borrower (before the funds are spent). But in the case of the borrower there is an offsetting liability (to the bank).

  • Mark Larkento

    Why Henry George had a point

    LAND prices mainly reflect location: farmers may till the soil, or drain it, but most increases in land’s value comes from the activity of other people. Nobody builds skyscrapers or shopping malls in the wilderness. Landowners, in other words, enjoy unearned income from the benefits bestowed by good transport links, and proximity to customers, suppliers and other businesses. Once they have bought their land, they keep this money. 

    But why not tax it? That simple but revolutionary idea has deep roots. David Ricardo termed unearned income from land as a pernicious anomaly: “that portion of the produce of the earth which is paid to the landlord for the use of the original and indestructible powers of the soil”.

    His best-known follower was Henry George, perhaps the only tax theorist in history whose beliefs have become the object of almost cult-like devotion. One of his fans invented the game now known as Monopoly, to exemplify the evils of untaxed rent. In a book called “Progress and Poverty”, published in 1879, George argued that land-value levies should replace all other taxation, leaving labour and capital to flourish freely, and thus ending unemployment, poverty, inflation and inequality.
    http://tinyurl.com/j5ll8xy

    • John

      “farmers may till the soil, or drain it, but most increases in land’s value comes from the activity of other people.”
      The worked soil on top of LAND may be regarded as CAPITAL, not LAND. The soil comes from LAND as does wood. Once trees are cut and worked into manageable wood pieces it becomes CAPITAL.

  • Jonathan D

    This is a great article. It pulls together some key insights about who gets what and why. The basic concept that earnings are, well “earned” in our economy is second nature. Distinguishing rents from other flows and asking about common wealth and externalities puts the emphasis back on the rules that determine who gets what share for what reasons and therefore on the primacy of redistributive flows rather than personally, individually ‘earned’ incomes. Sure we could debate the boundaries of rents in the finance sector, or whether patents pay off, as some responders do, but I hope we don’t miss the profound basic ideas at work here.

  • Floris

    Very interesting article. Assuming we would increase the use of virtuous rent, the important question becomes: who is everyone? Should we share the profits of oil from Alaska with all people living near the source, living in Alaska, living in the USA, living on earth?

  • Duncan Cairncross

    Excellent article
    As an engineer I have always been conscious of how much I/we rely on work done in the past – without the huge base of existing technologies and knowledge none of the new inventions we take for granted would be possible
    The most innovative modern invention is no more than a thin patina on the underlying structure required to make it work
    This underlying structure is the property of all of us – so when a modern inventor makes a huge profit from his/her invention most of that wealth actually belongs to the commons