Why rent matters

Philip Green doesn’t get much public sympathy, but he deserves our thanks for doing one thing: he is reminding us that economists have wrongly neglected David Ricardo’s theories of rent.

Mr G is fighting landlords to cut rents – as indeed are several other high street names. Which evokes Ricardo. He showed that profits can be squeezed not by worker militancy but by rising rents.

The basic idea here is straightforward. Imagine, said Ricardo, there were an abundance of fertile land. A landlord could not then charge farmers rent: the farmers would just move onto other land. As the economy and population grows, however, the best land becomes fully occupied so farmers must use less fertile land. As they do so, the owners of the best land can demand rent from their farmers. And as worse and worse land gets brought into cultivation so the difference in the output of the best and worst land increases, giving owners of the best land even higher rent. As Ricardo wrote:

By bringing successively land of a worse quality, or less favourably situated into cultivation, rent would rise on the land previously cultivated, and precisely in the same degree would profits fall; and if the smallness of profits do not check accumulation, there are hardly any limits to the rise of rent, and the fall of profit….In a progressive country…the landlord not only obtains a greater produce, but a larger share.

This isn’t just true of farmland. It also applies in retailing. Owners of the best sites – those with the highest footfall and greatest accessibility – can charge shop-owners a rent up to the difference in revenues they get between the best and worst sites. As Tim says:

Even in busy London stations coffee sellers don’t make much money because the landowner simply increases the rent. In other words, it’s the landowners via rents who make money in prime locations, not the operators of businesses. 

Retailers such as Mr Green have got the hump with this.

But it’s not just retail space of which this is true. It’s also true of housing. As Josh Ryan-Collins writes in his superb book, Why Can’t You Afford a Home?, “desirable location (typically in large cities) is inherently limited.” And Econ 101 tells us that if demand increases when supply is inelastic, we see big price rises. As Londoners get richer, everybody wants to live in Hampstead, with the result that only Russian oligarchs can afford to do so.

Historically, there has been a mitigation of this. In a lovely paper (pdf), Katharina Knoll, Moritz Schularick and Thomas Steger show that house prices were actually flat in many countries for years in the first half of the 20^th century. A big reason for this was the development of commuter train lines. The opening of the Metropolitan line, for example, allowed workers to travel easily from Neasden to central London. That reduced the monopoly which landlords in the city centre had, thereby squeezing their rents – just as cheap fertilisers would have squeezed farmland owners’ rents in Ricardo’s model.

This effect, however, was only one-off – at least it will be until we invent teleportation. And it has been replaced by another more powerful effect – financialization. Credit liberalization in the 1980s removed the constraint upon house prices imposed by current incomes by allowing people to borrow more. The upshot is that there has been a strong correlation between house prices and interest rates: as the latter have fallen, house prices have risen relative to earnings.

For this reason, as Ryan-Collins explains, high house prices are due in large part to financialization. This, he believes, means that there is a case for banking reform and a land value tax.

The point here, though, isn’t just about policy. It’s also about how economists approach their discipline. As Ryan-Collins writes:

Land and money are two of the most neglected concepts in economic theory. Land is immobile, irreproducible and appreciates in value over time due to collective investment – none of these features apply to capital goods. Yet modern economics and national accounts treat them as one and the same.

Herein lies one reason (of several!) why economists should study the history of economic thought. Doing so can show that classic economists knew things which modern ones have forgotten.

Comments

[Ralph Musgrave]

Can’t see the big problem with house prices being inversely related to interest rates. The rate of interest paid by mortgagors is now a third of what it was in the mid 1990s, while house prices have risen sharply in real terms. In fact house prices are now only two and a bit times what they were in the mid 1990s, thus mortgagors are now a bit better off than they were.

[luis enrique]

some exceptions that perhaps prove the rule

here's an old favorite in which land is very sensibly distinguished from capital
http://personal.lse.ac.uk/casellif/papers/mpk.pdf

and I am sure you know this tremendous paper
http://mattrognlie.com/brookings_capitalshare.pdf

[2slugbaits]

Joseph Stiglitz emphasizes the neglected importance of land rents as a source of inequality in this paper (it's actually part 4 of a 4 part series):

https://www.nber.org/papers/w21192

From the abstract:

"A significant amount of the increase in the wealth income ratio in recent decades is due to an increase in the value of land. We present a series of models that explain why land prices may have increased. These models help us understand the increase in both the wealth income ratio and wealth inequality. One model focuses on certain locations as being positional good. In another, we show that land bubbles are a natural part of market economies, and that on “bubble paths”, wealth may increase, even as the real wealth of the economy diminishes."

The old Physiocrats probably deserve a nod as well as Ricardo.

[Dan]

@Ralph

You don't see a problem with paying 3x your salary Vs 6x you salary for a house?

I know what I'd rather pay.

[Richard]

> Land ... appreciates in value over time due to collective investment

Only with a rising population. If you look at Japan, rural France, Detroit etc land prices are falling as people leave and few babies are born.

Has implications for open borders and freedom of movement.

[Ralph Musgrave]

Dan, You’ve got a point. It all depends on whether the relevant house owner has their heart set on eventually owning their house outright, or whether they are simply after a roof over their head and intend making minimum capital repayments to the bank. Most mortgages in the South East I think are interest only, i.e. they’re in the “minimum capital repayment” category.

For those “interest only” people, and assuming house prices vary inversely with interest rates, then there is no difference between for example a £100k mortgage at 10% interest, and a £200k mortgage at 5%.

[greg]

Hmm. The case of housing you raise WRT to financialization suggests the possibility that the only people who have benefited from financialization, (besides perhaps landlords,) in the entire economy are bankers and financiers. Everyone else in the economy might be pretty much as well off or better as they are now, except for the financial sector.

[MikeW]

Great work Chris. I loved your Tories 'run out of other peoples assets' quip the other day too :)

I was once outlining Henry George's LVT to a lefty and she said, 'but surely this is just Ricardo! And I said 'yes' in the sense that Marx's 'pauperisation of workers down to subsistence by Capital' is surely 'just' Ricardo too!

I will read the Katharina Knoll, Moritz Schularick and Thomas Steger paper with great interest. The 'New Georgists', tend to argue that, large scale Council house building, Bank lending ratios capped, Building Societies lending for housing only, legislation against landlords (pro tenant), and rent controls plays a huge part over the 20th century. It allows workers to keep some of their surlpus againsts the Rentier after the share taken by Capital and government. Remember folks - Rents are just a privately collected tax.

Re 'squeezing of landlords' I have not read the paper above yet but surely: Rent in Neasden + the bus + Train fares = Rent in London. Landlords in each location always push to take the workers surplus back down to Ricardo's subsistence level.So as you say, very time limited event for a few workers in the 1930's.

[alwalad]

Chart axes are wrong.

[Avraam Jack Dectis]

.
Obvious conclusion: It is a governmental core respondibility to engineer an effective surplus of desireable rentable or ownable entities.
.

[Blissex]

«As Londoners get richer, everybody wants to live in Hampstead, with the result that only Russian oligarchs can afford to do so.»

Ah the usual comical propertarian and rentierist propaganda and from a self-declared marxist too: the price of housing is not something that merely "happens", it is something that is strictly related to the availability of jobs.
People don't move to London or the Home Counties "just because", or because of the large beaches, the sunny weather, etc; they move because several tory governments have spent fantastic amounts of taxpayer money to attract businesses and thus jobs to the Home Counties and London.
The case of the oligarchs and Hampstead is quite misleading, because it is a corner case.

When property “appreciates in value over time due to collective investment” that is the investment in jobs, in the general case. Commuting as noted can expand the catchment basin of a job-rich area, but only at a large cost to commuters (but not to their spouses, and this has driven a lot of suburbanization BTW).

It is much better (except for a subset of rentiers) to spread job creation evenly. Perhaps once upon a time jobs had to be necessarily concentrated in a number of places because of slow transport and communications, but currently that is much less of an issue.

Put another, London and the Home Counties don't have a housing problem, the rest of the country has a jobs problem.

[greg]

Blissex:"...the rest of the country has a jobs problem."

Well. London is the paymaster, and decides where the best paying jobs will go. London has decided to keep those best paying jobs to itself, rather that disperse those jobs and their associated demand for housing about the country.

So it is a decision by the masters of London itself, to concentrate jobs, at the expense of the rest of the country. Just incidentally driving up London rentals, rentals whose profits many of these same masters also enjoy.

This has the added benefit of depressing values in the country, making them cheaper to buy with London collateral.

And do the mid-level executives gain any benefit at all from their raises, or does most of it go back to the owners, as rent?