Rents, Land Rents, and Economic Rents (Oh My!)
The (Discovery of the) Evolution of the Definition of Economic Rents
Henry George took great pains at the beginning of Progress and Poverty to define “The Meaning of the Terms”1. If it worked for dear Henry, it’s good enough for me!
Semantically Speaking…
In the early days, economists used the term “rents” and found “land rents” to be the most obvious form of “rents”, whatever they may be and which we shall soon explore. These days, it seems to be generally accepted that the term “economic rents” means roughly the same thing as olden day “rents”, despite the term arising much later.2 I suspect that “economic rents” only came about when it became necessary to distinguish from the more modern colloquial use of the term “rent” — which, in turn, is often also subsequently modified to highlight this difference, i.e. “contract rent”, “market rent”, “imputed rent”, and so forth. However, the definition of the term also has shifted over time whether we include olden day “rents” in our inquiry into its history or cleave it for the sake of rigor. Exactly when this occurred has not been precisely captured by economists, as far as I could find, and may benefit more from a linguist’s touch in the future.
Let’s Start Anywhere!
In conducting the standard due diligence via our favorite search engine3 to determine the definition of economic rents, I came across this meta analysis in the Journal of Economic Surveys titled “Taxation of Economic Rents”4. Since the paper expounded on the benefits of taxing land rent early and often, I figured I was probably in pretty safe hands at the time, despite the authors primarily using a neoclassical lens. It defined economic rent as follows:
Economic Rent
those benefits to an agent that are in excess of the minimum necessary for the agent to accept the transaction.
or
those payments to a good that are in excess of the minimum payment necessary to have it supplied.
Clear as mud so far, but sounds roughly like anything between the reserve prices of the two parties to the transaction.
From what I’ve gathered, reserve prices were originally thought to be roughly equivalent to cost-to-produce5 — which, for land6, is zero, since no human made the land, therefore, the entire amounts traded for access to land falls between the reserve prices7 under that line of thought. There are, however, a number of incidences we can think of which may shift reserve prices up or down from cost-to-produce. Holding costs come to mind. As holding costs go up, the minimum acceptable price for exchange goes down until it becomes more cost-effective to dispose of or abandon the inventory than to continue to try to sell. More on this in a minute.
Well This Looks a Bit More Promising…
If economists have such a tough time with the concept among themselves, do laypersons have much hope of fairing any better?
After some back-and-forth online with multiple parties, the challenge became getting anyone to cite quality sources. A friend of mine helped me out by finding this paper on the Rival Definitions of Economic Rent8. Discussed within it, the first problem is that each definition alludes to a benchmark of some kind, but fail to establish a consistent benchmark. In the above graphic, such a benchmark may be represented by the line between X and Y. The author found that neither the classical benchmark of marginal prices nor the neoclassical benchmark of opportunity costs were satisfactory and listed all the ways. To paraphrase the quote by Gunnison Brown included in the paper, neoclassical economists saw “economic rents” to be best represented by Y9, while classical economists saw “economic rents” as best represented by Z10. Toward the end, the author expresses the desire to explore X as a better definition for “economic rents” and proposed the following:
the maximum that that could be demanded for a given type of service (labour, loan of land or capital, etc.) in the context of equitably distributed control over persistently scarce and monopolisable assets.
So if monopoly privileges were abolished and everyone had equal bargaining power, the premium any agent could command or charge based on their outsized powers would be eliminated and what remains should be roughly the utility value.
What Did Henry George Say?
As our representative trailblazer and “economic rents” pioneer, did Henry George also choose the third option?
Though he mentioned all kinds of rents throughout Progress and Poverty, George only specifically mentioned “economic rent” twice.
In the first instance, he was speaking about the ineffectiveness of rent caps and eviction moratoria — the expected response to which would be for economic agents to create a middle-tier of rentiers (lease holders) who would sublet to capture the windfall gains which the top-tier rentiers (land owners) were forced to leave on the table.
If what is known as the Ulster tenant right were extended to the whole of Great Britain, it would be but to carve out of the estate of the landlord an estate for the tenant. The condition of the laborer would not be a whit improved. If landlords were prohibited from asking an increase of rent from their tenants and from ejecting a tenant so long as the fixed rent was paid, the body of the producers would gain nothing. Economic rent would still increase, and would still steadily lessen the proportion of the produce going to labor and capital. The only difference would be that the tenants of the first landlords, who would become landlords in their turn, would profit by the increase.11
It is in the second instance which we get a much clearer idea of his position on the difference between “economic rent” and other types of rents (e.g. “speculative rent”).
[…] while the value of a railroad or telegraph line, the price of gas or of a patent medicine, may express the price of monopoly, it also expresses the exertion of labor and capital, but the value of land, or economic rent, as we have seen, is in no part made up from these factors, and expresses nothing but the advantage of appropriation. Taxes levied upon the value of land cannot check production in the slightest degree, until they exceed rent, or the value of land taken annually for unlike taxes upon commodities, or exchange, or capital, or any of the tools or processes of production, they do not bear upon production. […]
[…] How speculative rent checks production may be seen not only in the valuable land withheld from use, but in the paroxysms of industrial depression which, originating in the speculative advance in land values, propagate themselves over the whole civilized world, everywhere paralyzing industry, and causing more waste and probably more suffering than would a general war. Taxation which would take rent for public uses would prevent all this; while if land were taxed to anything near its rental value, no one could afford to hold land that he was not using, and, consequently, land not in use would be thrown open to those who would use it. Settlement would be closer, and, consequently, labor and capital would be enabled to produce much more with the same exertion.12
Therefore, it looks like dear Henry would’ve seen X as representing “economic rent” (or “land value”), Y as representing “speculative rent”, and Z as rent more generally.
This crucial reference point (or “benchmark” in land surveying) allows us to infer (or triangulate) more confidently — through the handful of other instances where George used the term “speculative rent” — that synonyms of “economic rent” are “normal rent”131415, “actual rent”1617, and “margin of cultivation”18, and that the “present market value of land” would be best represented by Z19.
From here, we can get a much better feel for some of the insights of Georgism and the superior effectiveness of LVT as a … holding cost!
Broad-Strokes LVT Math Concepts
In the context of the above framework,
As LVT increases to approach the full value of X, Y will decrease until X = Z (roughly20). The ad valorem tax on land will be fully capitalized into the (sale) price of land as a discount (as opposed to an increase).21 This means that the legal incidence of LVT is the same as the economic incidence of LVT. Since most people are used to having taxes passed onto end consumers because we currently impose taxes on elastic things, this may feel counter-intuitive at first blush.
As long as Y is positive, the productive capacity of the community is diminished (“checked”), primarily by pricing out appropriate uses22 for the parcel in question but also partially by diverting resources toward land speculation instead of the production of more wealth or the provision of more services.
Without LVT to bring Z down to X, the cyclical nature of the real estate market periodically makes its own attempt to bring Z down to X (a.k.a. a “correction” in the market). This is now commonly known as the boom-bust cycle or, as Henry George called them, “paroxysms of industrial depression.”
X rises as agglomerative advantages increase (division of labor, specialization, immigration, population growth, urban migration, etc.) and technology advances (ability to produce more from less land and other natural opportunities).
Y typically rises faster than X in anticipation of X rising (i.e. “expectation of future increase of value”), thus the term “speculative rent.”
Since supply is fixed, Z reflects demand. Demand is desirability (rivalrousness or the competition between potential tenants) mitigated by ability to pay23 (typically cash, income, and access to credit24).
A final thought from Progress and Poverty before closing out:
But wages and interest will not recover their lost ground. The net result of all these perturbations or wave-like movements is the gradual forcing of wages and interest toward their minimum. These temporary and recurring depressions exhibit, in fact, as was noticed in the opening chapter, but intensifications of the general movement which accompanies material progress.25
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Book I, Chapter 2 (Free HTML version available here)
If you find differently, do let me know. Most results for the first incidence of the term reverts back to “rents” instead of “economic rents”.
Schwerhoff et al. © 2019 Journal of Economic Surveys Published by John Wiley & Sons Ltd
back when labor theory of value was more the standard, but even Henry George saw through that to a degree
nature, the universe, co-ordinates in space-time, etc.
or zone of possible agreement, bargaining range, etc.
Beth Stratford (2023) Rival definitions of economic rent: historical origins and normative implications, New Political Economy, 28:3, 347-362, DOI: 10.1080/13563467.2022.2109612
the opportunity cost as represented by the speculative value, i.e. the reason we might choose to park value in land instead of something else
surplus over cost of production, following the Ricardian tradition
Book VI, Chapter 1, Heading VI
Book VIII, Chapter 3, Heading I
“The period of depression thus ensuing would continue until (1) the speculative advance in rents had been lost; or (2) the increase in the efficiency of labor, owing to the growth of population and the progress of improvement, had enabled the normal rent line to overtake the speculative rent line; or (3) labor and capital had become reconciled to engaging in production for smaller returns. Or, most probably, all three of these causes would co-operate to produce a new equilibrium, at which all the forces of production would again engage, and a season of activity ensue; whereupon rent would begin to advance again, a speculative advance again take place, production again be checked, and the same round be gone over.”
“The normal rent line and the speculative rent line are being brought together: (1) By the fall in speculative land values, which is very evident in the reduction of rents and shrinkage of real estate values in the principal cities. […]”
“The rapid monopolization of the land, the carrying of the speculative rent line beyond the normal rent line, produced tramps and paupers, just as like effects from like causes have lately been evident in the United States.”
“What I have called the actual rent line, or margin of cultivation, is thus (as well as by the steady march of improvement and increase of population, which, though slower than it otherwise would have been, still goes on) approaching the speculative rent line, but the tenacity with which a speculative advance in the price of land is maintained in a developing community is well known.”
“For one of the elements in the present market value of land is the expectation of future increase of value, and thus, to buy up the lands at market rates and pay interest upon the purchase money would be to saddle producers not only with the payment of actual rent, but with the payment in full of speculative rent.”
See end note 13.
See end note 15.
Due to the lag between valuation, billing for LVT, and payment grace periods, there will inevitably be some degree of arbitrage opportunity provided that closing on real estate takes less time than the lag or cycle. It would probably be a good idea to increase valuation and collection frequency where land values are higher to minimize the opportunity for unpaid LVT bills to stack up for too long and put an outsized dent in the value being returned to those communities.
A 3.4 per mille points increase in land tax caused a 2.3 per cent decrease in sale price from the time of "reliable announcement" in June 2004 to January 2007.
“The approach adopted in this paper is a before, during, and after treatment setup due to the likely gradual formation of expectations of future tax rates described in section 2. This requires data on property prices for single family homes prior to the implementation of the reform as well as prior to the announcement of the reform. Single family homes sold from 2001 and up to the announcement in the second quarter of 2004 are used as a pre-treatment group. Single family homes sold between the third quarter of 2004 and the implementation of the reform on January 1, 2007 constitutes a during treatment group. The mergers and new tax rates were decided and announced during this period. Lastly the after treatment group consists of houses sold during 2007 and 2008.”
“[…] land taxes rose on average by 3.4 per mille points.”
“The results demonstrate a clear effect on sales prices of the observed changes in land tax rates. Furthermore, the magnitude of the changes implies full capitalization of the present value of the change in future tax payments for a discount rate of 2.3 per cent, which is within the range of reasonable discount rates for households during the period in question. The analysis consequently supports the hypothesis that perceived permanent land tax changes should be capitalized fully into the price of land and property.”
Offering multiple links to the same paper in case any of them get taken down again:
when something should “pencil” but it doesn’t
By themselves, utility and scarcity confer no value on land. User desire backed up by the ability to pay value must also exist in order to constitute effective demand. The potential user must be able to participate in the market to satisfy their desire.
which implies that:
when the value of cash is low because inflation is high,
income is low because wages are low (“tend to a minimum”), and
access to credit is low because interest is high, then
demand (Z) will plateau and drop.
“I do not mean to say that there are not other proximate causes.” —H.G.
Book V, Chapter 1
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i didn't vote on the poll, because the x and y portions could easily be swapped depending on, you know, value (probably location), right? so it was ambiguous to me.