Tuesday, January 10, 2012

The Destructive Power Of Rent

There are three basic kinds of income in economics. These are rent, profit, and wages. Of these three, the most destructive is rent. First thing to understand is that in economics words don't mean what you think they mean. Rent is more than what is commonly known as rent, for example, and wealth means less than is what is commonly thought of.

Rent is income derived in such a way no wealth is created. To understand wealth, it's best to use some examples. If I print $1 million, I have not created very much wealth. Other than the cost of printing and the paper and my lovely art skills, I did not make anything that adds to the value of the country. If I build a free game engine that is then used to make free games and everybody loves playing these free games, I have created a lot of wealth, but it is difficult to identify how much.

In the first case, money is made with no creation of wealth, and in the second wealth is created without the use of money. It's important to know that money is not wealth. Nor is it capital as is so often claimed. If that were the case then we could create more wealth with the flip of a switch, but that is not what the FED does.

Why is rent destructive?

A Tale Of Two Coffee Shops
It was the best of grinds, it was the worst of grinds....

One of these coffee shops is right in front of a subway station and the other is on the other side of a busy highway. The one in front of the coffee shop can charge much more because who wants to cross a highway to save a buck? You would think that that coffee shop earns more in profits than the other and you'd be wrong. It earns more in rent.

Let's consider the two shops renting the space they are in. Each has a landlord. Do the landlords charge the same rent to each shop? Of course not. So how much do they charge? Exactly the value difference of the location. If, due to location, one shop earns $1000 more per month, the rent will be $1000 a month more. So who gets the extra value for the location? The landlord.

Why does this make rent destructive?

If the extra money went to wages because baristas were in tight supply, more people would want to become baristas and wages would come down and more coffee could be produced at a lower cost to the customer. The wealth of the country would be increased by having more coffee produced by more baristas. If profits were high, somebody would open a new shop next door and profits would go down. Again this would cause more coffee to be produced at a lower price. This would also require hiring more baristas so wages would go up, but of course that would be temporary since more people would become baristas. If the landlord has a lock on the location, there is no encouragement to adjust the marketplace for a more beneficial distribution of effort. People just pay more and no market forces can alleviate the imbalance.

Now, the guy across the street thinks that if he can lick this highway problem then he could make bank! So he creates an elaborate crane to deliver coffee across the highway. His profits start to rise. So do you think the guy with the shop at the subway is going to get a lower rent? No. The guy with the crane is going to have his rent raised to the same level as the first shop minus the operational cost of the crane. Once again the landlord wins and the entrepreneur loses.

This is what is so destructive. The cost goes up and squeezes the consumer, so they buy less coffee. Since some of those people are employees of the coffee industry, some lose their job. This then makes them not buy coffee, so more are laid off.

"The layoffs will continue until demand improves" to paraphrase an equally ludicrous observation.

Here is where it turns from a problem to a crisis.

What happens when those landlords need people to count all that money for them? They hire them. So the financial industry gets bigger and creates new ways for landlords to make even more money without creating corresponding wealth. And more people get hired away from factories and into financial services. Finally you end up with the only things being made are products designed to suck all the money out of the economy and leave the country broke, derelict, and ignorant.

Economics is supposed to match limited resources to unlimited demand as efficiently as possible. One way to do that is by introducing money. When money is the dominant product of a society, it is effectively producing effluvium. There is no difference between the wasted resources of a gold rush or the wasted resources of a housing bubble. Desired products are not being created so that the ephemeral can be.

1 comment:

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