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2 Rent

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EXCEPT IN VERY exceptional circumstances, such as plague or war, every economy produces a surplus of output over and above what is necessary to support its population. How this surplus is used depends upon the nature of the society. The surplus may be directed, for example, to cultural aims, like art or architecture, or to warfare, or to scientific development. In economic analysis this surplus takes the form of rent.

Everyone is familiar with the concept of rent. We think of it as what has to be paid to a landlord. It may be rent of a house, business premises, a farm or whatever else requires access to a site or piece of land. Such a concept, however, is too restrictive for economic analysis. The concept of rent in Economics is broader, but at the same time more precise. It may be defined as the excess value arising from a site over and above the value arising from marginal land that is only just worth occupying or using. For example, the economic rent of a piece of very fertile farm land would be the excess value of the produce over the value of the produce of a piece of land barely worth farming. This means that both values must be calculated given the same application of labour and capital i.e. the same degree of effort and skill and the same quantity of suitable capital, such as farm machinery. In the case of houses the economic rent would be the excess value of living on a particular site measured against the value of living on a site only just suitable for habitation. Value here can be considered as whatever the occupier would be prepared to pay.

A major difference between rent paid to a landlord and economic rent is that the latter is the potential rent available if the site is put to its best use. Quite often rent paid to a landlord is for an inferior use, which is allowed to continue for a variety of reasons: inertia, inadequate knowledge, sentiment or even generosity. Such reasons do not affect the economic rent. This is determined by the objective conditions operating at the site concerned and at the marginal site.

What then are these conditions that determine the economic rent? There are four main categories of these. As noted earlier, they include natural aspects of the land, like fertility, vegetation, minerals, drainage, topography and climate. Secondly there is the presence of human population. This is a critical condition, which may even make natural features of little significance. For population provides a labour force, whose quality varies considerably with education, training and character of the people, and also a market for the products of economic activity, including living accommodation. Location in a city with a skilled and active population may completely outweigh any natural features of the site, especially when these can be enhanced by man-made services, such as water supply or landscape gardening. Thirdly there is the existence of other firms in the neighbourhood, which may provide services or supplies, or may simply make the site concerned more attractive, for example for shopping or recreation. Finally there are public services, which may include transport, law and order, schools, hospitals, power and water supplies and much else which is the function of government, whether national or local. The degree of law and order greatly affects the value of a site, as do flood control and other crucial public concerns.

Given that economic rent is the potential value arising on land and not just the amount actually paid to a landlord, there are obvious questions about how this is measured. In particular there is the situation where the tenant is the landlord; in other words when the tenancy is freehold. The economic rent is clearly not zero, even though no payment is necessary. It remains what it would be were a full rent payable to a landlord.

The importance of recognising this will become clearer when an industry like retailing – to take one example – is analysed later. If a large retailer owns the freehold of a central high street site, it may appear to be making very large profits. In reality much, if not all, of these are rent. Only if this is acknowledged can the proper efficiency of firms of any type be seen. Moreover, the optimal allocation of land to its best uses can only be accomplished if the true rent is known, regardless of freehold tenure.

Economic rent can also be measured by the capital value of the site concerned. When land is sold in a free market, the price paid is approximately the capitalised value of the rent receivable in the future. This is true whatever the land use. For housing, for example, the future occupier of a house on the site pays what he or she thinks it is worth to avoid paying a rent for the site in the future; or if the house is to be built for letting the price includes the capital value of future rents to be received.

One of the consequences of the neglect of the concepts of land and rent in present-day economic thinking is that the actual differentials between the rent on different sites is often overlooked. This is partly because rent is not evident when it is not paid, as with freehold sites; and partly because vested interests are reluctant to disclose the rent receivable on valuable sites. On long established freeholds the economic rent may be hidden in the profit statements of the companies, in the private accounts of wealthy individuals, or in the beneficial occupation of land used for recreation. For example, who knows the economic rent of land held under freehold in the City or West End of London? Likewise who knows the economic rent of land held for grouse shooting or fishing in the Highlands of Scotland? Were the values of the economic rent of all sites in the UK publicly available, there might be more questions asked about whether it is being optimally used, and even about who is entitled to receive the rent.

How our economy really works

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