A Tollgate Economy
Keith Wilde
You may have heard that “there’s no free lunch.” Tanstaafl. That was the word when economists began to address the environmental issue as it gained popular momentum in the late sixties-early seventies. According to the economic theory prevalent since the turn of the 20th century, payments to factors of production exhaust the total product. The important corollary is that all incomes are earned. Some early developers of this theory went so far as to assert that everyone receives in compensation the value of what they contribute to society – in a “free market” economy. That is, the income of an individual consists of payments for the value of productive factors he or she has “supplied” to the collective enterprise – the national income. The inevitable inference was that if people wished to reduce resource depredations and biosphere destruction they would have to pay for it out of their earned contribution to the national income.
But what if the highest incomes aren’t really earned, and their recipients are among the worst offenders in raping the earth? Maybe a few members of society are getting not only free lunch but also lavish dinners out of collective wealth and the labor of the majority. Authoritative and widely reported studies show that over the past five years income and wealth in the US have become more concentrated than at any time in its history.1 Commentators regularly point out the contrast with the mid-century US economy that was more equalitarian as a consequence of political action and regulation. Jared Bernstein has observed that “Economics, once an elegant and sensible set of ideas and principles devoted to shaping outcomes for the betterment of society, has been reduced to a restrictive set of ideologically inspired rules devoted to an explanation of why we cannot take the necessary steps to meet the challenges we face.” (Tanstaafl) The multi-million dollar compensation packages received by chief executives of failing corporations put a severe strain on the credulity of these payments as the “value of productive services provided.”
The Bernstein comment is a reminder that economics evolved as arguments for the advantages and value of removing restrictions to trade. Studies in medieval and early modern economic history point out that commerce was inhibited for centuries by payments demanded for the movement of merchandise through roads, rivers and ports by persons or groups who could dominate strategic locations where they operated tollgates. Merchants and financiers opposed them of course, and princes eventually found that fewer such impediments increased their own revenues as the realm prospered. Thus, as governments gained more power over regions, regulations became more systematically designed to foster collective productivity and well-being by minimizing unproductive constraints and tolls on commerce. The deliberate focus on principles for increasing the common-wealth evolved into political economy. This focus explains why the first professors of political economy in Britain were appointed to faculties of the moral sciences. For questions of what ought to be done call for an application of practical reason in Aristotle’s terminology, as contrasted to speculative (what is) and productive (how to do) uses of the mind.
The Concept of Economic Rent
The “no free lunch” stance of current doctrine is contradicted by economists who have been studying unearned incomes from early days of the specialty. (The extortion of tolls is a fitting metaphor.) In the economics literature, payments that individuals or companies are able to extort due to strategic advantage (or unique personal attributes) have been labeled rent. David Ricardo focused on the payments to aristocratic landlords from persons who labored on the land to make it productive, but in venerable English usage rent was a payment exacted from those who had insufficient will or ability to resist. These rentier incomes have been a focus for analysis of disparities in the sharing of collective wealth.
Michael Hudson is an analyst and historian of finance and of economic thought. He has explored the evolution of opportunities to extract rents, from pre-industrial Britain to our own times. It is a story of social change in response to technological developments. In a recent speech he showed how banks and other financial institutions have replaced landlords as the primary tollgate operators. As prelude to that, he gave some hints of the immense magnitude reached by the “tolls” in the 21st century. Most of what follows is direct quotation from the text of his speech.2
“Suppose someone at the end of World War II had been informed of the remarkable technological breakthroughs that have occurred over the past 60 years – the advances in medicine and pharmaceuticals, genetics, air and even space travel, communications, computers and information processing, atomic power, and a better ecological understanding of how our planet works. The expectation might reasonably have been for a leisure economy in which citizens could devote themselves to better educational and cultural pursuits. That was what futurists promised as they looked at the great potential of technological progress. Why haven’t these rosy pictures materialized? Why are employees working longer than ever before, with many couples holding three jobs between them? How can GNP be rising at about 4% a year in America while real wages have been drifting downward since 1979? Where are the fruits of productivity going?
“Henry George asked the same question in the 19th century: Why there still was so much poverty in the face of the Industrial Revolution’s remarkable explosion of productive power. His answer was that rent – and rising land prices – was diverting the economic surplus away from capital formation and consumption, exploiting both capital and labor. But the problem does not stem only from land-rent. The most notable examples of prices and incomes without corresponding (necessary) costs of production are finance and insurance, whose interest, commission and policy charges are set independently of costs. And much of what passes for industrial profits actually consists of monopoly rent and “intellectual property rights.” These rents are highest in areas where productivity and technological breakthroughs since World War II have been largest and were expected to bring society the greatest benefits.
Tollgate Operators are Creative
“Instead of showing up as increases to the general level of incomes, however, the benefits show up in accumulations of wealth where tollgate power is exercised by monopolies in areas such as fuels and minerals, the broadcasting spectrum and intellectual property rights. Technology has become a property right, permitting its owners to charge economic rent. The pharmaceuticals industry has been among the greatest abusers. The DNA code and even long-known Chinese herbal cures are being patented into “intellectual property.” And no companies are more notorious than the HMOs – “health management organizations” that have interjected themselves as a skimming operation [i.e., a tollgate] between patient and doctor. Broadcasting companies have privatized the electromagnetic spectrum rights originally and “naturally” in the public domain. Meanwhile, the phone and cable companies are trying to create tollgates for the Internet, much as Microsoft has become the major rent collector for information processors. The stock market’s major “industrial” growth areas turn out to be examples of economic rent, although their “super-profits” are reported as profits and dividends ostensibly produced by capital. These rents create prices “empty” of actual cost-value. They are a margin over necessary production costs, siphoning off income otherwise available for spending on goods and services.
“Notwithstanding these other manifestations of tollgate power, most wealth today is still based on rent from real property (shown, e.g., in the Forbes list of the world’s wealthiest people). The Federal Reserve’s “Balance Sheet of the US Economy” (quarterly) shows that real estate remains the economy’s largest asset, and further analysis makes it clear that land accounts for most of the gains in real estate valuation. Stock-market speculation today is largely a rent-seeking activity as companies are raided for their land or other property income. Earlier this year, corporate raiders wanted McDonald’s to mortgage the land value of its restaurants and pay out the loan proceeds as dividends. This raid illustrates how today’s real estate bubble3 itself is largely a financial phenomenon. The upshot is that the mortgage banker ends up with most of the net ground-rent. Since World War II, interest charges have absorbed the increase in real estate rent as a proportion of US national income, just as interest is absorbing a rising share of industrial cash flow and consumer income.
“It is mainly rentier income that distinguishes the wealthy from the working classes. A study for the Congressional Budget Office recently showed sharply increased concentration of those incomes in recent years, largely as a result of lowered tax rates on capital income and capital gains. “In 2003, the top 1% of the population received 57.5% of all capital income.” This was the highest proportion since the CBO began collecting data in 1979 – which also happened to be the year in which real wage levels peaked. At that time the top 1% of the population received “only” 37.8% of capital income…. The study concludes that “extending lower tax rates on capital gains and dividend income would exacerbate the long-term trend toward growing income inequality.”4 It illustrates the result of regressive tax policies replacing the progressive taxes that existed prior to the 1970s.
Finance as Parasitic Tollgate
“The bulk of this rentier income is not being spent on expanding the means of production or raising living standards. Instead, it is channeled back into the property and stock market to buy more rent-yielding real estate or ownership rights – legal rights and claims for payment from such productive capacity as already exists. This inflates prices for these assets, making property and financial speculation more attractive than new capital formation. The economy shrinks....
“The financial industry and its creative instruments have contributed to this process. For example, absentee owners buy property rights on credit, pledging the rental income to pay the mortgage interest, in accordance with the motto “Rent is for paying interest.” Equilibrium is reached when the winning bidder for a property pledges to pay all the free rental income (after costs) to carry the mortgage. The banker gets the rental cash flow, while the titular owner is willing to settle for the chance to get a capital gain. Thus the real estate game is an exercise in borrowing money to ride the wave of asset-price inflation (in which individual homeowners participate). These capital gains from asset-price inflation were called an “unearned increment” by John Stuart Mill.
“Other rent-extracting enterprises, including pharmaceutical and broadcasting companies with special monopoly, patent or intellectual property rights, have been ‘colonized’ in like fashion by the financial industry. It is the expectation of asset-price gains that motivates corporate raiders and other empire builders to issue high-interest ‘junk’ bonds, pledging corporate earnings to cover the interest charges. (Thus, rentier income ‘is for paying interest.’) Whether the rentier income is due to land price inflation or to other tollgate powers, therefore, it winds up in the form of interest payments. Tax systems encourage this debt pyramiding because they permit interest to be deducted as a “cost of production.” The effect of buying property on credit is thus to exempt rentier income from taxation.
“Taxes on rental income and land-price ‘capital’ gains are declining as the growing political power of rentiers enables them to shift the tax burden onto labor and industry. Classical economists and Progressive Era reformers had the contrary objective. Their ideal was an economy in which public revenues are collected from rentier incomes as user fees for land sites, subsoil mineral resources, transportation and communications infrastructure and other parts of the public domain that were natural monopolies – not from taxes on wages, profits or sales. Progressive policies included taxation of economic rents, anti-monopoly regulation, and a credit system that would finance industrial capital formation rather than exploit it as a parasite. Incomes would be earned by productive work and enterprise to generate wages and profits, not by tollgates. Prices would reflect the necessary costs of producing goods and services, free of economic rents. The harder one worked, the richer one could become.
To achieve and maintain reforms such as these requires political clout. Why are they not high on political agendas these days? Much of the explanation, says Dr. Hudson, is that the financial and real estate interests have promoted a self-serving economic ideology and body of theory. A summary of his most interesting exposition of that theme will have to wait until next time.
Keith Wilde
1. Teresa Tritch for the NYT editorial board, July 19, 2006, “The Rise of the Super-Rich.” The same is doubtless happening in Canada, for the same reasons, but the information is less available here.
2. “Real Estate, Technology and the Rentier Economy: Pricing in excess of Value, producing Income without Work” at the conference on Economics of Abundance at King’s College, London, 3 July 2006.
3. See the feature article in Harper’s magazine of May, 2006, by Hudson: “The New Road to Serfdom: An illustrated guide to the coming real estate collapse.”
4. The statistics, based on C.B.O., Historical Effective Federal Tax Rates: 1979 to 2003 (December 2005), are summarized in Isaac Shapiro and Joel Friedman, “New Unnoticed CBO Data Show Capital Income has Become Much More Concentrated at the Top,” Center on Budget and Policy Priorities, January 29, 2006. The CBO study defines “capital income” as “interest, dividends, rents, and capital gains.”
– from Economic Reform, August 2006
[Readers should contemplate the need to tackle the issue of usury/charging of interest on loans, and the potential effect of ending the banks’ power to create money as loans would have on the above scenario – BL]