( Originally Published Early 1900's )
1. Theory of distribution.—Thus far we have been concerned mainly with the production of goods and with the principles governing their value and ex-change. In this and succeeding chapters we shall consider the principles governing the distribution or sharing of new wealth among those who have claims upon it because of the part they played in its production.
Economists usually enumerate three factors of production, namely, land, labor and capital. In reality there are four. Land, labor and capital not wisely directed are unproductive. The human brain, there-fore; is the fourth factor, and it is the most important of all. Land and capital are dead, inert things in-capable of bringing new wealth into existence unless wisely manipulated. Business and industry do not prosper unless directed by intelligence. Hence in the business world we find a set of men called entrepreneurs directing business activities and receiving as a reward a considerable share of the new wealth created.
The share claimed by the owner of land is called rent. That going to labor is called wages. The share of the capitalist is called interest. The entrepreneur's reward is called profit.
The reader must not assume that the economist thinks of society. as made up of four distinct classes of men. A single individual may be capitalist, la-borer, land owner, and entrepreneur; in fact, many a farmer or small storekeeper or manufacturer may be all four of these, for he may be owner of the land and capital he uses and in addition to managing his business he may be also working with his hands. In the theory of distribution we seek to determine what are the laws governing the rate of wages, the rent of land, the interest on capital and the profits of the entrepreneur.
The reader should notice that the theory of distribution is not concerned at all with the physical distribution or transportation of commodities. It might perhaps more properly be called the theory of division, for its purpose is to explain how the world's new wealth is divided among various claimants.
2. Broad meaning of rent: As commonly under-stood, rent is the amount of value, usually in the form of money, which one man pays to another for the privilege of using some portion of the latter's property. So rent may be paid for the right to cultivate a farm, for the privilege of occupying a house, for the use of a boat, or horse, or wagon, or any other article of value. The man who owns the article is known to the law as the lessor, the one who gets the privilege of using it is known as the lessee. In the case of land and buildings one is known as the landlord, the other as the tenant. Rent plays a most important part in the modern business world and the rights of both lessor and lessee in most countries are guarded by a well defined system of law.
The reader may note that an analogy exists between rent and wages and interest. The man who works for you for wages gives you the benefit of his services. When you borrow money the capitalist surrenders to you the productive power of his capital. In each case the right to use a certain productive power is turned over to another by its owner. If you cultivate an-other man's farm as his tenant, the rent you pay him is compensation for the right he gives you to profit by using his property. In each case you pay for a satisfaction obtained thru the use of productive power belonging to other persons. This essential similarity between rent, interest and wages has led some economists to lump them together under the single term rent, but this is inadvisable, for it is not in accord with popular usage. Furthermore, the conditions determining rent, wages and interest are in some respects fundamentally different.
3. Economic rent.—In most treatises upon political economy the word rent is usually given a narrow signification, meaning only the compensation which is paid for the use of land or natural resources. Land is given the broadest possible signification, being made to include all kinds of natural resources,—soil, lakes, rivers, waterfalls, mines, forests, etc., in fact every-thing on the earth which is capable of ownership and of value to man.
The distinction between land rent and other forms of so-called rent is made because the natural resources which the economist speaks of as land are limited in quantity and cannot be increased by the efforts of man, whereas other rentable articles are the products of human labor and their supply is capable of in-definite increase. The owner of land is in a sense a monopolist. He possesses something for which there can be no substitute, and he has reason for believing that his possession will increase in value as population grows and the demand for the products of the land increases.
4. Rent of buildings.—Houses represent an investment of capital and are not built for rental unless it is estimated that the rent paid by tenants will be sufficient to yield a fair rate of interest upon the capital invested plus a sum sufficient to provide for taxes, repairs and depreciation. If the population of a town is growing, the increasing demand for houses tends to cause rents to rise and so to encourage the construction of more houses. As a result, building rents in any town or city in the long run yield only a reason-able return on the capital invested in their erection.
5. Ground rents in cities.—The rent which a city tenant pays is in theory divided between two persons, the owner of the land and the owner of the building. Both, of course, may be the same person, in which case we may think of him as being the recipient of two kinds of rent, ground rent and building rent. In a growing and prosperous community the ground rent tends to increase, whereas' the rent of a building tends to grow less, since it is in competition with newer buildings with more improvements. If a lot is in the part of a town or city which is developing rapidly, it is quite possible for the ground to become so valuable or so much in demand that the existing building on it may be torn down and one entirely different in style erected in its stead. Changes of this sort are constantly taking place in towns and cities where population is rapidly increasing.
6. Law of economic rent.—David Ricardo, the English economist and financier, early in the last century worked out the theory or law of rent which is now generally accepted by economists. The reader must bear in mind that the Ricardian law applies to land and not to buildings.
Ricardo recognized the fact that different lands possess different degrees of fertility; that some lands are so poor that their yield under cultivation barely offsets the expense, while other pieces of land are so poor that a man cultivating them cannot earn a decent living for himself and family. Ricardo argued that this latter land, on which tenants could not make a living, could not be rented at all. He called it, therefore, "no rent land." Land which barely yielded a living to the tenant he called "marginal" land. The tenant might pay a nominal rent, enough to cover taxes and enable the owner to keep the buildings in repair, but, strictly speaking, the land itself would yield no rent unless the tenant and his family were willing to content themselves with unusually hard conditions of living.
Ricardo assumed that, as a rule, a certain standard of living exists in every community and that tenants, consciously or unconsciously, insist upon the maintenance of this standard for themselves and their families. He also assumed that tenants compete with one another for the right to cultivate different pieces of land, and that this competition is so keen that the owner of an unusually fertile piece of land is able to exact a rental so great that the average tenant has left barely enough to enable him to maintain his accustomed standard of living. It would follow theoretically, therefore, that a tenant cultivating a good farm would pay a high rent and live no better than one who cultivated a marginal farm and paid no rent at all.
Briefly summarized, the Ricardian law may be stated as follows: The rent of a piece of land in any community is equal to the excess of its productivity above that of the poorest piece of land under cultivation, namely, the marginal land. Or the law may be stated thus from another point of view: The rent of a piece of land in any community equals that part of its produce in excess of the amount necessary for the maintenance by the tenant of the prevailing standard of living.
Let us assume that a satisfactory standard of living in a certain community can be maintained by the expenditure of one thousand dollars. Then a farm the products of which under cultivation did not have a value in excess of one thousand dollars would ac-cording to the Ricardian law of rent be a marginal farm. For the privilege of cultivating it the ordinary tenant would not be willing to pay rent. If an ad-joining farm, possessing a more fertile soil, yielded under cultivation, with the same outlay of labor and capital, produce worth two thousand dollars, it is assumed that competition among prospective tenants would result in the owner getting a rental of one thousand dollars, leaving to the tenant produce worth one thousand dollars for his own maintenance. If a third farm in the same neighborhood possessed so much very fertile soil that the average tenant could make it yield crops worth five thousand dollars, its owner would be able to rent it for four thousand dollars.
7. Economic productivity.—It is important to note that the rent of a piece of land depends upon two circumstances; first, its fertility or crop-yielding capacity; and, second its location or distance from a market. In other words, the rental value of land depends upon its economic productivity; that is to say, upon the value of its products. If a farm is located twenty miles from a market, it is evident that its crops will be worth less in the field than if it were only one mile from market, the difference in value being due to transportation costs. If a man owns two farms identical in fertility and capable of the same yield, one five miles from the city, the other one hundred miles distant the farm nearer the city will evidently possess the greater value and command a higher rental.
In the old days of ox teams location was a very important factor in the determination of the rental value of land, for transportation was slow and costly. The horse, the railroad and interurban trolley lines with their express and freight cars reduced costs, and so tended to raise certain rents and land values. Now the motor truck is reducing costs still further, and by so doing is lowering the margin of cultivation, that is to say, it is making it worth while to cultivate land which formerly could not be cultivated at a profit on account of its remoteness from a market. Nevertheless the location of a piece of land must always be one of the factors determining its economic productivity and its rental value.
8. Do all tenants fare alike?—If we grant the truth of the Ricardian law of rent, it would seem to follow that men who hire the farms of others and cultivate them are bound by an iron law preventing them from ever earning more than a bare living. It would seem that a tenant who wished to lay aside a little something for a rainy day would be able to do so only by dire and painful economies.
But sad inferences of this sort are not warranted. Farmers, whether they be tenants or owners, vary greatly in ability, in knowledge of soil and climate, in thrift, in energy, in foresight, in power to plan. Men differ in productive power quite as much as the farms they cultivate. In every community you are quite as likely to find what might be called a marginal man as to find a marginal farm. Whatever his opportunities, he seldom makes more than a living and never accumulates a bank account. The owner of a good farm will not accept him as a tenant on account of his ignorance and thriftlessness. You will usually find him on a poor piece of land and living in a ram-shackle house, with his horse and cow under a barn with a leaky roof.
If we should grade the farms in any community into three classes, A farms being the best, B farms being somewhat inferior, and C farms marginal, we would find different classes of tenants competing for these different classes of farms. An unusually industrious and thrifty farmer might hire one of the marginal farms at a nominal rent and make it yield twice what the average tenant was capable of getting out of it, or a very intelligent young man who had been brought up on a farm and had been sent by his father to an agricultural college might, as a tenant of one of the best farms in the community, increase its yield and build up a bank account. His income, much larger than that of the average farm tenant, would be the product of his brains and personal qualities rather than of the farm. Essentially it is profit, as will be explained in a later chapter.
9. Effect of improvements.—During the last fifty years scientists have devoted a great deal of time to the study of agriculture, and remarkable progress has been made in farm processes, in methods of cultivation, and in the use of fertilizers, and at the same time there have been great improvements in farm machinery. All these changes have had an influence upon the rent of agricultural lands.
Any improvement which makes land more productive tends to cause a rise of land rents, for the tenant is able to give the owner a larger amount of produce and still have enough left for his own support. It would seem therefore that the tenant does not get the benefit of improvements; that altho he is able to produce more, all the surplus goes to the land owner. Theoretically, this inference is correct, but in practice it is incorrect. The first effect of improvements is a tendency to lower prices for farm products on ac-count of the increase in supply. If a tenant is paying a rent of five hundred dollars a year, he will be obliged, prices being lower, to sell a larger amount of his produce in order to get the money. But he will be able to buy foodstuffs which he himself does not raise at lower prices than formerly, and, without his planning or intending it, his standard of living tends to rise. Thruout the community the same forces are at work. Food of all kinds is more abundant and cheaper and people generally insist on living a little better than they did in former years.
Nevertheless, as a general proposition it is true that the tendency of improvements in agricultural methods and machinery is to raise the rent of land. They tend, of course, to lower the margin of cultivation, for they make possible the cultivation of poorer lands at a profit.
Improvements in transportation facilities tend to raise the rent of land in certain territories and to de-press rent in other places. The lands which enjoy the advantages of the improved transportation command a higher rent, but land owners in other territories may suffer on account of the increased supply of farm products and the lower prices. For example, the construction of railways west of the Mississippi after the Civil War, connected the markets of the east with millions of fertile acres in the west and northwest, and so lowered prices of farm products that many, farms in New England became unprofitable and were abandoned.
10. Changes in the standard of living.—Methods of cultivation remaining the same, when the standard of living in a rural district rises, the rent of land falls. Conversely, a lowering of the standard of living tends to raise land rents.
In a preceding section (page 245) we assumed that a certain young man, because of his ability and education, greatly increased the productive capacity of a farm, and that he did not pay more than ordinary rent because other prospective tenants, being untrained, could not compete with him. Let us suppose that the success of this young farmer gives a boom to education, and that most of the young men of the district go thru an agricultural college before settling down to their life work. If they become, tenants of farms, there will be a great increase in the harvests, but will not the land owners get most of the benefit, for will not these young men, competing with one another, raise rents until nothing is left for them except a bare living?
That is exactly what the enemies of landlordism affirm, but there is good reason for doubting their assertion. The education the young men have received would undoubtedly have made them more ambitious than the ordinary young farmer and would have made them insistent upon higher standards of living that had been satisfactory to their ancestors. To them farming, as it were, would be a profession. They would insist upon rewards commensurate with their training and ability. If they doubled the yield of the farms in the district, both landlords and tenants would doubtless share in the benefits. The landlord would receive a higher rent and yet the tenant would have much more as his return than the tenants of former days. The public would also share in the benefits of the education of these young men, for the increase in production would mean lower prices of farm products.
In the United States during the last two or three generations there has been a notable lifting of the farmer's standard of living. Various forces have combined to bring about this result. Railroads and interurban trolleys have made nearby cities accessible to almost every farmer's family. The children of many farmers have gone to the cities and become prosperous, some in the professions, some in business, and some in trades. Farmers' children, especially their daughters, knowing something about the comforts and luxuries of city life, have insisted upon more comfort and beauty in their own homes. All social changes of this sort tend to lower the rental value of farms. As tenants demand more, the owner must inevitably accept less.
In the preceding section we mentioned that west-tern railroads were indirectly responsible for New England's abandoned farms. During these same years the standard of living among the New England farmers was rising, and this fact doubtless hastened the abandonment of many a farm. But during the last twenty years many foreigners, mainly Swedes, Poles and French Canadians, have settled in New England, bringing with them standards of living considerably below those of the native New Englander. As a result many of the abandoned "no rent farms" are again under cultivation.
11. Remand land values.—The value of a piece of land is often said to be the capitalization of the net rent it commands. For example, if a piece of land commands a rent of one thousand dollars a year in addition to such a sum as is necessary for taxes, for re-pairs, and to cover depreciation of buildings, the land will be considered worth twenty thousand dollars if five per cent is the current rate of interest. The present value of a piece of land is evidently the outgrowth of its rental value. If it yields no rent and is put on the market for sale, buyers in bidding will think mainly of the timber or minerals which can be removed from it and sold.
The statement that land value is the capitalization of rent, while true, is not the whole truth. In estimating the value of land men always give consideration to forces that are likely to be operative in the future. Is it likely that a new railroad may make the market more accessible? Is it picturesquely located, and can it be made more attractive to city residents who desire a summer home in the country? Could it be made to yield a profit if combined with adjoining land, so that cultivation could be on a large scale? Many matters of this sort are taken into consideration consciously or unconsciously when men are estimating the value of a farm. They capitalize not merely its present earning power but its probable future earning power.
It is well here to call attention to a popular fallacy, namely, that high agricultural rents are due to the high prices of farms. In some quarters land owners are censured because they charge such high prices for land, thus compelling purchasers to exact high rents from tenants. In this fallacy the proper relation of cause and effect is reversed. High rents are the cause of high prices of land and not the effect.
12. City rents and location.—In towns and cities location is the all-important factor determining rent. We may in a rough way say there are three classes of property in every city: (1) the business district, (2) the residence district for the rich and fairly well to do, and (3) the tenement house district, or the quarter where the poor live. In any large city these districts could be variously subdivided. The business district, for instance, might contain a financial quarter where banks are numerous, a wholesale section, and a fashionable shopping or retail district. Outside all these on the outskirts of the city might lie a manufacturing district.
Land located in the heart of a business district, at the intersection of the most congested thorofares, usually commands the highest rental and the highest market price. It is on sites of this sort in American cities that so-called skyscrapers are built. The owners or lessees of such sites seek by the erection of tall buildings to develop the fullest possible earning power latent in the site.
As a general proposition it may be said that the value of a city lot depends mainly upon the number of people passing it every day. The nature of the business that can be made to yield the greatest profit in a building upon a certain site, varies with the character and spending power of the people passing by. If the passersby are mainly poor people on their way to work, the shops must cater to their needs. If the passersby are fairly well-to-do business men, the shops will be of higher class, sales will be larger in volume and profits larger, and the land owner will get a higher rent in consequence.
We need not go into a detailed discussion of the various conditions affecting the rental value of city sites in the business district, nor need we discuss in this connection the application of the Ricardian law of rent, for within a city no such thing as a "no rent" site can be found. In estimating the value of a city lot, men take into account the future demand for it quite as much as the present. It may be unimproved and therefore be yielding no rent at all to the owner; yet its market value may be high because of the certainty that the growth of the city and the development of transportation facilities will soon bring it into great demand as the site for a business block or apartment house.
City lots possess economic productivity quite as much as do farms. The farm yields an income in the form of commodities. The city lot yields an income in the form of profit as a result of trade. We need not stop to discuss whether either income is proper and legitimate. Popularly the farmer is thought of as a producer of real wealth, and few people begrudge him any comfort he may enjoy as the result of his work. It is taken for granted that the farmer adds to the country's wealth. But the merchant who is paying high rent that his store may be located on one of the city's busiest streets, and the land owner who receives the high rent, are often spoken of as if they were not really entitled to what they receive, on the ground that they are non-producers. When we consider that the object of economic activity is the production of psychic income or the satisfaction of human wants, we must admit that the merchant who chooses a location that suits our convenience and who takes the trouble to arrange and display his goods in such fashion as to make it easy for us to make choices, per forms a service for us almost, if not quite, as important as that performed by the farmer or the manufacturer
In the residential district of a city rents depend upon a number of very subtle influences. The very rich, as a rule, own their homes. Many of the near rich, wishing to be thought better off than they really are, are willing to pay high rents for houses or apartments in the neighborhood of millionaires. Hence within the residence district of a city, rental values often vary most freakishly, a building lot in one quarter being worth much less than one in another quarter. As a result of this difference in the value of building sites, the rent of apartments or houses of the same character and desirability per se differ in different parts of a city.
The rental value of city lots is greatly affected by, changes in transportation. facilities. In New York, for example, the extension of the subway into the Bronx and into upper Manhattan tended to raise rents in the Bronx and to lower the rents of apartments and houses of a certain class south of Forty-second Street. This tendency after the outbreak of the war in Europe was counteracted by the cessation of building due to the high cost of materials, and by the influx of people who came to the city from all parts of the country as a result of war business and war prosperity.
13. Rent and the prices of commodities.—Most economists agree with Ricardo that rent cannot be regarded as a cost of production, and that, therefore, it is not an element of price. This is not the popular view. People are prone to think that high land rents are somehow responsible for high prices of foodstuffs. This view, indeed, is supported by some economists. Nevertheless it is erroneous.
The higher the price of farm products, the greater the money rent a tenant can afford to pay.
High prices of commodities, therefore, are the cause of high rents. In its relation to prices of commodities the rent of land is an effect, not a cause.
If landlordism were abolished by law and all land owners were forced to cultivate their own land, land rent would disappear, but the prices of farm products would not go down. Certainly no more land would be cultivated than now, for land owners would not cultivate poor lands which tenants now refuse to hire. Indeed, they might decline to cultivate that marginal land which yields to the tenant a bare living, in which case the supply of farm products would lessen, and prices would rise as the result of the abolition of rent.
In a city the individual business man undoubtedly thinks of the rent he pays as one of his costs. But insofar as his rent is` a payment for the privilege of occupying an advantageous location, that rent cannot enter into the prices of the goods which he sells. If he pays a high rent for an advantageous location, it is because that location increases the volume of his sales and so enables him to make a greater profit. A store on a popular thorofare, for which the proprietor pays a rental of ten thousand dollars a year, cannot charge higher prices than a store on a less frequented thorofare which rents at one thousand dollars a year. The first store commands a higher rent than the other, not because its location permits higher prices, but because its location enables it to get more custom, sell more goods, and so make a greater profit.
In this connection the reader must be careful not to confuse ground rents and building rents, for the latter represent an investment of capital on which interest must be earned. If a man leases a city lot for ninety-nine years for the purpose of erecting a building on it which shall serve as a department store, the rent he pays for the lot will depend upon the advantages of the location. To him personally it will be one of his costs, but he cannot let it affect the prices of the goods he sells. If the rent is high, it is because business men, his competitors, are of opinion that the location is a most advantageous one, one where a large volume of business can be transacted. But if he erects an unusually fine building and fits it up artistically and luxuriously—that customers may be attracted and pleased, he makes an outlay of capital for which either he or his customers will have to pay. He may attract customers who will be willing to pay a trifle more than normal prices because of the pleasure of trading in a beautiful environment, or he may sell at market prices and do such a large volume of business that his gross profit covers the ground rent, the interest on his building investment, and a satisfactory net profit for him-self.
1. Distinguish between ground rent and building rent.
2. What factors tend to fix the rent of agricultural lands; of city buildings?
3. Show how the advent of the motor truck has affected economic productivity.
4. Do high rents cause high prices of land and if not why not?