In economics, economic rent is any payment to a factor of production in excess of the cost needed to bring that factor into production. In classical economics, economic rent is any payment made (including imputed value) or benefit received for non-produced inputs such as location (land) and for assets formed by creating official privilege over natural opportunities (e.g., patents). In neoclassical economics, economic rent also includes income gained by beneficiaries of other contrived exclusivity, such as labor guilds and unofficial corruption.
Economic rent should not be confused with producer surplus, or normal profit, both of which involve productive human action. Economic rent is also independent of opportunity cost, unlike economic profit, where opportunity cost is an essential component. Economic rent should be viewed as unearned revenue, whereas economic profit is a narrower term describing surplus income greater than the next best risk-adjusted alternative. Unlike economic profit, economic rent cannot be eliminated by competition, since all value from natural resources and locations yield economic rent.
In regard to labor, economic rent can be created by the existence of guilds or labor unions (e.g., higher pay for workers, where political action creates a scarcity of such workers). For a produced commodity, economic rent may also be due to the legal ownership of a patent (a politically enforced right to the use of a process or ingredient). For operating licenses, it is the cost of permits and licenses that are politically controlled as to their number, regardless of the competence and willingness of those who wish to compete in the area being licensed. For most other production, including agriculture and extraction, economic rent is due to a scarcity of natural resources (e.g., land, oil, or minerals). When economic rent is privatized, the recipient of economic rent is referred to as a rentier.
Economic rent is different from other unearned and passive income, including contract rent. This distinction has important implications for public revenue and tax policy. As long as there is sufficient accounting profit, governments can collect a portion of economic rent for the purpose of public finance. For example, economic rent can be collected by a government as royalties or extraction fees in the case of resources such as minerals and oil and gas.
Historically, theories of rent have typically applied to rent received by different factor owners within a single economy. Hossein Mahdavy was the first to introduce the concept of "External rent", whereby one economy received rent from other economies.
According to Robert Tollison (1982), economic rents are "excess returns" above the "normal levels" that are generated in competitive markets. More specifically, a rent is "a return in excess of the resource owner's opportunity cost".
Henry George, best known for his proposal for a single tax on land, defines rent as "the part of the produce that accrues to the owners of land (or other natural capabilities) by virtue of ownership" and as "the share of wealth given to landowners because they have an exclusive right to the use of those natural capabilities."
In simple terms, economic rent is an excess where there is no enterprise or costs of production.
Classical factor rent
Classical factor rent is primarily concerned with the fee paid for the use of fixed (e.g., natural) resources. The classical definition is expressed as any excess payment above that required to induce or provide for production.
- "A payment for the services of an economic resource which is not necessary as an incentive for its production"; this can be simplified to when there is no enterprise given by the receiver of the economic rent
- "Any payment that does not affect the supply of the input"; this can be simplified to when there are no costs of production by the receiver of the economic rent
- "A payment to any factor in perfectly inelastic supply"
Neoclassical Paretian rent
Neoclassical economics extends the concept of rent to include factors other than natural resource rents. But the labeling of this version of rent may be opportunistic or incorrect in that Vilfredo Pareto, the economist for whom this kind of rent was named, may or may not have proffered any conceptual formulation of rent. The neoclassical understanding of "economic rent" is synonymous with the more appropriately named term "economic profit".
- "The excess earnings over the amount necessary to keep the factor in its current occupation"
- "The difference between what a factor of production is paid and how much it would need to be paid to remain in its current use"
- "A return over and above opportunity costs, or the normal return necessary to keep a resource in its current use"
Some returns are associated with legally enforced monopolies like patents or copyrights. In addition, companies like Microsoft and Intel have important de facto monopolies that can be quite valuable. The American Medical Association has traditionally regulated the number of students that each US medical school can graduate and has been accused of maintaining the high incomes of doctors by restricting the supply of new doctors. Some businesses, like public utilities, are by their nature monopolies. George Stigler estimated the impact of rents from non-labor monopolies on the US economy to be fairly low.
In political economy, including physiocracy, classical economics, Georgism, and other schools of economic thought, land is recognized as an inelastic factor of production. Rent is the share paid to freeholders for allowing production on the land they control.
"As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land ...."
Johann Heinrich von Thünen was influential in developing the spatial analysis of rents, which highlighted the importance of centrality and transport. Simply put, it was density of population, increasing the profitability of commerce and providing for the division and specialization of labor, that commanded higher municipal rents. These high rents determined that land in a central city would not be allocated to farming but be allocated instead to more profitable residential or commercial uses.
Observing that a tax on the unearned rent of land would not distort economic activities, Henry George proposed that publicly collected land rents (land value taxation) should be the primary (or only) source of public revenue, though he also advocated public ownership, taxation, and regulation of natural monopolies and monopolies of scale that cannot be eliminated by regulation.
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The generalization of the concept of rent to include opportunity cost has served to highlight the role of political barriers in creating and privatizing rents. For example, a person seeking to become a member of a medieval guild makes a huge investment in training and education, which has limited potential application outside of that guild. In a competitive market, the wages of a member of the guild would be set so that the expected net return on the investment in training would be just enough to justify making the investment. In a sense, the required investment is a natural barrier to entry, discouraging some would-be members from making the necessary investment in training to enter the competitive market for the services of the guild. This is a natural "free market" self-limiting control on the number of guild members and/or the cost of training necessitated by certification. Some of those who would have opted for a particular guild may decide to join a different guild or occupation.
However, a political restriction on the number of people entering into the competitive market for services of the guild has the effect of raising the return on investments in the guild's training, especially for those already practicing, by creating an artificial scarcity of guild members. To the extent that a constraint on entrants to the guild actually increases the returns to guild members as opposed to ensuring competence, then the practice of limiting entrants to the field is a rent-seeking activity, and the excess return realized by the guild members is economic rent.
The same model explains the high wages in some modern professions that have been able to both obtain legal protection from competition and limit their membership, notably medical doctors, actuaries, and lawyers. In countries where the creation of new universities is limited by legal charter, such as the UK, it also applies to professors. It may also apply to careers that are inherently competitive in the sense that there is a fixed number of slots, such as football league positions, music charts, or urban territory for illegal drug selling. These jobs are characterised by the existence of a small number of rich members of the guild, along with a much larger surrounding of poor people competing against each other under very poor conditions as they "pay their dues" to try to join the guild. (Reference: "Freakonomics: Why do drug dealers live with their Moms?").
Terminology relating to rent
- Gross rent
- Gross rent refers to the rent paid for the services of land and the capital invested on it. It consists of economic rent, interest on capital invested for improvement of land, and reward for the risk taken by the landlord in investing his or her capital.
- Scarcity rent
- Scarcity rent refers to the price paid for the use of homogeneous land when its supply is limited in relation to demand. If all units of land are homogeneous but demand exceeds supply, all land will earn economic rent by virtue of its scarcity.
- Differential rent
- Differential rent refers to the rent that arises owing to differences in fertility of land. The surplus that arises due to difference between the marginal and intra-marginal land is the differential rent. It is generally accrued under conditions of extensive land cultivation. The term was first proposed by David Ricardo.
- Contract rent
- Contract rent refers to rent that is mutually agreed upon between the landowner and the user. It may be equal to the economic rent of the factor.
- Information rent
- Information rent is rent an agent derives from having information not provided to the principal.
- land (economics)
- List of economics topics
- Rent seeking
- FIRE economy
- Rentier state
- Hotelling rent
- Ricardian rent
- Schumpeterian rent
- Johann Heinrich von Thünen
- Differential and absolute ground rent
- Property income
- Unearned income
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- What is Economic Rent?
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