THE POLITICAL ECONOMY OF RENTS UNDER CAPITALISM

THE POLITICAL ECONOMY OF RENTS UNDER CAPITALISM

Aleksei Izyumov

University of Louisville, Louisville, USA and Visiting Professor, Novosibirsk State University,

 Russia, Novosibirsk

ABSTRACT

The paper addresses a problem of economic rents and their role in the modern capitalist economies. Using expanded definition of rents to include unearned income accruing to the middle-class and low-income groups of population it considers the impact of rent accumulation on the microeconomic and macroeconomic performance of the economy. It further discusses the conflict over rents between rent payers and rent recipients and the role of the government in this conflict. In the policy part of the analysis, the paper places the problem of rents in the context of public debates over income distribution and suggests measures that could lead to the reduction of rent loads in the economy.

Keywords: rents, income transfers, social conflict, government policies.

1. Redistributive nature of economic rents

Defined in the broadest terms, rents are unearned incomes. From the theoretical point of view, under the market economy conditions, economic rent is an income in excess of marginal productivity of an asset.  The simple definition of economic rent according to that is:

R_i = V_i^a - V_i^c                                                                                                              (1)

Where R_i is rent income on asset i, V_i^a - actual value received, V_i^c - value that would be received under perfectly competitive market conditions.  See for example [14; 15; 18].

Not all rents carry a negative connotation. Some of the rent payments are voluntary and transparent, for example charitable donations. However involuntary and persistent rent transfers can and do generate exploitative relations leading to antagonistic conflicts between rent recipients and rent payers.  Moving from less competitive to more competitive economic conditions destroys rents. That makes beneficiaries of rents natural opponents of free markets [16, p. 1535-38].

On a theoretical level, the total sum of rents, measured in the proportion to the GDP, call it rent load (RL_t), can be interpreted as the quantitative measure of a difference between the real and the ideal perfectly competitive economy, a measure of economy’s distributional “imperfection”.

RL_t =  R_t / GDP_t                                                                                   (2)

Since a perfectly competitive economy is impossible to achieve, some level of rent load will always be present, with some of it, such as welfare transfers, socially desirable.  At the same time one can imagine that when rent load surpasses some critical point (say, 30 or 50% of GDP) a market economy can turn into a quasi-market or non-market. In classical socialist economies of Soviet type, for example, rent loads were likely very high, possibly exceeding the non-rent incomes. (In the absence of private ownership of productive assets most of rents in such economies were worker-to-worker income transfers, since the 100% employment, absence of bankruptcies and cradle-to-grave welfare could only be maintained with permanent redistribution of value from more productive to less productive workers and firms).

In a developed market economy, where the main part of national income is represented by wages and salaries of private sector workers, their labor income is the main source of rents.  Based on this assumption one can identify three important types of rent transfers paid out of labor income: “top rents” (R^T) flowing from workers to capital-owners and top managers, “bottom rents” (R^B) flowing from workers to the non-working population and “horizontal rents” (R^H) flowing from some workers to others [7; 8]. Most of the top rents are paid out of income of private sector workers as a result of underpayment of their wages and salaries and corresponding overpayment going to capital owners and top managers. Most of the bottom rents are funded by taxes on labor incomes and are represented by welfare payments. (With the exceptions of payment funded by previous contributions of their recipients, such as pensions and health insurance). In more narrow sense bottom rents include only payments to able-bodied welfare recipients, who can work but choose not to. That is, they exclude welfare payments to people who are unable to work, such as children and people in poor health. It is this narrow definition of bottom rents that is used in this paper.

As for horizontal rents, some of them are funded by taxes – such as in the case of public sector workers. In addition, they can be funded by the re-distribution of wages in the private sector – such as from non-unionized to unionized workers. Existing estimates of some of the top, bottom and horizontal rents done for the United States and other developed market economies [7; 8] indicate that the combined volume of these rents is substantial, amounting annually to hundreds of billions of dollars.

Figure 1 presents a simplified model of the flow of rents based on the above estimates. The model reflects the amounts of top, bottom and horizontal rents and approximate income levels of typical rent recipients. Most of the rent payers are middle income, middle class workers. Recipients of top rents (estimated at about $70 billion annually) are for the most part high-income individuals such as top managers and bankers. Recipients of bottom rents (estimated at about $100 billion annually), in contrast, are low-income individuals and families collecting tax-funded welfare payments. Recipients of horizontal rents (estimated at about $250 billion annually) come from the same group as rent payers as most of them are middle-class workers. However, they are not ordinary but “privileged” workers,

Figure 1. Sources and uses of rent-type incomes

whose wages and salaries are higher than wages and salaries of the majority of similarly skilled peers due to rent-type premiums. The main two groups of such workers are government employees and trade-union members. In Marxian literature such workers used to be called “labor aristocracy” [4].

2. Increasing role of rents

While accurate estimates of the aggregate value of rents are not available, it is clear that in the last 25-30 years, the top, bottom and horizontal rents have been growing faster than the GDP. Thus, the accelerated growth of top rents is reflected by the increase of a gap between the compensation of an average worker and a “typical” CEO - from 1:58 in 1989 to 1:278 in 2018 [2]. It is also reflected by the general increase in income inequality as measured by Gini coefficient from 0.43 in 1990 to 0.49 in 2020 [5] as well as an increase of the GDP share of the rent-heavy financial sector of the US economy - from 4.5% in 1980 to 7.2% in 2015 [11; 17].

Over the same period, the bottom rents also increased. The growth of income transfers via welfare payments surpassed the growth of GDP by a wide margin. The share of welfare spending in the GDP went up from 11.8% in 1979 to 19.3% in 2019 [12].

 A pattern of accelerated growth was also present for horizontal rents due to the fast growth in public sector employment and pay levels.  For example, in the US between 1978 and 2010, the average compensation of state and local public sector workers not adjusted for skills and education increased from 110% to 136% of average private sector worker, while the average compensation of federal civilian worker increased from 148% to 246% of average private sector worker [6; 13]. See Figure 2.

Figure 2. Ratio of average annual compensation of government and private industry employees, United States

In the last decade these gaps narrowed but still remained substantial. Thus in 2018 the average compensation of a federal employee at $136,000 was 1.8 times higher than that of an average private sector worker [13].

3. Struggle over rents

When rents grow faster than the GDP, the rent load of the economy increases, which can lead to a number of negative micro- and macroeconomic outcomes. On the microeconomic level, increased prevalence of top-down and horizontal rents stimulates rent-seeking and undermines the productive efforts of firms and individuals, from CEOs to ordinary workers. This is reflected in the increasing popularity of rent-heavy jobs, such as jobs in finance and in the public sector.  For example, in some US cities, waiting lists to join public fire departments are several years long.

Similarly, increased prevalence of bottom rents stimulates more people to quit productive activity altogether, adding to the ranks of welfare dependents. As the number of rent recipients and their benefits grow the rest of the working population perceive the “rules of the game” as becoming increasingly unfair and feel bitter and resentful. Such developments can undermine the competitive market-based system of remuneration and depress productivity [3; 9; 10].

On the macroeconomic level the rent overload can slow-down GDP growth and promote accelerated accumulation of debts as growing rents have to be funded by government and private borrowing. Countries, where rent loads grow particularly large make themselves weaker and more vulnerable to macroeconomic shocks. It is no coincidence that countries with particularly bloated and overpaid public sector, such as Argentina, Greece, Spain or Portugal, had more difficulty overcoming recent economic recessions compared to countries that are more successful in containing rents, such as Germany, Canada, Sweden, or Netherlands [8].

Why is the growth of rents not met with resistance of rent-payers whose incomes are increasingly siphoned off to fund rent transfers? The reasons for this anomaly likely fall into three categories: (i) lack of adequate information on rents available to the public; (ii) stronger bargaining power of rent beneficiaries compared to rent payers; (iii) government borrowing to fund rents.

Lack of publicly available information on economic rents is possibly the most important reason for their staying power.  Obviously, the recipients of rents do not have any incentive to publicize them.  This is particularly true for the horizontal rents provided by government agencies to their own employees in the form of outsized paychecks, generous pension and healthcare plans and enhanced job security.  In the US and Europe, only recently has information on particularly egregious cases of such rents started to be made public on a more or less consistent basis.

But even when excess payments are exposed, it may still not be enough to eliminate or reduce them. Despite their relatively smaller number compared to rent payers, rent beneficiaries are typically much better organized and, as Olson [10] and others noted, almost always have a strong bargaining advantage. Classical examples of that are corporate CEOs bidding up their paychecks even in the face of overwhelming opposition of shareholders; or farmers in Europe, US and Japan securing massive rent-type subsidies in spite of being a very small part of an electorate.

When the public starts to show the unwillingness to continue paying the rents the pro-rent lobby can still overcome such resistance by funding them via public and private debts. Thus, when tax revenues lag the growth of welfare transfers and public sector payrolls, many cities, municipalities and national governments in Western countries resort to taking out larger loans. Faced with stagnant revenues some of the largest corporations do the same to continue paying the oversized paychecks of their CEOs and union workers. Public borrowing by federal and regional governments in many advanced economies in 1990s, 2000s and 2010s contributed to the survival of the otherwise unsustainable rents.

Following the world-wide recession of 2008-2009 with falling incomes and the flow of credit drying up the public became less tolerant to unfairness in the income distribution. These feelings translated into political struggles. The unhappiness with the top rents-based economic inequity gave birth to mass street protests in the US, Europe, Canada and Latin America and the rise of left-wing parties. At the same time, record levels of public debt and protests against bottom and horizontal income transfers translated into taxpayer revolts, and anti-Big Government movements like the Tea Party in the US.

The public pushback against rents and recognition of their unsustainability forced Western governments to undertake some rent containment measures. So far however, the progress in rent elimination is modest as the resistance of all rent lobbies to these policies is strong.  Despite the precarious budget situation corporate welfare via budget subsidies etc. continues while reforms increasing rights of shareholders and reducing rent-generating opportunities in the financial sector are largely stalled.  Similarly, while public sector compensation benefits were reduced in a number of countries, cities and municipalities in Europe and the US, public sector unions and their political allies blocked benefits’ cuts or put them on hold in many others.  The political infighting over income distribution issues continues unabated. Sorensen’s [16] forecast about a possible escalation of political struggle over rents seems to be right on target.

4. Conclusions

In societies that value the rising living standards, dynamism and freedom of market capitalism, income distribution dominated by rents should be avoided. While perhaps the ideal goal is a rents-free economy a more realistic one is that of containment and reduction based on national consensus. 

Possibly the most important condition of rent containment is public awareness. In order to reduce rents, they first need to be fully exposed. A public system of rent monitoring should be created for all types of rents starting with the tax-payer funded horizontal and bottom rents. All government agencies would have to disclose the full compensation packages of their employees, including pension and other benefits. For welfare payments the same publicity rules should apply, so taxpayers know exactly how the eligibility standards of these payments are determined and how they are enforced.  Specific reforms targeting horizontal rents could equalize public sector compensation levels with those in the private sector.

Doing away with the secrecy surrounding rents will go a long way towards their elimination. As information and bargaining asymmetries that promote rents are corrected some of them will be made illegal while others will be competed away.

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