How Our Economy Really Works

Brian Hodgkinson

• Publisher: Shepherd Walwyn Publishers
• Year: 2019
• ISBN:
  9780856834424
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

This book is a response to the fundamental questions that have confronted the UK economy for decades which successive governments of the right and the left have failed to deal with adequately. Some of these questions are obvious, such as 'Why does poverty still beset a large number of people, whilst others are grossly well-off?'; 'Why are house prices continuously rising much faster than inflation, so that more and more people are left without a house of their own, or are borne down by the weight of a mortgage?'; 'Why does UK productivity remain persistently low, despite constantly improving technology?'. Other questions are less obvious, or are ignored through a belief that they arise from the natural order of things, such as 'Why do the majority of workers find themselves as employees in jobs that give them little real sense of fulfilment?'; 'Why is there awful traffic congestion, despite heavy expenditure on transport infrastructure?'; 'Why does the tax system fail to bring about greater equality, despite progressive rates of tax on incomes?'. These questions have confronted the UK economy for decades without resolution by governments of the right or left. It is the failure of economics, the author argues. Economists have long asserted that three factors of production lie at the root of their subject: land, labour and capital. Yet in the development of the subject into theories and practical applications there has been a thorough analysis of labour and capital but a grievous omission of the factor of land. This is reflected in the minimal place it holds in modern textbooks, in popular discussion and political debate. Much of the argument about major issues, like industrial policy, the distribution of wealth and income and government policy reverts to a polarised struggle between two antagonists, labour and capital. The third factor, land, hides in the background unacknowledged yet exerting a major influence on the outcome of the whole economic process.

1

Introduction

ECONOMISTS HAVE long asserted that three factors of production lie at the root of their subject: land, labour and capital. Yet in the development of the subject into theories and practical applications there has been a thorough-going analysis of labour and capital and a grievous omission of the factor of land. This is reflected in the minimal place it holds in modern text books, in popular discussion and in political debate. Indeed much of the argument about major issues, like industrial production, the distribution of income and wealth and government policy, reverts to a polarised struggle between two antagonists, labour and capital. The third factor, land, hides in the background, unacknowledged yet exerting a fundamental influence upon the outcome of the whole economic process. This book hopes to present many examples of this neglected significance of land in the economy, but one obvious example may help to clarify the point initially. The price of houses has risen continuously at a rate well in excess of the rate of inflation, causing difficulties for new buyers, creating serious problems in the mortgage market, and profoundly changing the distribution of wealth between generations and between regions. Yet what is called the ‘house price’ is really a combination of land price and building price. These two prices operate quite differently and require quite different approaches by policymakers. More will be said about this one example and the impact of the error upon the economy.

Why has this lacuna in economic thinking come about? There are three reasons that have a bearing upon one another. Firstly, the land enclosure movement in Britain took place over a long period, reaching its peak in the early nineteenth century, by which time little land was left for public use and access. Private claims on land, particularly those of the major enclosing landlords, but also of all others who came to regard a piece of land as absolutely ‘mine’, developed vested interests. They preferred to ignore the older tradition of land as communal property to be used by individuals under conditions that took account of the interests of others. This absolute claim on land now extends to large commercial companies, including foreign ones, and crucially to the ownership of urban land, in which over fifty percent of the population now have a vested interest.

Secondly, economic thought developed on lines that seemed to justify the growth of such vested interests, whilst theoretical reasons appeared to support the omission of land from most of the analysis. It was no coincidence that as the private enclosure of land grew, alongside it grew a theory of supply and demand that only employs the concepts of labour and capital, and later a theory of macro-economics that treats the whole economy as producing and consuming in a landless environment. When land gets mentioned at all, it is usually treated as capital. The consequence of this egregious sleight of hand will be examined.

The third reason for the omission of land from economic thought is that as urbanisation developed, following land enclosure, the general awareness of the presence of land became gradually attenuated. How often do people in cities realise that they are living on land? Houses, factories, offices, shops, pavements, and indeed all the built environment, seem to establish a kind of screen between people and land. When a building is pulled down, or a road dug up, the screen is broken. Bare mud or rock provides a glimpse of the earth that lies ubiquitously but unseen beneath our feet. One result is that the term ‘land’ becomes associated almost exclusively with the countryside, where a minority of the population live or work. The ‘land question’ that so disturbed our ancestors, when it occasionally arises, is usually in the form of debates about farming tenancies or pollution of agricultural land. The city dweller is not concerned. Yet that same city dweller spends hundreds of thousands of pounds on a house, with at least half the price consisting of the land price. Similarly the worth of a retail business may be largely determined by whether it has a freehold on the land it occupies. Urbanisation makes land invisible. Only a few shrewd businessmen realise its worth, and make fortunes from trading in it.

Despite this general neglect of the factor of land, economists have usually retained a concept of land that refers not just to the dry surface of the earth, but also to the natural features attached to that surface or to the subsoil. In particular, these include natural vegetation, like forests, and minerals such as metals, coal and oil. Only when these materials are extracted by human labour are they described as wealth, production or capital. This original notion of land is a firm basis on which to examine how it operates as a factor of production. An example of this, which anticipates the following discussion of rent of land, is that the value derived from the use of land by exploiting such materials can be correctly classified as rent and not as a return on capital.

Following the founders of the subject of Economics, notably Adam Smith and David Ricardo, we may then continue to take as the starting point of any economic analysis the three concepts of land, labour and capital. Land has already been defined. Labour can be defined as the application of human effort of body and mind to the production of wealth and services, where wealth means actual physical production, excluding claims on it such as money and securities. Capital means wealth used in the production of further wealth. Retaining this threefold foundation throughout any economic discussion yields conclusions far different from the conventional ones.

2

Rent

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.

3

Wages

A PRELIMINARY POINT about wages is that, as with rent of land, the true wages of labour may be concealed by the prevailing system of ownership. In particular, a self-employed person working in his or her own firm is really earning wages equivalent to what the firm would have to pay an employee for the services of the owner e.g. as a manager. Above this the income of the owner is profits. If his income falls below the wages level, the difference is a loss to the firm.

Britain in the twentieth century evolved into a society very heavily reliant on the Welfare State. The majority of people are mainly dependent for their living on wages which are inadequate in almost all cases to provide many of the essentials of a decent life for a family. Health services of all kinds, education for all ages, unemployment and sickness benefit, old age pensions and, for many if not all, housing require public finance on a massive scale. The term social wages has come into use to refer to this huge supplement that is needed to bring wages earned by work to a level that provides a reasonable modern standard of living.

Why is this? To some extent it is because in a democracy the majority may prefer some of these services to be provided publicly. There is a strong case, for example, for at least some health and education services to be in the public sector. Yet even so, there is no real choice about this, since the present level of wages makes proper provision for these solely out of wages impossible. Government naturally has full responsibility for defence of the realm and for law and order, but should it necessarily have to provide services that could be paid for by wage earners were wages at a considerably higher level? After all, the minority who are relatively well off often do choose private health care and independent schools.

It is a matter for public debate which services should be privately or publicly provided and, moreover, there are many different ways in which either alternative can be implemented. Politics in Britain has revolved around these questions for at least the past century. We have come to accept a fundamental division between left and right which is fostered by this issue, even if it no longer takes the basic form of capitalism versus socialism. What usually passes unnoticed is that the debate is underlain by the simple fact that wages are too low to pay for most of the services currently offered by the State.

There is, however, an even more basic aspect of the modern economy that goes unnoticed and is rarely discussed at all. Wages are too low to enable wage-earners to provide the capital required at their workplace. Owing to confusion over the meaning of the word ‘capital’, the situation cannot easily be recognised at all. Shares in a company are seen as its capital. So the question becomes ‘Should employees own shares in the company they work for?’ But the proper meaning of ‘capital’ in Economics is ‘wealth used to produce further wealth’. Wealth is everything produced by the factors of production, namely land, labour and capital itself. Put simply, capital is the means of production, excluding land, i.e. buildings, machinery, plant, office equipment, stocks of goods and so on. Shares and bonds in firms are claims on capital – and usually on land as well – and not capital itself.

Thus the real question becomes ‘Should employees in a company own the capital that they themselves use in production?’ This happens straightforwardly in a business owned by a sole trader or small partnership. But usually when capital becomes substantial employees cannot afford to provide it. A carpenter may buy his own tools; workers in a modern car factory cannot afford to buy the factory. It is now taken for granted that, except in rare cases like the John Lewis Partnership, the firm is owned by absentee shareholders, or perhaps by a handful of very wealthy entrepreneurs. Why is this taken for granted? The answer is very simple: wages are too low to enable employees to buy the very capital which they themselves use in their daily work. Were wages much higher they might either buy capital directly or raise loans on the security of their future income.

Current discussion of wage levels focuses on differentials. Workers in particular industries or with particular skills demand higher relative wages. Successful firms pay bonuses; failing ones propose wage cuts. CEOs are criticised for earning many multiples of the average wages in their companies. Top sportsmen and celebrities earn enormous amounts. Women earn less than men. And so on. These clearly raise legitimate questions. The more fundamental one, however, is ‘What determines the general level of wages?’ Such a general level is difficult to quantify. Is it the average wages, the median wage, the gross wage before deductions for tax, NIC etc., is the social wage to be added back?

What is certain is that take-home pay is what counts for the typical wage-earner, whether he or she is an executive in a City firm or a bus driver. In particular, the PAYE and NIC may just as well be seen as tax levied upon the employer of labour. Indeed its impact on production is best analysed in that way (see below p.32)

Why then is take-home pay so low? Total wages in the whole economy measured in this way consistently fall well below half of the gross national product. This means that the majority of the population, including dependents, are receiving less in total than the share distributed in one way or another as unearned income. Economists seem to have abandoned the question of what determines the distribution of income between the three factors of production, a question which was central to the researches of the founders of the subject, such as the French Physiocrats, Adam Smith and David Ricardo.

The reason for this serious omission from current analysis lies once more in the development of the British economy since the land enclosure movement. With little or no land freely available, wages are inexorably forced down to the least that workers will accept. The only alternative to being unemployed seems to be taking employment at the going rate of wages. What sets that going rate? It is clearly the lowest rate at which the employer can find workers. In other words it is set by the minimum that the unemployed worker is prepared to accept. Were he or she to demand more than that, a fellow worker gets the job. The labour market – the phrase presents a useful analogy with slavery – is loaded in favour of the employer to a degree determined by the level of unemployment. Were no other workers available the employer would have to offer more, as tends to happen in particular trades in the short-run.

Yet surely there is an alternative for the worker besides being unemployed? He can become self-employed. A minority find this a genuine option, especially in industri...

Table of contents

• Cover
• Title Page
• Copyright
• Contents
• Acknowledgements
• Preface
• 1 Introduction
• 2 Rent
• 3 Wages
• 4 Capital
• 5 Structure of Industry
• 6 Property
• 7 Taxation
• 8 Public Expenditure
• 9 Money, Banking and Interest
• 10 Transport
• 11 Housing
• 12 Public Utilities
• 13 Retailing
• 14 Agriculture
• 15 Foreign Trade and Investment
• 16 Historical Outline
• 17 Economic Justice