Economics has always been rather esoteric for most people. Most people's knowledge of the subject is limited to the law of supply and demand, of which they have the most vague understanding. Any understanding beyond that is usually aligned with their political ideology. If they're conservative, they follow the supply side theory that lowering taxes create more jobs and helps the economy. If they're liberal, they follow the Keynesian idea that government spending projects can stimulate the economy. But there's one important economic principle that even economists today have long forgotten or ignored, at the expense of their discipline. That principle is the law of rent.
Before I lay out the law of rent, it bears mention that "rent" in the economic sense is not the same as what is meant in its common usage. We commonly apply the term to apartments, cars, videos, and various other commodities. In economics, its focus is more narrow. It is applied mostly to land, though it can also be applied to things like natural resources or the radio spectrum. Rent is the difference between what a factor of production is paid and what it would need to be paid to remain in current use. Applied to land, it essentially refers to the profit to be gained by virtue of its ownership. Essentially, land rent is equivalent to land value.
Now that we have laid out what rent is, lets examine the law of rent. This law, formulated by David Ricardo in 1809, states that the rent of a piece of land is equal to the economic advantage of putting that piece of land to its optimum productive use compared to the same application application of labor to marginal, or rent-free, land. In other words, the same inputs of capital and labor yield different results on different land, and in places where one gets greater results from the same input, the difference in output is rent.
To most people, this would seem to make sense for farmland, but they have trouble seeing how it would apply to urban land. And yet, urban land has a much higher rental value than farmland. How is this so? Farmland is easy to understand because its value is largely tied to its fertility. But land in general has a more common source of value, and it is one of the top rules in real estate: location, location, location. Consider a supermarket. Where do you think it would generate more revenue: in the middle of a busy street downtown, or in a small suburb on the outskirts of town? If you guessed the former, you'd be correct. The downtown location would yield a higher rent. Now what about residential property? Since it is not used for commercial activity(unless, like me, you own a home business), it may be confusing to hear that residential land also yields rent. But consider that one's residence also contributes to one's productivity. If you live in upper Manhattan, you have access to the commercial center of America. The job opportunities are much greater than in rural Alabama. This is not to say that job opportunities are the only factor. Crime rate, education, public services, and many other factors come into play. I think you get the general idea.
Now let's get to why you should care about this. One of the most important implications of the law of rent is its effect on wages. It means that wages are set not by the productivity of labor anywhere, but rather by its productivity on marginal land. Thus, as land values rise, wages tend to fall. As development extends further, labor is forced onto more marginal land, bringing down wages for everyone, and increasing unemployment. This downward tendency is further accelerated by land speculation which keeps more valuable land out of use.
This speculation doesn't just mess things up for the lower class. It screws up the economy. The "business cycle," as it's called today in economics, can largely be linked to the buildup of land values. As land rent and speculation increase, there is a smaller portion of the land being used for production. After a while, the ability to maintain that land reaches its breaking point, resulting in housing crises like we're seeing today.
It's common to point the blame for these kind of crises at banks(particularly the Federal Reserve) and their "predatory lending" practices. While there may be some merit to this, the real blame lies in our system of land tenure itself. Only when the land rent is rendered common property will these problems be resolved. To do this, the rent should be the source of public revenue, while harmful taxes on wages and interest are removed. In this way, our economy can run better than ever, free of the social injustices of poverty and unemployment, and the imbalance of the business cycle.
