Tuesday, February 16, 2021

The Henry George logic of wages as an economic rent

George was concerned that property owners gained all the economic rents. But his logic relies on a quite arbitrary and limited concept of property rights.

We know, for example, that human slaves could historically be the exclusive property of another person.

By George’s logic, the economic gains to human-type property owners would be an economic rent, just as the gains to location-type (or land-type) property owners are an economic rent.

From the viewpoint of property and economic rents, freeing slaves transferred a property right, in the form of the right to choose labour tasks and receive payment for them, from the slave owner to the slave.

Thus, the wages of freed slaves are the economic rent from the property right they now own. The owner of human-type property still gets the rent. It is just that each person became an own-slave-owner.

Hence, when modern Georgists say things like “all taxes come out of rents” they are just saying “all taxes come from property rights owners who can capture the economic surplus.” Or simply, “all taxes come from someone.” 

But because the understanding of property rights is limited mainly to location-type resources, not human and other resources, they miss a big part of the economic picture. While it is certainly the case that owners of location-type property need not labour for their share of economic gain, changes in the distribution of the ownership of location-type property can spread those gains more widely, just as a change in the distribution of slave-type property owners spread the gains from human labour. 

George's idea of a tax on the value of location-type property is a good way to socialise the gains from concentrated land ownership. In the modern era of high top labour incomes, taxes on the high value of these human-type property rights might also be a good way to socialise some of these economic rents.

The balance of wages, profits and rents, are not a product of physical aspects of production, but rather than property rights distributions. George somewhat indirectly makes this point when he writes:
Where land is free and labour is unassisted by capital, the whole produce will go to labour as wages.

Where land is free and labour is assisted by capital, wages will consist of the whole produce, less that part necessary to induce the storing up of labour as capital.

Where land is subject to ownership and rent arises, wages will be fixed by what labour could secure from the highest natural opportunities open to it without the payment of rent.
Where property rights to land are limited (i.e. land is free), wages and capital owners get all the surplus. As one would expect, only those with property rights can get a share of the surplus. If then property rights to capital were removed, or limited, then all the gains would go to labour. We can get any economic distribution we like with different sets of rights (aka rules). 

The relationship between George's insights on rents and the concept of property rights need more careful consideration in the modern world where the evolution of property rights tends to be invisible to many economists and policymakers. 

Monday, February 8, 2021

Downs-Thomson housing paradox

Anthony Downs and various others made the observation that “the equilibrium speed of car traffic on a road network is determined by the average door-to-door speed of equivalent journeys taken by public transport.”

Though known as the Downs-Thomson (DT) paradox, it is not a paradox at all. It is merely an observation that people adapt their behaviours to road network changes that affect the cost of driving.

The basic idea is that there are three margins from which substitution towards peak hour use of new freeway capacity occurs.
  1. many drivers who formerly used alternative routes during peak hours switch to the improved expressway (spatial convergence), and
  2. many drivers who formerly travelled just before or after the peak hours start travelling during those hours (time convergence), and
  3. some commuters who used to take public transportation during peak hours now switch to driving, since it has become faster (modal convergence).
This is a simple application of the logic of substitution in microeconomic consumer theory. If an alternative has a lower economic cost for the same value gained, people will substitute towards the lower-cost alternative. Consumer choices are what enables markets to select for the more efficient producers and mix of goods and services over time as they respond to relative prices. 

In the DT example, the three alternatives and the peak hour freeway use start at the initial equilibrium. Prior to the new freeway, all the transport alternatives are taken up to the degree that the total cost (time/money/convenience) is equalised across them.

The cost of travelling on an alternative route, or at an alternative time, or using an alternative mode, is roughly the same as the cost of peak hour freeway transport. It must be because if it wasn’t there would be a substitution towards the lower-cost option.

If you reduce the cost of one of these alternatives what happens? That option begins to look relatively attractive, and people substitute from the other alternatives until there are no remaining gains from substitution.

Afterwards, the new equilibrium looks like this. I’ve put a dashed line at the old equilibrium to show that there can be overall gains from expanding transport capacity, even though they are not observed in the option that received the investment.[1]

How much below the previous equilibrium the cost profile of the transport alternatives remains depends on how much these costs can adjust downwards and the preference for substituting towards non-transport uses of time and money.

For example, if alternative transport modes have a fixed cost (e.g. taking the train in peak hour has a fixed price and time cost that does not change based on usage), then the new cost equilibrium will occur at the same level as previously. That fixed cost of the alternative mode will anchor the equilibrium time and cost level at which these options equilibrate.

This is what is meant by the observation that “the equilibrium speed of car traffic on a road network is determined by the average door-to-door speed of equivalent journeys taken by public transport.”[2]

Similar margins of substitution happen in housing. Housing is another spatial allocation problem where the cost involves a trade-off between price and time costs amongst alternatives.

Location alternatives are one such margin. Total cost equilibrates, via rent adjustment, between comparable dwellings at alternative locations based on relative transport/accessibility costs.

When the transport/accessibility cost of a location falls, the rent in that area rises so that there are no gains from substitution between locations.

Another margin of substitution in housing is between modes, like renting and buying. When the cost of some buying goes up, it can drag up the cost of renting as market participants close the gap between buying and renting. Alternatively, if the cost of renting falls, it tends to pull down the cost of buying.

What if there is another alternative housing mode? Say, a social or public housing option that has a fixed price. In this case, the point at which there is no substitution between them is where they all have the same economic cost.

If the cost of public housing falls, this puts pressure on the housing equilibrium. Homebuyers and renters begin substituting to this cheaper alternative, just like the case of the new freeway in transport equilibrium.

This substitution process continues until there are no gains from substituting between housing modes. Public (non-market) housing alternatives can create an anchor for prices, just as public transport alternatives anchor congestion levels.

One could argue that “the equilibrium price of housing in a private market is determined by the average price of equivalent public housing.”

Our policy choice not to extensively provide cheap housing alternatives has allowed housing prices to be anchored by the maximum willingness to pay in the market rather than the cost of public housing.

The DT paradox is why places with low traffic congestion are usually those that have good alternatives. It is also why places with cheaper private housing markets have cheaper and more widely available non-market alternatives.

[1] This is actually how monetary policy works. The overnight cash rate is manipulated, and then all the alternative interest rates shift because there is a substitution between the overnight rate and long-dated assets.

[2] The D-T paradox has implications for pricing choices on transport networks. For example, peak-hour congestion charging will raise the cost fo driving, creating substitution to alternatives, including the alternative of not travelling. When a new rail line is built to relieve pressure on roads, tickets must be priced low enough to attract people towards that alternative and away from road travel. If new rail lines are privately owned and earn a return from ticket sales only, they have an incentive to maximise their own revenue, but this may involve a ticket price that is too high to maximise overall transport gains by attracting more substitution away from road travel. New toll roads also are likely to over-price compared to the optimum for the network as a whole that would see more substitution to these new roads.