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Explainer: How economic "rents" affect inequality

Economist Thomas Piketty's book, "Capital in the Twenty-First Century," highlights the dangers of an economy dominated by inherited wealth -- an economy in which birth is more important than effort and ability. He provides evidence that the U.S. is headed in this direction -- toward what he calls "patrimonial capitalism" -- and Piketty recommends taking measures such as imposing high wealth and inheritance taxes to offset the accumulation of wealth that appears inherent to capitalist systems.

One of his explanations for rising inequality in the U.S. and elsewhere around the world is what economists call "rent-seeking behavior." That refers to the ability of the wealthy and powerful to influence the political process, keep top tax rates low and increase their income at the expense of everyone else.

The central question: Can the capture of "economic rents" by those at the top of the income distribution explain the rising inequality that fuels patrimonial capitalism?

There are two definitions of economic rents -- a textbook definition, and a definition that prevails in more common usage. The textbook definition is straightforward. Suppose it would take $10 per hour to induce someone to work. If the wage were any lower, the person would prefer not to work at all. If he or she is paid $15 per hour, then the difference between what they are actually paid and what it takes to induce them to work ($15 - $10 = $5) is economic rent. It is any payment over and above the minimum payment needed to bring a factor of production -- labor, capital or land -- into productive use.

How does this relate to inequality? Suppose that a major league baseball player who really loves the game would be willing to play for $50,000 per year. If the player is paid $1 million per year, then the difference between that $1 million dollar salary and the amount needed to induce him to play for the season -- $950,000 -- is economic rent. If globalization and digital technology then allow the team to get much wider worldwide exposure and much higher broadcast and memorabilia revenues, then the player is more valuable and his salary might increase. Any increase in salary would also increase the rent, so expanding markets through changes in technology could explain rising rents for those with high incomes.

Many markets have become more globalized due to technological change -- movies, for example -- and many people believe this "superstar" model explains at least part of the rise in inequality.

But there is another more common usage of the term "rent" that explains the rise in inequality another way. This refers to any return over and above what would occur if a market were perfectly competitive. One example is monopoly power that occurs naturally or that is due to government action, such as requiring occupational licenses that restrict entry into a profession and increases profit above the competitive level.

More generally, the idea is that "rent-seeking behavior" by those with political power -- such as the wealthy -- will tilt the rules in their favor and allow them to capture a larger share of the economic pie. The ability to keep taxes relatively low for those at the top is one example of this.

The decline of labor unions in recent decades can also be explained in this way. According to this story, those with economic power -- the wealthy owners of businesses -- used their influence to get laws passed that undermined employee power. Unions had leveled the playing field, and as labor groups were stripped of their influence, power shifted to business owners, allowing them to capture a larger and larger share of national income.

Any change in rules or regulations, or even the failure to act -- not raising the minimum wage, for example -- that appears politically motivated and favors those in power would be defined as rent-seeking behavior.

The concept of economic rent originated with David Ricardo in the early 1800s. For Ricardo, economic rent was the extra profit earned on the most productive land as prices rose to bring less productive land into cultivation. The modern meaning of the term by either its textbook or more general definition above is much broader, and some believe that understanding rents is the key to understanding inequality.

Can rents alone explain the rise in inequality over the last few decades? Perhaps not, but they are certainly part of the story.

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