Rent Is Too Damn High: The Reemergence of Rent Theory in Urban Economics

Neoclassical urban economics handles the analysis of urban physical space poorly. For a subfield defined by geography, that is a major problem. For a subject matter of global importance—over half of the world’s population now dwells in urban places—the policy implications could be disastrous. The problem reduces to the fact that for the neoclassicals, the active life of homo economicus unfolds in comparatively simple singular behaviors undertaken by actors identified as “representative” individuals, firms, organizations, municipalities, nations, and so on. These representative behavioral actors, viewed as operating in arms-length relationships with one another and devoid of institutional context, connect via exchange transactions motivated by universal desires to maximize individual and/or organizational gain (utility). The medium in which the transactions occur is presumed to be more or less competitive markets of the type described in the opening chapters of introductory mainstream textbooks. The neoclassical faith in the universality of these assumptions renders any need for understanding the complexity of the actors, the stage upon which they act, or the historic or institutional evolution of the transaction as at best secondary concerns.

Case in point: consider the way mainstream economics handles the topic of zoning and land use regulation. Within the neoclassical mainstream, zoning is almost never a solution to any urban problem; instead, it is frequently defined as THE urban problem. Examining the high cost of Manhattan housing, Glaeser, Gyourko, and Saks (2005: 333) concluded that the cost problem was a supply problem resulting as a “consequence of an increasingly restrictive regulatory environment”—meaning zoning. Kicking the indictment of zoning up a notch, Jason Furman, a chairman of President Obama’s Council of Economic Advisors, contended that zoning is a significant cause of the income and wealth inequality besetting the nation at large:

We do not fully understand what is causing these reductions in fluidity in the US economy. . . One such barrier that is plausibly playing a role in reduced fluidity is zoning. Zoning and other land use regulations, by restricting the supply of housing and so increasing its cost, may make it difficult for individuals to move to areas with better-paying jobs and higher-quality schools. (Furman 2015: 3)

As with Glaeser, Gyourko, and Saks (2005), so too with Furman (2015), the evidence marshaled in support of this strong indictment could only be made by implication—in the final analysis defining what one means by terms like “restrictive regulatory environment” is a slippery slope at best. Not to worry: using neoclassical theory as explanation, these economists all assume a competitive building industry and, hence, observed construction prices are efficient prices. Ergo if housing sale prices diverge significantly from building costs something must be impeding the market. Why? Because neoclassical economics ex ante assumes competition among sellers will drive prices down close to production costs. Using national data, Glaeser et al. (2005) conclude that the construction industry is an industry comprised of small competitive builders. They further argue that there are no technological constraints on building very high in Manhattan and that the marginal cost of additional floors becomes a relatively small expense in the context of an entire skyscraper. Therefore, by logical deduction, the culprit can only be regulation, that is, zoning. As the books under review here demonstrate, these are assumptions of extremely heroic proportions.

When one looks in depth into the operation of the actual urban land market in Manhattan and at the complex intersections of property ownership, finance, market opportunities and structures of development, and the politics of zoning policy, such simple answers ring hollow. A national market of small single family and even small multifamily home builders is not the same thing as the small number of international construction and engineering firms that are qualified to put up Manhattan’s skyscrapers.

Nor does it explain the complex and monopolized patterns of land ownership in global cities like New York. Any in-depth inquiry into local zoning in similarly situated cities would demonstrate that ownership of critical parcels is closer to a monopoly than a competitive market. Manchester University economist Diane Coyle, a London resident writing in the Financial Times about the rise in housing cost in her hometown, concluded that the market would never fix the urban affordability problem because:

on the whole private developers will not want to increase housing supply enough to bring prices down. They sell too many properties, especially in the capital, on the promise of capital gains. Near my home in west London are some grand new-built homes in an ideal location that have been empty for two years. Why? Because the developer will not want to reduce the price and crystallize a reduction in the value of the asset on their balance sheet. (Coyle 2017)

Coyle raises the important intersection of speculative housing construction and finance, one of several that need to be considered and is discussed further below. Whereas the mainstream of neoclassical economists sees only the presence of local development opponents thwarting supply to enrich themselves, Coyle and others see the complexity of actual institutional constraints. The villains identified by Furman, Glaeser, and other neoclassical economists are cast up as naïve environmentalists or self-interested, greedy locals typically referred to as NIMBYs. ¹ These NIMBYs are only seeking to gain appreciation in their house prices at the expense of restricting market supply for the rest of society.

This simple model only works because the nature of urban land as an economic good is erased from the analysis. The problem is of course obvious: urban land can’t obey the laws of supply and demand because it is fixed in supply. An increase in demand can only lead to a jump in the prices of land. Thus, the old economic problem of land rent refuses to go away. A substantive and policy-relevant economics of urban space has to engage with the ways in which determinations are made over the disposition of this socially generated surplus. The three books under review address that challenge. Each in its unique way seeks to reintegrate analysis of urban land rent into contemporary policy models. All share a belief that to do less is to seriously misperceive the challenges facing the human race living a world that is rapidly becoming ever more urban.

“Reintegrate” is the operative word. Until well into the early decades of the twentieth century, the distribution of land rent was an obvious analytic focus for a broad range of economists. From Adam Smith through Henry George, the unique challenge of the social governance of the value of place, and the economic rent created by its restricted supply, was always acknowledged as a key concern. Given the strong political implications of land rent as an unearned increment, starting around the mid-twentieth century, the concept of land rent was slowly tamed and cut loose from space via a more conservative analysis that argued that any restrictions on competitive markets end up in rent seeking. Rent seeking in turn, freed from rooted institutional concerns, has been fashioned into an indictment of public or collective action as almost always an attempt to impose a monopoly on others and extract rent (Tullock 2008). This has become an integral part of the intellectual case for privatization and the sale of public assets. Along the way, the powerful impact of land rent per se on contemporary urban form dissolved into an intellectual form of background noise. In undertaking this reintegration, these authors render a much-needed and highly productive correction to an otherwise intellectual dead end at the core of the neoclassical approach to the study of cities.

All three volumes hold that the creation and extraction of land rent, a socially-created value, via forms of property title holding is not a passive ex post result of urban real estate markets but an active determinant of them. That in turn means that the physical shape of the city and who has, and who is denied, access to it are driven by the ways in which social institutions and public policy mandate the distribution of the social gains. By not taking this reality into account, the policy analysis emanating from neoclassical economics thwarts our ability to establish socially equitable and environmentally sustainable cities.

Anne Haila’s book, Urban Land Rent: Singapore as a Property State, seeks to understand “how land and real estate policies produce cities” (20). Methodologically, her analysis is a case study of the unique city/state of Singapore. She weaves her Singapore evidence into a larger exploration of urban land rent theory, both historically and contemporaneously. In Singapore, 100 percent of the land is urban and 90 percent of it is publically owned. Haila’s study fashions that experience into a narrative comparing Singapore with cities in other places (mainly Europe) where an apparent headlong rush into land privatization is underway. She argues that Singapore does a far better job of meeting its social obligations. Her target concerns are for decent housing across all social classes, but especially the middle class.

A valuable contribution of her rent analysis is her extensive unbundling of the ways urban land rent becomes manifest. The most common forms are as differential rent, absolute rent, and monopoly rent. The first reflects the Ricardian notion that different locations have different marketable advantages. The second reflects the fact that landowners can always insist upon some rent because access to the land is always the necessary condition for all else. Last, monopoly rent arises on top of absolute rent depending upon the degree to which demand exceeds supply. She then describes other manifestations of rent: class monopoly (a result of housing market discrimination), redistributive rent (state actions to apportion the gains), and potential rent (the difference between actual and possible). The last of these leads to a rent gap. She acknowledges other uses of rent by analysts such as bid rent and rent gradient. She argues that all make sense when contextualized in their own intellectual traditions. Regardless of tradition, she holds that “the cause of all forms of rent is landownership, the monopoly of landowners” (61).

She especially seeks to illustrate with her Singapore example the fact that government can be the key positive player in determining who captures how much of the socially-created rent. At the same time, she is clear that Singapore is not a model for any other place in particular. The important fact for her is that its success demonstrates that there is more than one way to address the challenge of social equity in the city, reminiscent of Nobelist Elinor Ostrom’s (1990) point that there is more than one way in to resolve problems of sharing a common pool resource. In the present case, the resource would be urban land. Haila is especially keen to refute the notion of another economic Nobelist, Douglass North (2005), that only privately-held assets are efficiently used, the by now trite “governing the commons” problem. The implicit governing assumption in Singapore is that rent is a public good to be invested in the service of the entire society, and it is the government’s duty to fulfill that goal.

Franklin Obeng-Odoom, an Australian-based Ghanaian-born economist, takes the urban rent challenge in a complementary but different direction. His Reconstructing Urban Economics: Towards a Political Economy of the Built Environment has a pedagogic mission. He wants to develop an urban economics curriculum for “those traditional disciplines concerned with building technology, architecture, construction management, planning, and most notably property economics, real estate studies, or land economics” (18).

Obeng-Odoom’s critique has two essential elements. He argues the current neoclassical economics approach assumes property rights as a fixed order of the universe rather than a socially, historically, and politically bounded right that changes with time and place. Within that order, it assumes that “cities are made of free-standing individuals, households, or firms without any social bonds” (20–21). Following from that notion of methodological individualism, decisions are then driven by spatial separatism. Spatial separatism assumes that the spatial problems of cities are in some way separable from the wider urban context.

Obeng-Odoom challenges this dualist view, rooting his analysis in a more complex institutional and historical set of approaches. His approach is an urban political economics that he characterizes as a mix of institutional political economy, Marxist urban political economy and Georgist (as in Henry George) political economy, and postcolonialism in the rapidly urbanizing sections of Africa and Asia.

The subject matter of his book chapters takes this up in detail and applies that analysis. Because his book is a stinging critique of the subfield of urban economics as it is taught within the larger neoclassical mainstream, it is helpful to have some familiarity with the broader literature of economics. Much of what he says references and draws upon understanding that background.

Ryan-Collins, Lloyd, and Macfarlane’s Rethinking the Economics of Land and Housing draws on the United Kingdom generally, and London experiences more specifically, to link land and housing to finance and explore the insidious impact of unregulated land rent.

As with the other two volumes, this one too places the evolution of land rent in historic and contemporary perspective. Its singular contribution is a fuller explanation of the contemporary financialization of urban land rent and the larger implications of this for the macroeconomy.

These authors trace the history of the disappearance of land from the aggregate production function. I can remember my undergraduate economics instructor putting a three-element production function on the blackboard—land, labor, and capital. By the time I finished graduate school, aggregate production functions concerned themselves only with capital and labor. The Ryan-Collins, Lloyd, and Macfarlane volume delves into this evolution and uses it to understand how important policy implications vis-à-vis land rent and housing flow from the ways economic ideas are fashioned. Land becomes real estate, and real estate becomes a balance sheet asset, the dilemma pointed to by Coyle in the earlier quote. At the same time, the bottom line on a profit and loss statement lumps land rent into investment return along with returns on actual capital investments. Rent as a powerful urban social and political relationship then disappears from the policy dialogue.

Real estate finance is almost always a leveraged endeavor. Consequently, rising land rents make land-based property highly attractive collateral. Monetary systems are built on fractional reserves and thus the private creation of credit. Given rising land rent, real estate becomes a highly attractive item of easy collateralization. Real estate loans expand the money supply; the expansion in the money supply makes real estate investments more attractive. Round and round it goes until it does not anymore. This in no small measure plays a large role in the periodic collapses of real estate markets. As Ryan-Collins et al. observe, “a key challenge facing economists and policymakers today is how to break the positive feedback cycle between the financial system, land values and the wider economy” (190).

A particular strength of this volume is its attempt to link the analysis to politically attainable workable solutions. The authors then take on that challenge, exploring policy in the areas of forms of land holding such as Singapore’s to challenges of land value taxation and value capture, to ideas about financial reform. They close out the book echoing the concerns of Obeng-Odoom about the need to reform the ways in which economics is taught and the ways in which national income accounting treats the problem of urban land rent.

That three different volumes all with a similar theme should appear about the same time suggests that addressing urban land rent is an idea whose time has come. Land rent greatly impacts the social and physical realities of urban life. Absent a deep understanding of the institutional relationships within which it is embedded, policy prescriptions rooted in ahistorical and ainstitutional utility maximization are at best platitudinous, and do more harm than good.

This is not a small matter. We are over seventy years into in a century-long process of rapid global urbanization. The present wave began just after World War II. In 1950, about 30 percent of the world population lived in urban places and 70 percent rural. Around 2050, these proportions will approximately reverse, 30 percent rural and 70 percent urban. More important than proportions are absolute numbers. The 1950 world population was approximately 2.5 billion, and the 2050 population is projected around 10 billion, a fourfold increase. The urban population will have increased almost ten thousand-fold, from three-quarters of a billion to about 7 billion. All of these seven billion urban dwelling people will need to live and work at a high physical density of persons per km². Moreover, according to UN Habitat (2016), around one-sixth of the current global urban population, approximately one billion people, already lives in harsh slum conditions. Bear in mind that the matter of decent urban living is not solely a development challenge. In affluent New York City on an average night in August 2017, over 60,000 people, three-quarters of them families with small children, were housed in emergency shelters. Thus, the matter of who captures the land rent from the agglomerative economies of urbanization has enormous implications for our ability to shape an urban world that is socially equitable and environmentally sustainable.