Max Goldsworthy

Suppose I approached you and offered you a one time deal of either £1 million guaranteed or a fair, 50/50 chance at £3 million: which deal would you take? When a similar question was posed in one of my maths class, I was surprised to see a majority of my classmates opt for the £3 million. Obviously they had calculated that the deal offered a higher expected value and, being mathematicians, figured that was the end of it. But my reaction to the question was different: I simply considered all of the things that £1 million could buy me; the freedom, the financial security, the ability to own a home and then wondered whether I’d really choose to risk all that for what seemed like comparatively little marginal gain. If £1 million offered me a firmer sense of ownership over my own future, then £3 million also offered that, plus maybe a bigger house or a yacht. This line of reasoning convinced me that the safer choice was in fact completely rational and not, as had been implied, based on a human inability to interpret risk ‘correctly’. If you need any more convincing of this fact, then suppose that you received this offer when you were exactly £1 million in debt to a loan shark with a penchant for grizzly murders: gambling on that first million would simply be gambling on the value of your own life.

What troubled me about this realisation – a realization which is no doubt obvious to anybody more practically minded – is that it seemed wrong to conclude that our decision making here must involve anything more than simple value maximisation. Suppose we varied the terms of the offer; the £3 million became £10 million, or the odds became better, or the odds of the £1 million became less than 100% – how would we decide between any two possible choices if not by maximising something like our expected value? It seems that the correct conclusion to be drawn here is that the actual value of each monetary reward, understood as the value I want to maximise, is not the same thing as the nominal value of that reward: that is, the first million I could earn is legitimately worth more to me than the following two million. This conclusion – that the actual value of something, even of money itself, can be distinct from it’s nominal value (or ‘price’) – is both indisputable and awkward for economics.

The awkwardness is down to two features of ‘actual value’ that make it extremely difficult to work with: it is impossible to measure directly, and it is irreducibly subjective. Someone else might reasonably have opted for the chance at the £3 million, or I myself might have taken the risk if I already had big sums of money in the bank. What is important to recognise though is that this subjectivity is not absolute: there are features of value that we can be confident apply pretty much universally. The first obvious one is that value increases with price: everybody will value £2 higher than £1. The second feature already mentioned is that value diminishes with increased wealth, and this is simply because any extra money a person earns will go to fulfil increasingly less pressing needs.

This description of value alone – as an increasing yet diminishing function of price – is in my view a wholly adequate theory with which to approach any of the contrived ‘economic trolley problems’ presented above. But we must appreciate that it is still just a value theory, and as such it cannot be demonstrated empirically right or wrong; its appeal lies exclusively in its intuitive reasonableness. This is useful to keep in mind as we turn our attention to value theories that occur in more real world scenarios, such as in the exchange of commodities.

We might hope that in any free exchange, value might once again be equivalent to price, based on the sound principle that people tend to exchange things of equal value. The problem with this is that there are some exchanges where it seems that one party is able to trade money for more money – either via loan interest, collecting rent on a property, or on profit returned to capital investment. These scenarios must either be indicative of value not equaling price (because if it did, then the exchange of money for more money is clearly not an exchange of equal value), or else these scenarios indicate an exchange that is not genuinely free. It is instructive to consider the solution offered to this problem by Austrian economics: that it is the result of time preferences. In theory, there is a general preference for money today versus money in the future, and hence the exchange of money today for more money tomorrow can in fact be an exchange of equal value. Whatever the merits of this explanation, we can immediately see that it is nothing more than an unfalsifiable value theory, and it must be judged on these terms – as a theory of the humanities rather than of science.

We will suspend this judgement for now, and instead introduce the alternative value theory that I feel better explains all of these unbalanced exchanges: capital rents. Put simply, having access to wealth gives one side of the exchange a decisive advantage over the other side, which they can leverage to extract a rent – that is, an unearned income. This is most obvious when we look at property rents – after all, this is the situation where the term ‘rent’ originated, and as all the classical economists agreed, the situation of property rent was one synonymous with unearned income. In my value theory, the reason that I would chose to pay rent to a landlord for no return in equity is simply that I need a place to live, but cannot afford to buy a property outright, and so somebody with the capital to buy an extra house is able to do so and then charge me rent. It is not, as the theory of time preferences would suggest, because I simply prefer to consume more now rather than investing my money into a house. What is perhaps remarkable about this value theory is just how obvious it is: we know that renters are generally not making a deliberate choice to rent and are forced into renting by their weak bargaining position – it is only the mystical pull of modern value theories that can make us lose sight of this obvious fact.

If we turn our attention to corporate profits, the situation is more subtle and there are more dynamics at play, but it seems reasonable to ask whether a similar logic could still apply. Could it be the case that there are a class of people who need to earn a wage to survive, but actually producing anything requires significant capital, and so the people who own the capital are able to collect a rent on it’s use? In economics, there are hundreds of ways, some more legitimate than others, of disguising the fact that the share returned to ownership is in fact a rent. But rather than painstakingly consider all of the justifications – time preference, compensation for risk, capital’s contribution to economic growth etc. – it is perhaps more enlightening to consider the position of a typical billionaire today who, through almost no active effort, could invest their fortune into an index fund and provided they saw average returns of 5% a year, they would get £50 million a year to consume or reinvest as they saw fit, in the long term attracting even more money through compounding interest. How could we account for this £50 million as anything other than a rent collected purely through the power of owning the things that produce value?

A note of caution is required here about the morality of these terms: value and rent. After all, the landlord, the investor and the creditor are all in one sense providing a valuable service that would otherwise not get done. If we banned property rents tomorrow and made no other changes, then the result would be mass homelessness. Whilst this is no doubt true, we should recognise that this also applies to that other type of rent that economists try so hard to mitigate: monopoly rent. The provider of a monopoly service is still providing a valuable service that would otherwise not get done, but this does not mean we fail to recognise that their prices are fundamentally unfair and so, in my view, should we regard the ‘capital rents’ described above. It is no use getting all moralistic and decrying the investor or the monopolist for their profits, but we should still view their ability to extract rent as a fundamentally corrosive and undesirable state of affairs.

The great difficulty with doing this, and why I think we are so willing to deceive ourselves about the nature of these rents, is that whilst there are some ‘natural monopolies’ that have proven difficult to squash, capital rents are something much more fundamental to the structure of our economy. Free exchange will always create inequalities of wealth, and we might reasonably justify this as a fair meritocratic outcome. But these inequalities of wealth then create a power imbalance that allows the wealthy to extract rents, exacerbating the wealth inequality, which in turn gives the wealthy even more power that they then use to extract even greater rents. This vicious cycle is fundamentally how we must understand the dynamics of wealth and the nature of inequality in our economies today: in the absence of any countervailing forces, there will be a continuous, accelerating flow of wealth upwards and because this wealth has to be coming from somewhere, this flow will inevitably push the great mass of people downwards; if left unchecked, ultimately to the level of subsistence. It remains to be seen whether the forces that have traditionally resisted and stabilised this system – economic growth, labour unions and government intervention – can continue to do so, despite today all three being much diminished – or whether, as Marx predicted, the system is doomed to collapse. What to my eyes seems logically unassailable though, is that there is an inherent contradiction between the idea of free trade and the reality of rent extraction.

Addendum: The ‘Labour Theory of Value’

In the above; I talked about the idea of “value theories” and why they are never a science, but you might have noticed I never gave an explicit account of the value theory that I believe underpins these rents. This was deliberate, as I believe that working with any concept as nebulous and subjective as ‘value’ will almost always add more confusion than it brings clarity – so it is analytically sharper to focus on the idea that everybody already understands: power imbalances create opportunities for rent seeking.

There are some on the left today though who insist on gesturing authoritatively towards Marx’s labour theory of value as a universal solution to all thorny problems of value. In essence the idea is sound, and there is a reason why all of the classical economists from Smith down held some variant of the labour theory: the value of a commodity should be the work that it would take to reproduce. After all, what is the process of production, other than a way of exchanging labour for the commodity produced? As critics rightly point out though, there is something of a circularity in assuming that all value belongs to labour and then using this to demonstrate that the share that does not go to labour must therefore be a rent. This was perhaps excusable when in dialogue with Smith, Ricardo and the “bourgeois” economists of the 19^th century, but that is not our reality today. Today we are in dialogue with marginalism and with an economics discipline that usually, but not always, considers value and price to be synonymous – and the way to have this conversation is not by insisting on an antiquated and undeniably metaphysical concept of value, but to use modern concepts like ‘monopoly rent’ to expose the other kind of rent that dominates our economic life.