Part 1 (2/2)

The rent on meadowland, therefore, will always be equal to the difference in grain yield between meadowland and whatever land is available rent-free to new farinal” land because it is at thecultivated (You will soon see that econoin quite a lot) In the beginning, when meadowland was more plentiful than set-tlers, it was not only the best land, it was also the ”inal” land because new farmers could use it Because the best land was the sainal land, there was no rent, beyond the trivial sum needed to compensate the landlord for his trouble Later, when there were so o around, scrubland becainal land, and rents on meadows rose to five bushels a year-the difference in productivity between the inal land (in this case, the scrubland) When Cornelius arrived, the grass-land becainal land, inal land, and so the landlords were able to raise the rent on ain It's important to note here that there is no absolute value: everything is relative to that inal land

From meadows back to coffee kiosks A nice story, but those of us who like Westerns iven or the psychological isola-tion of High Noon So, David Ricardo and I get no prizes for our screenwriting, but weas our little fable actually tells us so useful about the modern world

We can start with coffee kiosks Why is coffee expensive in London, New York, Washi+ngton, or Tokyo? The commonsense view is that coffee is expensive because the coffee kiosks have to pay high rent David Ricardo'sway to think about the issue, because ”high rent” is not an arbitrary fact of life It has a cause

Ricardo's story illustrates that two things determine the rent on priricul-tural productivity between ricultural productivity itself At a dollar a bushel, five bushels of grain is a five-dollar rent At two hundred thou-sand dollars a bushel, five bushels of grain is a h dollar rents only if the grain they help produce is also valuable

Now apply Ricardo's theory to coffee bars Just as rain they produce is valuable, prih rents only if custoh prices for coffee Rush-hour customers are so desperate for caffeine and in such a hurry that they are practically price-blind The willingness to pay top dollar for convenient coffee sets the high rent, and not the other way around

spaces suitable for coffee kiosks are like meadows-they are the best quality property for the purpose, and they fill up quickly The ground-floor corner units of Manhattan's Midtown are the preserve of Starbucks, Cosi, and their coton DC's Dupont Circle, Cosi has the prime spot at the south-ern exit, and Starbucks has the northern one, not toout territory opposite the adjacent stations up and down the Metro line In London, AMT has Waterloo, King's Cross, Marylebone, and Charing Cross stations, and indeed every Lon-don station hosts one of the big-name coffee chains These spots could be used to sell secondhand cars or Chinese food, but they never are This isn't because a train station is a bad place to sell a Chinese e of other places with lower rents from which noodles or cars can be sold-custo to walk, or order a delivery For coffee bars and si snacks or newspapers, cheaper rent is no compen-sation for the loss of a flood of price-blind custoed to write an analysis of cappuccino bars in train stations before either cappuccino bars or train stations existed This is the kind of trick that makes people either hate or love econoue that if ant to un-derstand how thean analysis of far published in 1817

But many of us love the fact that Ricardo was able, nearly two hundred years ago, to produce insights that illu today It's easy to see the difference between nineteenth-century far, but not so easy to see the similarity before it is pointed out to us Econo basic principles and pat-terns that operate behind seely complex subjects like the rent on farms or coffee bars

There are other s A n and architecture of coffee bars could be useful as a case study for interior designers A phys-ics enerates the ten atmospheres of pressure required to brew espresso; the sa about suc-tion puine Today we have ical irounds Each s, but a ”, the ecology, and the economics would be no si to our understanding

Ricardo'sthe relationshi+p be-tween scarcity and bargaining strength, which goes far beyond coffee or far and ultimately explains much of the world around us When economists see the world, they see hidden so-cial patterns, patterns that beco processes This focus leads critics to say that economics doesn't consider the whole story, the whole ”systeh, could a nineteenth-century analysis of far proclaim the truth about twenty-first-century coffee bars, except through grossly failing to notice all kinds of impor-tant differences? The truth is that it's si co on certain eles they like to focus on, and scarcity is one of them This focus means that we do not notice the mechanics of the espresso machine, nor the color sche, iain froain is an understanding of the ”syste than many people realize

A word of caution is appropriate, though The simplifications of economic models have been known to lead economists astray Ricardo himself was an early casualty He tried to extend his brilliantly successful model of individual farmers and landlords to explain the division of income in the whole economy: how much went to workers, how much to landlords, and how much to capi-talists It didn't quite work, because Ricardo treated the whole agricultural sector as if it were one vast farricultural sector had nothing to gain froation, because those iood land But an individual landlord in competition with the others would have plenty of incentive to make improvements Tied up in the technical details, Ricardo failed to realize that thousands of land-lords co with each other would le one

So Ricardo'sBut we are about to discover that it goes farther than Ricardo hiined It doesn't just explain the principles behind cof-fee bars and farislation can dramatically affect income distribution It explains why soh profits, while in other industries high profits are a sure sign of collusion It even ration by other educated people, while the working classes coration by other unskilled workers

Different reasons for high rent Do you care if you get ripped off?

I do A lot of things in this life are expensive Of course, some-times that expense is a natural outcome of the power of scarcity For instance, there are notCen-tral Park in New York or Hyde Park in London Because so many people want them, those apart disappointed There is nothing sinister about that But it's not nearly so obvious why popcorn is so expensive at the e last tiht want to do is to distinguish between different reasons for things being expensive

In Ricardo's terh rents Knowing this about(unless you are a farnifi-cance when applied to the question of why your apart us off But we can start with meadows and apply e learn more widely

We know that rents on the best land are determined by the difference in fertility between the best land and the h is that the best land produces very valuable crops relative to the o, five bushels of grain is a five-dollar rent at a dollar a bushel, but at two hundred thousand dollars a bushel, five bushels of grain is a rain is expensive, it's only natural that the scarce meadows that produce it will also be expensive

But there's another way to drive rent on meadows up, and it is not nearly so natural Let's say landlords get together and e to persuade the local sheriff that there should be what in England they call a ”green belt,” a broad area of land around the city on which property developulations The landlords claim that it would be a sha on the land should be ely froal land Remember that rents on meadowland are set by the difference between the productivity of inal land Ban farinal land, and the rent onrent and farrassland rent-free, now there is no alternative Far on the grassland is illegal, and the rent they're willing to pay is her too

So we've found two reasons why rents ood land, because the grain that good land produces is so valuable The second is that it's worth paying a lot for good land because the alternatives that should be available are not

Those readers currently renting property in London may have furrowed brows at this point London is surrounded by the origi-nal ”Green Belt,” created in the 1930s Is that why property in London is so expensive to rent or buy-not because it's so much better than the alternative, but because the alternative has been al?

It is a combination of both: it is certainly true that London is unique, and a better place to put plush aparts than Siberia, Kansas City, or even Paris Rents are high, in part, for that reason But another reason why property in Lon-don is expensive is because of the Green Belt One effect is to keep London froion- which ood idea The other effect is to transfer a massive amount of money from London tenants to London landlords: the Green Belt keeps rents and house prices in London her than they would be, in exactly the sa keeps rents on her than they would otherwise be

This is not an arguainst the Green Belt There are lots of benefits in having London's population capped at around six million people, instead of sixteen million or twenty-sixthe pros and cons of legislation like the Green Belt, we understand that its effects are more than simply to preserve the environher than in Manhattan or central Tokyo-in fact, the West End is the most expensive place in the world to rent an office, and it also holds the world record for the most expensive home, at 70m (about 130 million dollars) The Green Belt has made property in London scarce relative to the people ant to use it, and of course, strength comes from scarcity

Now it's time for your first economics test Why would im-provements in the quality and price of the co people into New York's Penn Station fro suburbs please anyone who rents a property in Man-hattan? And why ht New York landlords be less enthusiastic about such improvements?

The answer is that improved public transportation increases the alternatives to renting a place in the city When a two-hour coet a seat on the train instead of standing, some decide they'd rather save money and move out of Manhattan Vacant apart-ments then appear on thecommuter services wouldn't just affect commuters; it would affect everyone involved in New York's propertyripped off?

One of the proble an undercover econoreen belts” of one kind or another all over the place How can we tell the difference between things that are expensive because they are naturally scarce, and things that are expensive because of artificial ulation, or foul play?

Ricardo's model can help here, too We need to appreciate a hidden parallel between natural resources, like fields or busy lo-cations, and co stuff into dif-ferent stuff: rain Companies are the saredients into cars A gas station turns puasoline in your tank A bank turns co services Without per-petrating too much intellectual violence, we can replace ”rent” with ”profit” throughout Ricardo's model Rent is the return land-lords receive from their property; profit is the return co as an exa services-it has a fantastic corporate culture, strong brand, and has developed the best specialized bank-ing software Good people work there and other good people join just to learn from them All this adds up to what economist John Kay (who explicitly invokes Ricardo'sthe sort of edge over the competition that will produce profits year in and year out

Let's call this uberbank Axel Banking Corporation A second bank, Bob's Credit and Debt, is not quite so competent: the brand is less trusted, the corporate culture is so-so It's not bad, but it's not great either A third bank, Cornelius's Deposit Enterprises, is extremely inefficient: it has a terrible reputation, the tellers are rude to the customers, and control of expenses is nonexistent Cornelius's bank is less efficient than Bob's outfit and grossly inco Corporation All this should remind us of the three types of land: rain; scrub, which is less efficient; and grassland, which is even less efficient

Axel's bank, Bob's bank, and Cornelius's bank co people to open accounts or take out loans But Axel's bank is so effective that it can either pro-duce banking services more cheaply or produce better quality services for the sae profits, and Bob's bank, which serves its custo rather more modest, and Cornelius's bank will just break even If the banking o out of business If the bank-ing et more attractive, Cornelius's bank would start to make a profit, and a new bank, even less efficient than Cornelius's, would enter the business The new bank would be theevery step of the analysis, we can remind ourselves that the rent on meadowland was set by coinal grassland In the same way, Axel's profits are set in coinal bank, which we know should expect to make little or no profits: company profits, like rents, are determined by the alternatives A company with stiff competition will be less profitable than a co of a flaw in the analogy: the acreage of row But that's only partly true; co their reputation and the other capabilities that e cannot change, the distinctions between different types of land will shi+ft over tiy develops Ricardo's es over tiricultural prices over decades but not over centuries, while it will explain corporate profitability over years, but not decades As with many economic models, the analysis ell for a certain time scale-in this case, the short and medium term For other time scales, different models are needed

This is all very wellbut what does it have to do with corporate profiteering?

The newspapers often point to high corporate profits as a sign that the consuht? Only soests that there are two reasons why average profits of an industry like banking reat service and reputation, both Axel and Bob will inal bank and can expect very little) Newspaper hacks will be able to complain about excessive profits If custoreat service, Axel and Bob will be only inal bank, still e profits should be low The coies used by the industry haven't changed-the only thing that changed was that custo anybody off; instead, Axel and Bob are being rewarded because they are offering soh profits are not always earned so fairly; soe is justified There's a second explanation for high corporate profits What if a kind of banking ”green belt” completely excluded Cornelius's bank from the market? In the real world there are lots of reasons why potential new companies cannot enter a market and compete At times the consule to enter the market because customers will deal only with established co” products, including condohly profitable because new entrants find it hard to create a buzz about their products More frequently, the fir to be pro-tected frorant hly restrictive of entry into ”sensitive” industries like banking, far, or telecommu-nications Whatever the reason, the effect is the sah profits In fact, be-cause of the sied on land with few substitutes and the profits enjoyed by a firm with few competitors, economists often call those profits ” term, but you can blaination shown by econo- ripped off by super companies, I can find out how profitable those industries are If they are h profits, then initially I am suspicious But if it seems that it is fairly easy to set up a new com-pany and coh profits are caused by a natural scarcity: there are not ood banking orga-nizations are much more efficient than bad ones

Resource ”rents”

Landlords and executives are not the only people who like to avoid competition and who like to enjoyfor a professional qualification, and even national govern to avoid competition or reap the rewards of others who have succeeded in doing so Econo rents” and ”rent-seeking”

It's not easy to do this It turns out that the world is a naturally competitive place, and it is no simple matter to steer clear of coh co end of it, it is pleasant to be on the right end, as the custo with people who are co to offer us jobs, news-papers, or vacations in the sun, just as our mythical landlords benefited from competition between Bob and Axel