What are the factors behind high economic rents?

In research and debates about economic inequality in the United States, there’s been a resurgence this year in explanations for rising inequality that emphasize market power and market imperfections. In a recent piece for the New York Review of Books, Paul Krugman details how increasing market power seems to be a more attractive story of how inequality became so large in the United States. A paper that Krugman cites—by Jason Furman, Chairman of the Council of Economic Advisers, and Peter Orszag of Citigroup—emphasizes the role of “rents” in contributing to inequality and suggests increasing market power could be the reason for this trend. But an interesting new paper from Dean Baker, economist and co-director of the Center for Economic and Policy Research, proposes a very different reason for why those rents came about.

First, let’s define economic rents. In short, a rent is the extra return to an economic agent above what it would have been able to get under a different set of circumstances. If you’d be willing to do a job for $10 an hour and I pay you $15 an hour to do it instead, the extra $5 you’re earning could be considered a rent. You often hear the term “rent” used when discussing monopolies because those firms have lots of excess returns due to being the sole provider of a good.

It’s with this story that Baker lays out a key role for rents. Baker points to four areas where rents are pervasive in the U.S. economy: patents and copyrights, the financial sector, high pay for CEOs and executives, and high pay for professionals more broadly. What brings these areas together is that the institutional arrangements in these portions of the economy have not only created rents, but that these rents disproportionately go to those at the top of the income ladder. Getting rid of these rents would stop the “upward redistribution of income.”

The first area Baker highlights—patents and copyrights—is easiest to understand. Patents and copyrights are explicitly monopolies created by the government to reward producers of new research, pharmaceutical drugs, movies, and a number of other types of intellectual property. Baker argues that these schemes are providing rents to the intellectual property creators and that other setups could produce the same amount of research, for example, without producing these rents.

Baker has a similar argument about the financial sector: The industry is simply inefficient and takes in income well above its contribution to the rest of the economy, as other research has shown.

When it comes to the high pay of CEOs and professionals such as doctors, Baker’s argument is that institutions have been arranged so that these CEOs and professionals make more money than their productivity would necessarily predict. CEOs make much more money than they would if their pay was actually in line with their contribution to the success of their firm. And professionals would be paid less well if the government allowed more competition for those jobs in the form of more highly educated immigrants.

Altogether, these factors could have a big impact on the level of inequality. According to Baker’s calculations, the combined amount of rents from these four areas would be equal to between 6 percent and 8.5 percent of U.S. gross domestic product in 2014. That’s about the same size as the increase in the share of income going to the top 1 percent of income earners in the United States from 1979 to 2012.

What differentiates Baker’s argument from similar ones is that he is less persuaded that decreased competition among firms and firm consolidation is a major factor. Furman and Orszag mention patents as a potential cause of excess returns, but the emphasis seems to be more on market power as is the case with similar narratives of U.S. income inequality.

In short, Baker sees the story of rents less as capital versus labor and more about a fight within labor. His read of the data leads him to believe that the share of income going to labor has really only declined since the Great Recession, but of course that read is debatable. (Measurement is always important when it comes to rents.) So while rents might have broken through as a compelling story for why inequality has risen in the United States, the reason for high rents is still very much up for debate.

(Photo by Bartex Szewczk, veer.com)
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