How our economy really works - Brian Hodgkinson

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a central high street site, it may appear to be making very large profits. In reality much, if not all, of these are rent. Only if this is acknowledged can the proper efficiency of firms of any type be seen. Moreover, the optimal allocation of land to its best uses can only be accomplished if the true rent is known, regardless of freehold tenure.

      Economic rent can also be measured by the capital value of the site concerned. When land is sold in a free market, the price paid is approximately the capitalised value of the rent receivable in the future. This is true whatever the land use. For housing, for example, the future occupier of a house on the site pays what he or she thinks it is worth to avoid paying a rent for the site in the future; or if the house is to be built for letting the price includes the capital value of future rents to be received.

      One of the consequences of the neglect of the concepts of land and rent in present-day economic thinking is that the actual differentials between the rent on different sites is often overlooked. This is partly because rent is not evident when it is not paid, as with freehold sites; and partly because vested interests are reluctant to disclose the rent receivable on valuable sites. On long established freeholds the economic rent may be hidden in the profit statements of the companies, in the private accounts of wealthy individuals, or in the beneficial occupation of land used for recreation. For example, who knows the economic rent of land held under freehold in the City or West End of London? Likewise who knows the economic rent of land held for grouse shooting or fishing in the Highlands of Scotland? Were the values of the economic rent of all sites in the UK publicly available, there might be more questions asked about whether it is being optimally used, and even about who is entitled to receive the rent.

      Wages

      A PRELIMINARY POINT about wages is that, as with rent of land, the true wages of labour may be concealed by the prevailing system of ownership. In particular, a self-employed person working in his or her own firm is really earning wages equivalent to what the firm would have to pay an employee for the services of the owner e.g. as a manager. Above this the income of the owner is profits. If his income falls below the wages level, the difference is a loss to the firm.

      Britain in the twentieth century evolved into a society very heavily reliant on the Welfare State. The majority of people are mainly dependent for their living on wages which are inadequate in almost all cases to provide many of the essentials of a decent life for a family. Health services of all kinds, education for all ages, unemployment and sickness benefit, old age pensions and, for many if not all, housing require public finance on a massive scale. The term social wages has come into use to refer to this huge supplement that is needed to bring wages earned by work to a level that provides a reasonable modern standard of living.

      Why is this? To some extent it is because in a democracy the majority may prefer some of these services to be provided publicly. There is a strong case, for example, for at least some health and education services to be in the public sector. Yet even so, there is no real choice about this, since the present level of wages makes proper provision for these solely out of wages impossible. Government naturally has full responsibility for defence of the realm and for law and order, but should it necessarily have to provide services that could be paid for by wage earners were wages at a considerably higher level? After all, the minority who are relatively well off often do choose private health care and independent schools.

      It is a matter for public debate which services should be privately or publicly provided and, moreover, there are many different ways in which either alternative can be implemented. Politics in Britain has revolved around these questions for at least the past century. We have come to accept a fundamental division between left and right which is fostered by this issue, even if it no longer takes the basic form of capitalism versus socialism. What usually passes unnoticed is that the debate is underlain by the simple fact that wages are too low to pay for most of the services currently offered by the State.

      There is, however, an even more basic aspect of the modern economy that goes unnoticed and is rarely discussed at all. Wages are too low to enable wage-earners to provide the capital required at their workplace. Owing to confusion over the meaning of the word ‘capital’, the situation cannot easily be recognised at all. Shares in a company are seen as its capital. So the question becomes ‘Should employees own shares in the company they work for?’ But the proper meaning of ‘capital’ in Economics is ‘wealth used to produce further wealth’. Wealth is everything produced by the factors of production, namely land, labour and capital itself. Put simply, capital is the means of production, excluding land, i.e. buildings, machinery, plant, office equipment, stocks of goods and so on. Shares and bonds in firms are claims on capital – and usually on land as well – and not capital itself.

      Thus the real question becomes ‘Should employees in a company own the capital that they themselves use in production?’ This happens straightforwardly in a business owned by a sole trader or small partnership. But usually when capital becomes substantial employees cannot afford to provide it. A carpenter may buy his own tools; workers in a modern car factory cannot afford to buy the factory. It is now taken for granted that, except in rare cases like the John Lewis Partnership, the firm is owned by absentee shareholders, or perhaps by a handful of very wealthy entrepreneurs. Why is this taken for granted? The answer is very simple: wages are too low to enable employees to buy the very capital which they themselves use in their daily work. Were wages much higher they might either buy capital directly or raise loans on the security of their future income.

      Current discussion of wage levels focuses on differentials. Workers in particular industries or with particular skills demand higher relative wages. Successful firms pay bonuses; failing ones propose wage cuts. CEOs are criticised for earning many multiples of the average wages in their companies. Top sportsmen and celebrities earn enormous amounts. Women earn less than men. And so on. These clearly raise legitimate questions. The more fundamental one, however, is ‘What determines the general level of wages?’ Such a general level is difficult to quantify. Is it the average wages, the median wage, the gross wage before deductions for tax, NIC etc., is the social wage to be added back?

      What is certain is that take-home pay is what counts for the typical wage-earner, whether he or she is an executive in a City firm or a bus driver. In particular, the PAYE and NIC may just as well be seen as tax levied upon the employer of labour. Indeed its impact on production is best analysed in that way (see below p.32)

      Why then is take-home pay so low? Total wages in the whole economy measured in this way consistently fall well below half of the gross national product. This means that the majority of the population, including dependents, are receiving less in total than the share distributed in one way or another as unearned income. Economists seem to have abandoned the question of what determines the distribution of income between the three factors of production, a question which was central to the researches of the founders of the subject, such as the French Physiocrats, Adam Smith and David Ricardo.

      The reason for this serious omission from current analysis lies once more in the development of the British economy since the land enclosure movement. With little or no land freely available, wages are inexorably forced down to the least that workers will accept. The only alternative to being unemployed seems to be taking employment at the going rate of wages. What sets that going rate? It is clearly the lowest rate at which the employer can find workers. In other words it is set by the minimum that the unemployed worker is prepared to accept. Were he or she to demand more than that, a fellow worker gets the job. The labour market – the phrase presents a useful analogy with slavery – is loaded in favour of the employer to a degree determined by the level of unemployment. Were no other workers available the employer would have to offer more, as tends to happen in particular trades in the short-run.

      Yet surely there is an alternative for the worker besides being unemployed? He can become self-employed. A minority find this a genuine option, especially in industries where small entrepreneurs have opportunities, such as currently occurs with new technology. But for the great majority of workers this is not an option. How many in retailing, manufacturing, banking, transport, power, mining and construction can do this? – even if some industries, like construction, employ workers

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