Econ 101. Rent.

The institutional critique turns our attention to market failures that generate what economists call “rent.” Rent is income that exceeds what would be needed to ensure that a particular asset, such as labor, continues to be deployed in a competitive market. A manager, for instance, is collecting rent when she earns more than she would in a perfectly competitive market (bearing in mind that a perfectly competitive market is an “ideal type” that doesn’t obtain in any existing economy). Because of corruption, bottlenecks in labor supply, or sweetheart deals, the manager is paid in excess of what would be needed to convince her to do the job.
The concept of rent is tailor-made for the OWS argument that power and privilege are built into our markets. Although the market is usually represented as highly competitive, the OWS retort is that such a representation only camouflages the many ways in which the rules are rigged to benefit the already advantaged. This is a simple story about an economy rife with rent.
It’s one matter to argue that opponents of inequality have embraced the rhetoric of rent and quite another to demonstrate that the rhetoric is on the mark. To make that case, I offer two illustrations. The first suggests that the increasing financial benefits of schooling, well appreciated as a main cause of rising inequality, are partly attributable to market failure. The second suggests that excessive executive compensation is rooted in non-competitive practices and that a true market wage would likely reduce inequality. These two examples imply that rent benefits the rank-and-file college-educated worker as well as members of the 1 percent. In laying out both, I will draw heavily on the work of others, especially that of Kim Weeden.


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Education Rent
With all the recent worrying about the travails of the college-educated, it is easy to forget that the payoff of a college education has dramatically increased over the long run, with the sharpest increase occurring in the 1980s. The growing earnings gap between the college-educated and the rest of the labor force is an important source of rising inequality.
But why has this college premium endured, indeed, expanded? To understand the puzzle, let’s imagine that we live in a perfectly competitive economy. In that economy, information about the high returns of a college education would gradually diffuse, workers in pursuit of those returns would invest in college, and the resulting influx of college-educated workers would drive down the premium. The high returns generated by a shortage of educated labor would therefore disappear.
Since 1975, the share of pre-tax income flowing to the top 1 percent has more than doubled.
But they haven’t disappeared. The persistence of high returns suggests that institutionalized bottlenecks are preventing workers from responding as they would in a competitive market. Although other explanations are possible, the bottleneck account is appealing because it is consistent with our understanding of how education is rationed to the select few.
Two types of bottlenecks are especially important. The supply of potential college students is artificially lowered because children born into disadvantaged families are poorly prepared for college and, in any event, haven’t the money to afford it. The demand for college students is kept artificially low because most elite universities, both public and private, ration their available slots. It’s not as if Stanford, Harvard, and Berkeley are meeting the rising demand for their degrees by selling some profit-maximizing number of them. If top universities met demand in this way, the outsized benefits of a high-prestige education would disappear.
Is this how a competitive market works? Absolutely not. When, for example, the demand for hybrid cars increased dramatically in the United States, car manufacturers didn’t set up admissions committees charged with evaluating the qualifications of prospective buyers. Instead, they ramped up production to a profit-maximizing level, and the shortage-driven uptick in prices soon corrected itself. We have become so accommodated to high prices for college-educated labor that we don’t appreciate the rationing and market failure that underlie them.
These bottlenecks create inequality by changing the relative size of the college-educated and poorly educated classes. Because bottlenecks generate an artificially small college-educated class, its wages are inflated and its unemployment rate suppressed. Because they generate an artificially bloated class of poorly educated workers, its wages are suppressed and its unemployment rate inflated. This crowding at the bottom has helped build a massive reserve army of unskilled labor evocative of mid-nineteenth century England.
By addressing such market failure with redistribution, we could indeed prop up wages at the bottom, but with all the angst, opposition, and political drama that redistributive programs evoke in a market-loving society. The better response to market failure is to undertake market repair. If all children, even those born into poor families, had access to adequate primary and secondary school training and then to college education, the high unemployment and poor pay at the bottom would be reduced, as would the low unemployment and excessive pay at the top. We’d have less poverty and inequality if we increased the number of slots in higher education and committed to fair and open competition for them.
Who would win and who would lose from such market repair? The losers would be those who are now artificially protected from competition and are therefore reaping excessive returns. The winners, by contrast, are those currently locked out of higher education who would gain access once markets are repaired.
But these are not the only winners. The other main winners are the businesses that currently pay inflated prices for high-skill employees but will no longer have to do so once higher education is opened up fully to competition. It’s hardly in the interest of business to pay the excessive cost of rationed higher education, nor is it in the wider interest of any country to settle for the lower national income that such restrictions on competition imply. If the emerging economic niche for the United States is product innovation, creative oversight of global product streams, and related forms of high-skill production, then we need a well-educated labor force. We risk choking off that high-road strategy by allowing bottlenecks and high labor costs to persist.
The happy conclusion is that market repair, if taken seriously, can yield a higher national income as well as less inequality. Although it’s conventionally argued that a taste for equality can only be indulged at the cost of reducing total output, this standard tradeoff thesis no longer holds once we realize that existing economies, and perhaps especially the U.S. economy, are burdened with inequality-increasing rent.
This rent will not be shorn off with the usual half-hearted, flavor-of-the-day reform efforts. What’s required is a radical overhaul of our education system. The seemingly uncontroversial objectives of such reform would be to provide the same opportunities to rich and poor children alike and to provide enough higher-education slots to meet the additional demand that equalization would generate. In the education reform industry, most initiatives are marketed on the basis of their effects on school quality, and any possible residual effects on equalizing opportunity are treated as a convenient side benefit. That’s a travesty. We should instead begin and end all discussion of reform by asking whether it secures our commitment to equalizing opportunity. This should be our main goal in just the same way that equalizing civil rights was in the 1960s and 1970s. If we were to commit to this objective, as many other countries have, it would be child’s play to settle on the reforms needed to implement it.