Friday, June 12, 2009

"Cost Push Inflation"

Something people like to talk about is things like rising oil prices "causing" "inflation". The idea is that there are certain commodities which are used in nearly every productive process, and as a result movements in the price of this commodity can influence the prices of just about every other commodity. Petroleum provides both the energy for many, many productive processes, the vast majority of the energy for transportation of products, and the raw materials for everything from the fertilizer used in growing the food to the plastics they are stored in. Because a rise in the price of oil causes a rise in the price of everything else (debatable, but I don't need to go there this time), it follows that The State is justified in engaging in collective action to keep these prices down. Or, another side goes, the prices being left as they are, a certain amount of the higher prices, inconveniencing people as they do, should be collected for the benefit of the state. Right?

I am, of course, referring to subsidies to the oil industry (up to and including war on the industry's behalf) on the one hand, and special taxation of the industry on the other. In addition, I am playing devils advocate here, for the sake of another argument. Certainly, subsidization of the oil industry (or any other) to bring prices down doesn't make sense because the money still has to come from somewhere; ie. taxes. In addition, seeking to reduce the profitability of a commodity will discourage the development of new sources of that commodity, keeping prices up in the long run. However, there is one other thing, an entire category, one of the factors of production, the price of which drives all other prices even more surely than the price of petroleum, but which is not subject to the same market dynamics of petroleum.

I am referring to land. Access to physical space is necessary for existence itself, let alone to the productive processes that support existence. Thus, the costs involved in occupying this physical space must be accounted for in the costs of production. This is true whether you're dealing with a business that is paying rent to an owner, a mortgage to a financial institution, the costs of physical security in a land where the State does not assume this burden, or even if the business owner is also the landowner and is simply paying out market norms for all the other factors, while keeping the surplus (including the rent) for himself. And even if one has found a way to make a living in a place neither tethered to ownable land nor threatened by criminal violence, one is only making use of marginal land... and if it is profitable, this land will not be marginal for long, as others move to imitate.

As an economy grows, the price of a given unit of land relative to the price of a unit of just about anything else grows. For while increasing economic efficiency enables people to get more out of smaller and smaller quantities of any given input, including land , the result is larger available quantities of every other input... but not land. One can squeeze more and more productivity out of a given area of land, which is good for those who own the land, since they can claim an ever larger quantity of goods and services in exchange for the use of their land.

And this increasing cost of access to land must ultimately come out in the prices of goods and services for production to be profitable. These price increases, furthermore, enter the cost of production at a multitude of points.

The minimum price of labor must account for land prices increases, since they affect the price of living space. This minimum price is also affected by food prices, which are affected by rising land prices. The price of everything the laborer must use is affected by land prices. This doesn't necessarily mean all these prices are rising in an absolute sense, but compare what prices are when efficiency increases are opposed by rises in land prices to what they could be if the cost of physical space were somehow magically removed, and you get an idea what I'm talking about here.

Then there's the price of capital goods: machines, facilities, goods on the shelf. All of those who produced these had to pay for access to land; therefore rising land prices affect the prices of these thigns, as well. And the inputs that went into producing the capital goods ALSO were impacted by rising land prices in the previous cycle.

All of this is in addition to the compensation for the landholder for permitting the land to be used by one individual rather than another. Clearly, land prices (or actually, the rental value of land, which impacts, but does not exclusively determine, the purchase prices of land titles) affect prices economy-wide to a degree equal to or greater than the price of oil. IF you happen to believe that goods with this degre of influence over other prices (like oil) fall under the purview of government regulation, taxation, and subsidy (and I admit, I do not share that belief, but work with me here), certainly land falls into this category.

When does this fact become most obvious? When domsetic producers are displaced by producers located in developing regions, the land in which has lower rental values due to things like a lower or less educated population, more frequent violence, less capital development, and overall factors that produced a lower historical degree of interest in developing in those lands. This will not last forever, since this disequlibrium of rental values will eventually stabilize... which is to say, eventually, developing country will become developed country, and what was once marginal land will be pulled into production.

Attempting to legislate rental values down would be foolish, since it is those prices that ensure that land, when it changes hands, goes into the hands of those most capable of making use of it. All you would end up doing is pushing rents into a black market. Because land, by definition, cannot be created, an attempt to stimulate production of land (increase supply) through subsidies is clearly not going to succeed. However, this same fact makes taxation of landholdings unable to reduce the availability of land; thus, unlike special oil taxes, land taxes cannot discourage future production.

For those of you who do not think this is enough to justify regulation and taxation, I will attempt, once again, to present the moral argument next week.

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