Post Covid Prices and Revenues - Revenues - Interest and Rent

Interest and Rent 

Interest 

I've already set out why interest rates are set to surge, as massively increased borrowing meets falling realised profits and savings, but what about the actual amount of interest? The rate of interest is the price of money-capital, whereas interest itself is a revenue to the owner of that money-capital.  If you put your money in a bank savings deposit, the matter is straightforward. A £1,000 deposit, with an interest rate of 1% gives you £10 of interest, whereas, if interest rates rise to 10%, it gives you £100. However, things are not so simple when it comes to the interest on bonds and shares. A £1,000 bond, for example, may have a £10 coupon. i.e. it pays you £10 of interest each year. If you bought the bond at par, i.e. for £1,000, that is a rate of interest/yield of 1%. Now, if interest rates rise, the amount of coupon you get from this bond remains £10. So, for example, if interest rates rise to 10%, and the government or companies issue £1,000 bonds, they would have to pay a £100 coupon on these bonds. The consequence is that all of these older bonds have to fall in value to just £100, in order for their £10 coupon to represent a 10% yield. That is what their owners would get for them if they sold them in the secondary markets. Its a bit like the moral depreciation on fixed capital. Given that the total mass of bonds already in existence far outweighs the mass of new bonds being issued, this is how a rise in interest rates causes a crash of bond prices. The owners of all these existing bonds do not get any additional interest, and the only way their rate of interest/yield rises is because the value of their bonds is itself slashed, inflicting a capital loss on them, if they sell those bonds prior to maturity. 

The same applies to shares. The equivalent of the coupon on a bond is the dividend on a share, except that the amount of dividends is not a fixed amount. In theory, the dividend should only be a market rate of interest, risk adjusted for the additional risk in owning shares as against risk free bonds, i.e. AAA rated government bonds. However, in practice, shareholders appoint company boards and executives, and these directors determine how much should be paid as dividends. As these directors are themselves usually shareholders and get additional shares through share options schemes, they have an incentive in paying out high levels of dividends in excess of this risk adjusted rate, and these higher dividends also act to boost share prices providing additional capital gains for shareholders. That is why dividends have risen from 10% of profits in the 1970's to 70% of profits today. 

However, there is a limit, especially when profits have been used to boost share prices in other ways, such as buying back shares so as to reduce their supply and inflate the earnings per share figure. Its for that reason that, as QE artificially boosted bond prices, and depressed yields, big companies issued bonds to get money to buy back shares and obtain cash to pay as dividends. But, as interest rates rise, and bond prices crash that option no longer exists, and as realised profits are squeezed by rising costs, including rising wages, the mass of profit available to pay as dividends falls. So, the amount of dividends is likely to fall, and as yields on equities also, thereby, fall that provides an incentive to sell shares and buy bonds. That means that share prices also fall, along with bond prices. Again, therefore, the amount of interest does not rise, and the only way the yields rise is by share prices falling. 

But, as the lockdown ends, those businesses still operating will need to expand, and the only way of financing that is by additional borrowing, whether from banks, bond issuance or share issuance. As well as Ford drawing down on its credit lines, many companies are proposing share issues. The additional supply of bonds and shares will again depress those prices, and with lower prices they have to issue a greater volume to obtain any given amount of capital. Unlike QE, used to inflate asset prices, the money-capital required cannot come from money printing. It would simply result in higher commodity price inflation requiring even greater amounts of borrowing. The additional money-capital could only come from additional saving, including a diversion of all of the saving from rents and interest that was previously spent on speculation in existing assets. However, in the conditions already described, where savings have been run down, it will require much higher interest rates on savings to attract these deposits. One source of that may be that many of those who speculated in property, particularly buy to let property, will sell up in favour of a guaranteed return on their money without the risks of being a landlord, especially as land and property prices fall. 

Rents 

Last year, a number of property funds became closed, as redemptions threatened to force them into a firesale of commercial property. The problems of the high street were already leading to falling commercial property prices and rents. Now, as a result of the lockdown, all property funds have closed their doors, essentially telling speculators in them that they cannot take their money out. If they allowed such redemptions, they would have to sell property to raise funds, and, in the current climate, that property would sell at knock down prices, provoking a property market crash.  Property developer Intu has already gone into administration.

House prices are already falling sharply.  According to Nationwide, UK house prices have fallen on an annual basis for the first time since 2012. In June they fell by 0.1% compared to a year earlier. They fell by a whopping 1.4% between May and June, but that is not as much as the 1.7% fall recorded in May compared to the previous month. As an average monthly fall of around 1.6% that is equal to a fall around 18% for a full year, if it continues in coming months.

But, rents themselves will come under pressure. One use of commercial property will be conversion to residential accommodation. That will increase supply acting to put downward pressure on rents. In Britain, Brexit is another factor, as the tens of thousands of EU workers go home, and their replacements no longer come. In addition, as buy to let landlords sell up, able to get guaranteed returns on savings, large amounts of property will come on to the market reducing property prices. Rising interest rates will also cause falling land and property prices, reducing the price of new houses, and enabling builders to build more of them profitably. So, millions of people, still in work, but currently forced into private renting, will be able to buy a house, reducing the demand for rental property, and, thereby, causing rents to fall.  Again, this will widen the divide between a, generally, better educated younger population, able to obtain the jobs that will grow, as against a poorly educated older population, concentrated in decaying towns, whose unskilled jobs will be in decline.

Revenues - Wages

Next Revenues - Profit of Enterprise

The Number of UK Wage Slaves Rises

At Prime Minister's Questions, yesterday, Theresa May opened her remarks by associating herself with opposition to slavery, and its persistence into the modern world. She did not seem to recognise the irony of almost immediately going on to welcome, and indeed praise the role of her government in facilitating, the fact that the latest employment data shows that the number of UK wage slaves has again risen. Everyone understands that those who benefit from more slaves being put to work are the slave-owners, who appropriate the surplus product produced by the slave, yet, the Tories continually expect us to bow down in gratitude that more wage slaves have been employed, in order for those wage slaves to produce a larger surplus product, and surplus value, for a handful of very rich capitalists. The irony of May's statements would not have been missed by economists, and MP's, such as David Ricardo, in the 19th century. Ricardo recognised that being a wage slave was a misfortune that as few people should be subjected to as possible.

The irony would also not have been lost on the author of “Black Swans”, Nicholas Nassim Taleb, who wrote in his book, “The Bed of Procrustes”,

“Karl Marx, a visionary, figured out that you can control a slave much better by convincing him he is an employee.” 

Adam Smith, following on from the Physiocrats, had recognised that value is labour, and that in all modes of production, other than the most primitive, the producers (workers) produce a greater quantity of new value by their labour than is required for the reproduction of their own labour-power, and physically this is reflected by the fact that they thereby produce a surplus product. For so long as these producers owned their own means of production, they were able to appropriate this surplus product/value themselves. It is what led Smith to understand the law of value as being one in which not only is the value of a commodity equal to the labour-time required for its production, but it is also equal to the amount of labour it can command. In other words, a peasant producer of a metre of linen that has a value of 10 hours of labour, can thereby exchange the metre of linen for other commodities with a value equal to 10 hours of labour, and thereby has command over this equal amount of labour used to produce say beer, or bibles.

However, Smith recognised that as soon as a small number of people in society are able to monopolise ownership of either land, or means of production, this law of value appears to break down, because it then becomes obvious that this small group of people is able to command labour for which they have given no equal amount of value/labour, in return. As soon as this situation arises, the owners of this land or means of production, are able to appropriate themselves the surplus labour/product of the producers, just as surely as is the slave owner who directly appropriates the surplus product created by the slave. This situation confused Smith, because he did not distinguish between the value created by labour, and the value of labour-power itself, and the fact that it is precisely because, under capitalism, the producer/worker, sells their labour-power as a commodity, and thereby becomes a wage slave, that the law of value by which the value of commodities is determined by the labour required for their production continues to operate, and yet the capitalist is able to get something for nothing, that the commodities in their possession commands a greater quantity of labour, than is required for their own production.

The reason for this is precisely because these commodities, wage goods, in the possession of the capitalist, do not act as commodities, but as capital. The capitalist only exchanges these commodities, that comprise their variable-capital, or their money equivalent, wages, with the worker on condition that the worker provides more labour, and thereby creates more new value, than those commodities themselves require for their production. In short, if the total economy were viewed, the producers/workers create a quantity of products that are immediately appropriated by capital, and capital only gives back a proportion of those products to the workers, just as the slave owner only gives back to the slave those things required for their subsistence, and capital then directly appropriates the surplus product/surplus value. The tiny number of owners of capital, thereby, can use this surplus product/value to create a lavish lifestyle for themselves as well as to use it to create more capital, and thereby to increase their command over labour, and ensure their ability to appropriate even more profits in future. It is this extension of wage slavery, and exploitation that Theresa May, and the Tories expect us to show our gratitude for!

Adam Smith recognised that the landed aristocracy was able to appropriate the surplus product produced by peasants simply as a result of the fact that their ancestors had been effective murderers and cutthroats, who had built up their ownership of landed property, throughout Europe, and that, on the basis of this ownership, they were able to demand that the surplus product that the peasant producers would previously have owned themselves, was paid, instead, as rent, to the landowner. It was why Smith was scathing of such parasitic elements in society such as the aristocracy, the clergy etc. Smith also recognised that it was the fact that the means of production had been monopolised by a small group of capitalists, and that as capitalist production replaced peasant production, and the old guild production, the labourers could only work, if they had access to these means of production.

It was the fact that there were many labourers seeking work, but a relative shortage of capital, which Smith believed explained the breakdown of the law of value, so that the owners of capital were able to command a greater quantity of labour with the commodities in their possession, than was represented by the value of those commodities. In other words, Smith believed that the law of value broke down because the relative oversupply of labour, pushed down its price, whilst the relative shortage of capital pushed up its price. Writing near the dawn of this capitalist production, Smith saw the rapid accumulation of capital, and the rapid growth in the number of people who were themselves becoming capitalists. On this basis, Smith mistakenly believed that this relative imbalance in the supply of labour and capital would be resolved, as the supply of capital was thereby increased, and the demand for labour increased along with it. The result would be that the ability of capital to appropriate the surplus value created by labour would then be diminished, so that the mass and rate of profit would continually be squeezed. 

This was Smith's explanation for the historical tendency for the rate of profit to fall, and he saw it as inevitably leading to a crisis for capitalism, as eventually the profit would disappear altogether. He was wrong, as Marx describes.

“A distinction must he made here. When Adam Smith explains the fall in the rate of profit from an over-abundance of capital, an accumulation of capital, he is speaking of a permanent effect and this is wrong. As against this, the transitory over-abundance of capital, over-production and crises are something different. Permanent crises do not exist.” 

(Theories of Surplus Value, Chapter 17, Footnote 1)

Marx recognised that although, there are indeed times when capital accumulates rapidly so that the demand for labour-power rises, pushing up wages, and squeezing profits, it is the very fact that capital will only employ wage slaves when those wage slaves hand over a portion of their labour gratis that ensures that this cannot be a permanent situation. It only arises exceptionally, although periodically, in temporary crises of overproduction. The response of capital to such situations is always to create for itself a relative surplus population, and it does this by investing in the development of new labour-saving technologies, so that the existing output can be produced with less labour, and increased output with the same amount of labour, so that the relative shortage of labour-power is overcome, wages are pushed down, and the rate of exploitation thereby pushed up.

As Marx puts it,

“Take, for example, the rise in England of agricultural wages from 1849 to 1859. What was its consequence? The farmers could not, as our friend Weston would have advised them, raise the value of wheat, nor even its market prices. They had, on the contrary, to submit to their fall. But during these eleven years they introduced machinery of all sorts, adopted more scientific methods, converted part of arable land into pasture, increased the size of farms, and with this the scale of production, and by these and other processes diminishing the demand for labour by increasing its productive power, made the agricultural population again relatively redundant. This is the general method in which a reaction, quicker or slower, of capital against a rise of wages takes place in old, settled countries. Ricardo has justly remarked that machinery is in constant competition with labour, and can often be only introduced when the price of labour has reached a certain height, but the appliance of machinery is but one of the many methods for increasing the productive powers of labour. The very same development which makes common labour relatively redundant simplifies, on the other hand, skilled labour, and thus depreciates it.”

(Value, Price and Profit) 

Rather than the amount of profit falling, as Smith believed, therefore, it is actually increased. Yet, as Marx also describes, it is these measures to overcome the crisis of overproduction, which then lead to the tendency for the rate of profit to fall, that Smith, and other economists had been struggling to explain. That is because, this rise in productivity means that more material is processed by the same amount of labour, which in turn means that the proportion of the value of the final output accounted for by material rises, whilst that of labour (divided into wages and profits) falls. This tendency for the rate of profit to fall, therefore, does not, as Smith and others believed, represent some existential threat to the system, but on the contrary, is the manifestation of its ability to continually overcome these periodic crises of overproduction, to raise productivity, and with it the mass of profit, and thereby to continue its upward path. It represents not an indication of decay, but of continued vibrancy, of the ability to continually be able to revolutionise the means and methods of production, so as to overcome those temporary shortages of labour.

If anything, therefore, the rise in UK employment of wage slaves, and fall in unemployment should be seen as a bad thing, when combined with the further fact that UK productivity has not just slowed, but is now falling, and with the fact that the wages of British workers are lower today, in real terms than they were ten years ago. It indicates that UK capital is suffering from decay, and a failure to revolutionise the means and methods of production, so as to increase the mass of profits via greater efficiency. Instead, it is relying on maintaining its existing levels of profits by reducing wages, and forcing workers thereby to sustain their level of subsistence by increasing resort to debt, not to mention the resort to food banks, and other forms of charity, reminiscent of the 19th century, and the novels of Charles Dickens.

The critique of the bourgeois-liberal view of the freedom of the labourer was also indicated by Linguet. Ricardo pointed out that it is better for a society to have only 200 labourers who are productive enough to be able to support a population of 300, than to have a society of 300 labourers that are able to support a population of 400. The gross product is greater in the latter case, but its net product, i.e. the product left over after the consumption of the labourers has been met, is only 33.3%, whereas in the former case, although the gross product is 25% less, the net product is 50%. Ricardo argued that the fate of the productive labourer is to produce a surplus product and surplus value always for someone else, and so the number of people placed in this unfortunate position should be kept to a minimum.

The Tories have tried to deflect criticism of the fact that real wages are lower today than ten years ago, by talking about the cuts in income tax, but those tax cuts primarily benefit those on higher incomes. Moreover, whilst they mention the raising of income tax thresholds, they fail to mention that, after 2010, they and their Liberal allies increased the rate of VAT by 20%, from 17.5% to 20%, and indeed in January 2010, VAT was only at 15%. Given that the lowest paid workers have to spend all their wages in buying goods and services, to live, the rise in VAT is far more burdensome on them than any relief given from a reduction in income tax. Moreover, lower paid workers are more reliant on public services provided by local councils, and it is again those, often free, services that have been cut, by the Tory policies of austerity, forcing those households now to have to pay for what were once free services, or else to do without them altogether.

The Tories also talk hypocritically about the need to make work pay, and that the way out of poverty is through work. Of course, the fact is that it is those in work who have seen their wages fall in real terms, and who are also the main recipients of benefits that have also been cut as a result of Tory austerity. But, as Ricardo and others point out, the idea that it is work that pays, or is the way out of poverty is itself a lie. It is not the workers who are the main beneficiaries of their labour, but the owners of capital, and, unlike in Ricardo's day, the main owners of that capital are not even functioning capitalists, but merely rentiers, people who own money-capital, and whose wealth is in the form of fictitious-capital, of shares and bonds, from which they can simply draw interest. They are no different to the useless parasitic, landed aristocracy that was criticised by Adam Smith, and who have no further useful role to play.

Take someone with £1 million, who even just puts it in a savings account that currently pays them even the measly 1% interest currently available. It would provide them with an income thereby of £10,000 a year, or just under half the national average wage, and about two-thirds the average wage in a place like Stoke. Yet, they have to do no work to obtain this £10,000, they have to own no business, or risk their capital in any way. By the same token, someone with £10 million would get an income from it of £100,000 a year, or four times the national average wage. So, how is it possible to argue that work is the means to riches, or that work is being made to pay as against not working? Its quite clear here that those who do not work, but who have even a modest amount of capital are the ones who are the ones that are benefiting, and the interest they are paid on their capital is the direct result of the surplus value being produced by those in work, whose wages amount to only a fraction of the unearned incomes of the rentiers.

But, then look at the situation that exists in Britain. There are 134 billionaires in the UK. Just 1% interest on a billion Pounds comes to £10 million a year! For that, you would need do no work, invest in no productive activity, simply sit back and draw the interest. And, where does that interest come from? It comes from millions of workers, paid minimum wage, doing jobs of varying degrees of security, who, like the slaves before them, produce all of the goods and services, but who only consume themselves a portion of those very same goods and services, the surplus product they produce thereby being appropriated by capital, and portions of it then being handed over in the form of interest to share and bondholders, rents to landlords, taxes to the capitalist state, as well as lucrative sinecures to all of the bureaucrats, lackeys, and executives who look after the interests of the capitalists, and ensure that the payment of these dividends, rents, and interest continues.  No wonder the Tories see the increase in the number of wage slaves as cause for celebration!

In between the £10,000 interest of the rentier with just £1 million of capital, and the £10 million of interest received by the billionaire rentier (and in fact, the yield they get on their ownership of shares is greater than 1%) there are thousands more who draw large huge incomes in this way without contributing anything of any value to society. The idea that in capitalist Britain work pays, is a cruel deception, perpetrated by the Tories.

Business Rates

There has been a lot of discussion, over the last week, about Business Rates. The Tories have once more got themselves into a bit of a pickle, because they are in danger of alienating some of their small business supporters in the better off parts of the country, particularly London and the South-East. The basic issue is this. Business Rates are calculated on commercial property values, and in the better-off parts of the country, particularly London, commercial property values along with other property values have soared into an unsustainable bubble over the last decade. That means that Business Rates in these areas should rise. On the other hand, in other parts of the country, property values have stagnated or fallen, and so Business Rates in these areas are scheduled to fall. Overall, the Tories claim that the falls in Business Rates, will be larger than the rises, but it is those facing the rises, and specifically the largest rises that are complaining, and putting pressure on their Tory representatives.

Of course, the fact is that, commercial property has not been revalued for seven years. The revaluation should have been done, and the effects implemented ahead of the 2015 election, but the Tories, fearing the kind of hostility they are now encountering, deferred it to boost their election hopes. The reality is, therefore, that for the last seven years, when property values in London have soared, businesses there and elsewhere, that experienced these property bubbles have benefited compared to other parts of the country, who likewise, therefore, continued to pay too much in Business Rates. In other words, as with many more things, for example, the cost of commuter rail travel to London, the rest of the country has been subsidising already buoyant businesses in the capital.

The owners of these businesses in London, are complaining about the size of the rises they now face, of as much as 300%. But, the fact is that they know how Business Rates work, and they know that in the last seven years, at least, property values in London have been in an unsustainable bubble. They have had seven years, during which time their Business Rates were lower than they should have been, to have set aside some of their profits to cover this rise when it came, or else to have used that time to relocate their business to other parts of the country, where property values have not soared, if the question of such rates are a significant impediment to their business.

After all, that is how the capitalist market is supposed to operate. If costs rise in London to a level where firms make lower profits than in say Stoke, those businesses should relocate to Stoke, where their costs will be lower, and their profits higher. That would provide work for the people of Stoke who over the last seven years and more, have suffered from the policies of fiscal austerity that in part have been driven by the government's attempts to keep interest rates low, and to keep the property bubbles in places like London inflated. The increase in the demand for labour-power in Stoke would then increase workers wages in the area, and increase the demand for property, bringing about a rebalancing, whilst the fall in employment in London, and fall in the demand for property, would decrease London wages, burst the London property bubble, and thereby bring about an equalisation. This is the basis for the formation of a general rate of profit that drives the allocation of capital in a capitalist economy.

As this reallocation of capital, to places like Stoke, then occurs it not only raises living standards in the area, which have been decimated, as a result of the conservative policies implemented over the last thirty years, but on the back of those higher revenues for workers and businesses, it would also raise local taxes to finance the decayed infrastructure and so on that has been destroyed over that period, and which has led to the rise of reactionary forces such as UKIP and Brexit. There is then no economic rationale for the Tories collapsing, over the demands of business owners in London and other areas, where property values have soared. But, as with the situation before the 2015 election, and other issues relating to property bubbles, the reason the Tories are likely to buckle is purely political.

It isn't big businesses that are complaining about the rise in business rates. For these businesses, such taxes represent only a small part of their profits. It is the small businesses that are complaining, because the tax forms a larger part of their profits. But, that is the problem the Tories face, because they represent the interests of these small private businesses, as well as the interests of money-lending capitalists, and landlords. It is these small private capitalists that make up the core of the Tory party membership, and of its electoral base. Yet, if the Tories concede to those interests in London, it will relatively disadvantage the same social layers in the rest of the country.

Looking at the small businesses in London, either they own or rent those properties. The business owners who own the property, of course, have not complained about the huge speculative capital gains they have made in the prices of those properties over the last seven years and beyond, which have absolutely nothing to do with any effort on their part. Their is a good economic argument for encouraging such beneficiaries of these speculative capital gains to realise them by selling their properties and moving their business to some other lower cost part of the country, as described above. There is no economic argument for facilitating further such speculative gains, and allowing those business owners to benefit from them, by effectively subsidising their current Business Rate liability.

After all, the basis of the rise in those rates is not a rise in the actual tax rate itself, but is the fault of that very rise in property values. If small businesses in London want to see lower Business Rates, they should place the blame where it lies, on hugely inflated property values, and seek to burst that property bubble.

For those businesses in London that rent their premises a different set of questions arises. Firstly, high commercial property prices are a reflection of high commercial rents, because property prices are capitalised rent. But, as Ricardo and Marx described long ago, the reason there are higher differential rents in one area as opposed to another, is because the difference between commodity values and the price of production is greater in some areas than others, so that surplus profits are obtained, and landlords thereby levy a differential rent on this surplus profit. In other words, the economic conditions in London, facilitate surplus profits for businesses there, which enables landlords to levy higher differential rents, which thereby inflates property prices. There is little economic basis, let alone social justice basis, therefore, for the less well off, economically depressed parts of Britain, to subsidise London business, and London landlords, by subsidising the business rates of small businesses in the capital.

The same small businesses that are complaining about the rise in Business Rates, do not seem to have complained in the same way about the higher commercial rents they have had to pay over the last seven years, and yet one might assume that these rents are a more significant portion of their profit than is Business Rates. Higher Business rates, required to finance local services and so on, in London, would reduce the amount available to be paid out as rents to landlords, which would in turn assist in lowering London property values. There is no reason that anyone should be subsidising London landlords, who have made a killing from simply being parasites leaching off the economic activity of others.

The Tories, of course, are likely for purely political reasons to subsidise both the small businesses and landlords in London and the South-East, which again effectively means helping to keep those property bubbles inflated, and paying for it by draining surplus value from productive investment, and from the more deprived areas of the country. It is the same conservative political agenda, which over the last thirty years left large swathes of the country in a state of decay and decline, with similar conservative policies in the US and EU having the same effect that then leads to the rise of reactionary separatist and nationalist agendas and parties.

When house prices entered an unsustainable bubble, it led to the 2007-9 financial crisis. The bubble in house prices should have meant that demand for them, itself largely artificially stoked, for speculative purposes, by the Tory government in the 1980's and after, collapsed, causing a collapse in those prices. In fact, that is what happened. In parts of the US, property prices fell by around 60%, the same was true in Ireland. In Britain, house prices fell by 20% in short order – demonstrating that the high prices had nothing to do with some structural shortage of supply – and were on their way to exceeding the 40% drop they suffered in similar conditions in 1990. But, instead of allowing that collapse to proceed in order to restore some semblance of rationality to the property market, first the Labour government of Gordon Brown, slashed banks borrowing costs so that they could subsidise mortgages, and then as those money drugs wore off, after 2010, the new Tory-Liberal government, artificially boosted demand yet again with the Help To Buy scams, and so on, so as to prevent the bubble from bursting. The Tories are addicted to these property and financial bubbles, because the illusion of wealth they create is central to the fictitious wealth of those sections of the population on which they rely for their support. But, the cost of keeping those bubbles inflated is to damage actual economic growth and productive investment. Moreover, the cost of doing that has grown more and more over the years, so that it is now unsustainable.

Rents are at massively inflated levels, and yet rental yields are at record lows; dividend and bond yields are at near zero levels, and yet the amounts paid out in dividends and interest are at high levels; mortgage rates have been reduced to record low levels, and yet mortgage payments have soared, and an increasing number cannot afford to buy a house, because house prices themselves have ballooned to ridiculously high levels. In the meantime, dragged down with all of this debt, increasing numbers of people cannot get through the month without resort to high cost credit on their credit cards, or to payday lenders charging up to 4000% p.a. interest rates. This is not just unsustainable, it is way beyond unsustainable. The lesson that should have been learned over the last thirty years is that economies cannot be built upon such fictitious wealth and debt, and when this bubble inevitably bursts, the consequences will be much greater than in 2008, when that reality first broke through.

Of course, Business Rates are themselves a bad tax, just as domestic rates had been, and as Council Tax is now. They are all regressive forms of taxation, which is why, in relation to Business Rates, it is the small businesses that are complaining, not the big businesses. It would be far better to replace both Business Rates and Council Tax with a local income tax. Modern computer technology makes that quite easy to achieve.

In fact, asI wrote previously, I would also scrap Corporation Tax, and replace it with much higher taxes on dividend income, so as to encourage firms to reinvest their profits into the business rather than pay it out as dividends. I would accompany that with changes in the laws on corporate governance, so as to remove the rights of shareholders to elect company boards, and instead give that right to the workers and managers within the company. That would also deal with the question of corporate raiders simply buying up the shares of a company, and then using their control to shift production elsewhere.

And, as I also wrote some time ago, if companies are to be taxed, they should, like workers, be taxed on their sales not their profits. If workers paid income tax only on the profits they made from selling their labour-power, as companies do in paying corporation tax on their profits, then workers would pay no income tax, because they make no profit on selling their labour-power. The cost of producing their labour-power is equal to the price they obtain for it, in the form of their wages – if they are lucky!

The problem with local income taxes is that in those areas of the country where economic activity is already depressed, and where more is required to cover things such as social care, health care and so on, the tax base is also lower. That means that either the services provided in those areas are of lower quality, reducing the use value of labour in that area, and also acting as a deterrent for other inward investment, or else the rates of tax levied in such areas have to be higher, again acting as a deterrent for inward investment, and encouraging the better paid workers to also move out to lower tax areas. That was witnessed in New York, during the 1970's, for instance.

In order for such local income taxes to work properly, therefore, they have to be accompanied by forms of fiscal transfers from a central state authority, so as to create a more level playing field within the overall economy, and in order to prevent a race to the bottom in relation to taxes, and services. In fact, that is one reason that not only is Socialism In One Country a reactionary and utopian concept, but in the modern globalised world, with a world economy, and capital taking the form of huge multinational companies, even the idea of social-democracy in one country is a reactionary and utopian concept. It is why the foundation of the Eurozone was always flawed, and why the EU will have to bring about greater fiscal and monetary integration, and introduce greater fiscal transfers across the member states, so as to promote growth in economies such as Greece, Portugal, Italy and Spain.

It is also why Brexit is a thoroughly reactionary concept that will damage the interests of workers, particularly in Britain, for decades to come, if it is ever pushed through.

Differential Value

Differential Value is a concept developed by Marx to deal with a logical problem arising from his theory of rent. Marx outlines the nature of this problem, and the basis of Differential Value as the means of resolving it in Theories of Surplus Value, Chapter 12.

The problem amounts to the following. Marx distinguishes between two types of rent – Absolute Rent, and Differential Rent. Differential Rent also divides into Differential Rent I, which arises from varying fertility of different types of land, and Differential Rent II, which arises from the addition of increasing amounts of capital to a given area of land, i.e. what orthodox economics would describe as the marginal productivity of land and capital respectively.

The Absolute Rent arises on all cultivated land, contrary to the belief of Ricardo, who denied the possibility of Absolute Rent. The basis of Absolute Rent, Marx sets out, is the existence of landed property. The owners of land have no reason to permit its use by capitalist farmers, unless they are paid a rent for its use. The economic basis of the Absolute Rent is the overall surplus profit obtained in agriculture compared to the general annual rate of profit in industry. That surplus profit arises because the organic composition of capital in agriculture is lower than in industry.

In industry, such surplus profits, between different spheres, are competed away, as capital moves from low profit areas to high profit areas, increasing the supply of commodities in the high profit areas, and thereby reducing their prices to the price of production, where only the general annual rate of profit is obtained. But, capital can only enter agriculture, if it is prepared to pay this absolute rent, and it will only do so, if it can also still make the average profit. Capital will then be restricted from entering agriculture, and reducing agricultural prices, and will remain in industry, keeping industrial prices lower than they would have been, and keeping the general annual rate of profit lower than it would have been.

The Absolute Rent, then, as its name suggests, is an Absolute Rent, a flat rate that must be paid by all cultivated land. The Differential Rent, is an amount of rent paid in addition to the Absolute Rent, and is determined by the specific surplus profit made on one type of land compared to another. The more surplus profit a piece of land produces the higher the Differential Rent. Absolute Rent acts as a limitation on additional capital investment, but Differential Rent does not. Absolute Rent limits capital investment, because capital will only be invested if market prices are high enough to cover both the general annual rate of profit, and the absolute rent, but Differential Rent requires that such a condition already exists. Additional capital investment, therefore, not only covers that absolute rent, but produces additional profit for the capitalist farmer. 

Total rent is then the sum of the Absolute Rent and the Differential Rent. However, the logical problem that Marx identifies is that under some market conditions, the market value of output is not determined by the least fertile land. Under those conditions, the market value of output, will not be sufficient to cover the payment of Absolute Rent, on some types of land. Marx sets out various scenarios where this occurs in a set of tables Tables A-E, presented in an insert between pages 264-265, of Chapter 12 of Theories of Surplus Value.

But, if the Total Rent on a piece of land is the sum of the Absolute Rent and the Differential Rent, and if, as must be the case, the Absolute Rent, is a flat rate payable on all cultivated land, if the actual rent paid is less than the Absolute Rent, that has to mean that the Differential Rent would be a negative amount. The idea of a negative rent, of a landlord paying a tenant to use their lower fertility land is irrational. It is in order to overcome this irrationality that Marx introduces the concept of Differential Value.

In Theories of Surplus Value, Marx uses the term “cost-price” for what in Capital Volume III, he defines as “Price of Production”. Wherever Marx uses the term “cost-price” here, therefore, it has to be born in mind that he does not mean cost-price as used in Capital, or as generally understood to mean the cost of production (c + v), but means price of production, the cost price plus the average profit, or k +p.

The basis of Absolute Rent is the surplus profit produced in agriculture compared to the general annual rate of profit in industry. Marx sets this out as follows.

Industry

c 80 + v 20 + s 10 = 110, r' = 10%.

Agriculture

c 60 + v 40 + s 20 = 120, r' = 20%.

If agriculture were like other industries, capital would flow into it, in search of this higher rate of profit. Agricultural prices would fall and industrial prices rise until both settled at the price of production of 115, where both sectors would make an annual rate of profit of 15%. But, landed property prevents such a free flow of capital. The landlord says, to the capitalist farmer, you have invested 100 of capital, and like other capitalists you are entitled to a 10% rate of profit. But, the value of your output is 120, so I will take 10 as an absolute rent, which means you will still make that average annual rate of profit.

On this basis, the general annual rate of profit is that set in industry of 10%. Both industrial and agricultural capitalist obtain this same average rate, whilst the landlord appropriates the surplus profit of 10, as absolute rent. The basis of the Absolute Rent then is the difference between the market value of output (120) and the price of production of that output (110). Ricardo's assumption in his theory of rent, is that it is the least fertile land that determines this market value. Because Ricardo does not understand the difference between market value, or exchange value, and price of production, he cannot understand the basis of Absolute Rent, which is why he denies its possibility.

But some agricultural producers operate on more fertile land than others. If the least fertile land determines the market value, then these other producers, using more fertile land, will have lower costs of production, and so will make surplus profits, resulting from this advantage. This additional surplus profit, is the basis of the Differential Rent. The Differential Rent is then equal to the difference between the Individual Value of output from a particular type of land, and the Market Value of that output.

By extension, therefore, the total rent for a particular type of land is the difference between its individual price of production and the market value. Marx sets these relations out as follows.

“In order to put this down in the form of equations, we shall call the absolute rent AR, the differential rent DR, the total rent TR, the market-value MV, the individual value IV and the cost-price CP. We then have the following equations:

1. AR=IV-CP=+y

2. DR=MV-IV=x

3. TR=AR+DR=MV-IV+IV-CP= y+x=MV-CP

If MV>IV then MV-IV=+x. Hence: DR positive and TR= y+x.

And MV-CP=y+x. Or MV-y-x=CP or MV=y+x+CP. 

If MV < IV then MV - IV = -x.  Hence DR negative and TR = y - x.
And MV-CP=y-x. Or MV+x=IV. Or MV+x-y=CP. Or MV=y-x+CP.

If MV=IV, then DR=0, x=0, because MV-IV=0.

Hence TR=AR+DR=AR+0=MV-IV+IV-CP=0+IV-CP=IV-CP=MV-CP=+y.

If MV=CP [then] TR or MV-CP=0”

(Theories of Surplus Value, Chapter 12, p 294)

But, its then obvious, on the basis of these formulas, that, under certain market conditions, as Marx sets out in the Tables A-E, that although in each case, Total Rent (TR), should be greater than zero, Differential Rent (DR) could be negative.

Marx introduces the concept of Differential Value to deal with this anomaly. He writes,

“As regards products of separate classes, it is quite possible, that their [individual] value is above or below the market-value. If it is above the market-value, the difference between the market-value and their cost-price is smaller than the difference between their individual value and their cost-price. But as the absolute rent equals the difference between their individual value and their cost-price, the market-value cannot, in this case, yield the entire absolute rent for these products. If the market-value sank down to their cost-price, it would yield no rent for them at all. They could pay no rent, since rent is only the difference between value and cost-price, and for them, individually, this difference would have disappeared, because of the [fall in the] market-value. In this case, the difference between the market-value and their individual value is negative, that is, the market-value differs from their individual value by a negative amount. The difference between market-value and individual value in general I call differential value.”

(Theories of Surplus Value, Chapter 12, p 268) 

The Differential Value is calculated per unit of output as the difference between its market-value, and individual value. On more fertile lands, the market value of output per unit should always be higher than the individual value per unit of output, and so the differential value will be positive, but on the less fertile land, the market value per unit could be lower than the individual value per unit resulting in a negative differential value. To take one of the examples that Marx gives, to illustrate where such a situation could arise, if some new land is brought into use that is very fertile, so that the supply of commodities (Marx in these examples uses the output of mines) increases, it could push market prices for these commodities down.

At these lower market prices, demand may expand so that all of the output from all land can be absorbed. But, if this market price is lower than the individual value of production on the least fertile land, not only will it not, be able to pay any Differential Rent, but it will not be able to pay the full amount of Absolute Rent. But, producers on this land would be unable to raise prices to a level where the full Absolute Rent was payable, because if they did, demand for the commodities would fall, and their particular output would not be saleable.

Suppose, £1,000 of capital is employed on this land comprising £600 c + £400 v, and the rate of surplus value is 50%, so s = £200. If 1,000 units are produced, there individual value is £1.20 per unit. If the average rate of profit is 10%, the individual price of production is £1.10 per unit. If the market value of these commodities is also £1.20 per unit, then an Absolute Rent of £10 is payable. However, suppose some new more productive land comes into production, which causes the market value of these commodities to fall to £1.15 per unit. This new production means that now 1,200 units are produced each year. At this lower price of £1.15 per unit, all of these 1,200 units can be sold, but at £1.20 per unit, only 1,000 units can be sold, which means that 200 units of the first capital's output would be unsaleable.

Yet, at £1.15 per unit, it still produces a profit of £0.15 per unit over its cost of production of £1, and moreover, this profit of £0.15 per unit, or 15%, is more than the average rate of profit in industry of 10%. So, there is still an incentive to produce, but it would then not be possible to pay the full amount of absolute rent.

Differential Rent II

Differential Rent II arises when, instead of additional capital being invested on additional land, the same land is cultivated, but increasing increments of capital are applied to it. Differential Rent I remains at the root of this form of rent, but the changes in the amounts of surplus profits obtained result from the marginal productivity of the capital employed.

With Differential Rent I, the same amount of capital is applied in each case.  Any differences in output can then be seen to be attributable to the fertility of the particular type of land, not to the capital.  But, with Differential Rent II, the starting point is one type of land, to which varying quantities of capital are applied.  In that way, any changes in output can be determined as the product of this additional capital.

In modern orthodox economics, the three factors of production - land, labour and capital - are treated separately to determine their marginal productivity.  In other words, two of these factors would be held constant, and the result of marginal increments of the third analysed to determine its marginal product.  But, Marx includes labour in capital, in this analysis, because the capital applied consists of both constant and variable capital, and with prices of production, the profit appropriated by each capital is determined by the average rate of profit.

If we take, a hectare of land, therefore, if £1,000 of capital is applied to it, and it produces 1,000 kilos of wheat, and then on the same piece of land, observe that £2,000 of capital produces 2,000 kilos of wheat, we can determine that this additional 1,000 kilos is the product of this additional £1,000 of capital.  The amount of additional output produced by this additional £1,000 of capital, is the same as that produced by the first £1,000 of capital, and so the marginal productivity of capital here would be constant.  However, if the additional £1,000 of capital resulted in output rising to 2,500 kilos, this second instalment of capital would have been responsible for an additional 1,500 kilos.  In that case, the marginal productivity of capital would be rising.  Conversely, if the output rose, but only rose to say, 1,800 kilos, the second instalment of capital would have caused this rise in output, but it would be a rise in output of only 800 kilos, compared to the initial 1,000 kilos.  In that case, the marginal productivity of capital would be falling.

Land Type	Cost of Production £	Output	Price of Production £	Income £	Profit £	Rate of Profit %	Surplus Profit/ Rent £
A	4,000	4,000	1.25	5,000	1,000	25.00	0
B	8,000	15,000	1.25	18,750	10,750	134.38	8,750
C	4,000	6,000	1.25	7,500	3,500	87.50	2,500
	16,000	25,000	1.25	31,250	15,250	95.30	11,250

As a result of a rising marginal productivity of capital, it now becomes land type B which produces the highest surplus profit and rent. The capital employed has doubled, but the output has trebled, causing the rise in the rate of profit.

In their analysis of rent, Marx and Engels give numerous examples of these multifarious changes in the amount of rent produced by different marginal productivities of land and capital, and under conditions where the marginal productivity may be rising or falling. Production on a larger scale makes possible the use of more effective capital, for instance. The continued use of fertiliser, and working of the land, can bring about more permanent changes in fertility etc.

Another aspect of Marx's analysis of rent is the difference between the rate of rent and rent per hectare (rental), and again, this is affected by whether the rent is a consequence of Differential Rent I or II. Where cultivation is more extensive than intensive, additional areas of land are brought into cultivation to satisfy the increased demand for agricultural products. The consequence is that more rent is levied, in total, but the amount of rent per hectare may be unchanged, because more hectares are cultivated. If however, the increased output is achieved by a more intensive cultivation, by applying more capital, this may result in an absolute rise in rents, as Differential Rent II rises, but as no additional land is brought into cultivation, the rent per hectare rises. 

As with Differential Rent I the surplus profit, created by the marginal increments of capital, is the equivalent of the marginal revenue product of capital, in orthodox economics. But, similarly, as with Differential Rent I, although these marginal increments of capital result in variable increases in the physical product, that is not the same as an increase in the value created. The value created depends upon the labour-time expended, and if the employment of additional capital results in an increase in the volume of output relative to any given amount of labour-time expended, the value per unit of output will necessarily fall.

Capital III, Chapter 47 - Part 26

In the case of the small producers, Marx says, rational cultivation is impossible, because they lack the means and the knowledge to apply social productivity. Lenin, writing on agriculture, quotes Kautsky's analysis that it was only the more developed western European agricultural labourers who had shaken off the limitations of individualism, typical of the small peasant, and developed a sense of social solidarity through their trades unions, and other such bodies, who could develop agricultural co-ops, like Ralahine, that offered a progressive and superior alternative to capitalist farms.

But, rational agriculture was not possible for the large capitalist farms either, Marx says, because they were driven by the market, which led to both the soil and the agricultural labourers being degraded.

“Small landed property presupposes that the overwhelming majority of the population is rural, and that not social, but isolated labour predominates; and that, therefore, under such conditions wealth and development of reproduction, both of its material and spiritual prerequisites, are out of the question, and thereby also the prerequisites for rational cultivation. On the other hand, large landed property reduces the agricultural population to a constantly falling minimum, and confronts it with a constantly growing industrial population crowded together in large cities. It thereby creates conditions which cause an irreparable break in the coherence of social interchange prescribed by the natural laws of life. As a result, the vitality of the soil is squandered, and this prodigality is carried by commerce far beyond the borders of a particular state (Liebig). [ Liebig, Die Chemie in ihrer Anwendung auf Agricultur und Physiologie, Braunschweig, 1862. — Ed.] (p 813)

That was particularly evident at the time Marx was writing. Engels had detailed, at length, the appalling conditions of workers in the towns, but, as Marx sets out, the conditions of agricultural workers, and those of other workers detailed in Capital I, such as the miners, or the itinerant workers, moving around the country, building railways, roads, canals etc. was often worse.

“While small landed property creates a class of barbarians standing halfway outside of society, a class combining all the crudeness of primitive forms of society with the anguish and misery of civilised countries, large landed property undermines labour-power in the last region, where its prime energy seeks refuge and stores up its strength as a reserve fund for the regeneration of the vital force of nations — on the land itself. Large-scale industry and large-scale mechanised agriculture work together. If originally distinguished by the fact that the former lays waste and destroys principally labour-power, hence the natural force of human beings, whereas the latter more directly exhausts the natural vitality of the soil, they join hands in the further course of development in that the industrial system in the countryside also enervates the labourers, and industry and commerce on their part supply agriculture with the means for exhausting the soil.” (p 813)

Yet, it seems to me that this is a peculiarly one-sided, rather than dialectical view presented by Marx. It sounds more like a Malthusian or Ricardian pessimistic view, as opposed to the generally optimistic view of the potential for progress and modernisation that Marx usually presents, and which he also set out in the previous chapter. In Capital I, having lent on such a view of the destructive nature of capital, in respect of the extension of the working day beyond natural limits, Marx then described how the objective requirement of capital not to kill the goose that lays the golden egg, leads it, despite competition between capitals, to establish a normal working day, and to enshrine it in law, along with other similar provisions of the Factory Acts, so as to be able to continue to harvest surplus value from the workers in increasing masses.

Engels in his later Prefaces to his own “Condition of the Working Class in England”, sets out how the development of capitalism itself is sufficient to bring about such changes, in the self interest of the capitalists as a class.

“And in proportion as this increase took place, in the same proportion did manufacturing industry become apparently moralised. The competition of manufacturer against manufacturer by means of petty thefts upon the workpeople did no longer pay. Trade had outgrown such low means of making money; they were not worth while practising for the manufacturing millionaire, and served merely to keep alive the competition of smaller traders, thankful to pick up a penny wherever they could. Thus the truck system was suppressed, the Ten Hours’ Bill was enacted, and a number of other secondary reforms introduced — much against the spirit of Free Trade and unbridled competition, but quite as much in favour of the giant-capitalist in his competition with his less favoured brother. Moreover, the larger the concern, and with it the number of hands, the greater the loss and inconvenience caused by every conflict between master and men; and thus a new spirit came over the masters, especially the large ones, which taught them to avoid unnecessary squabbles, to acquiesce in the existence and power of Trades’ Unions, and finally even to discover in strikes — at opportune times — a powerful means to serve their own ends. The largest manufacturers, formerly the leaders of the war against the working-class, were now the foremost to preach peace and harmony. And for a very good reason. The fact is that all these concessions to justice and philanthropy were nothing else but means to accelerate the concentration of capital in the hands of the few, for whom the niggardly extra extortions of former years had lost all importance and had become actual nuisances; and to crush all the quicker and all the safer their smaller competitors, who could not make both ends meet without such perquisites. Thus the development of production on the basis of the capitalistic system has of itself sufficed — at least in the leading industries, for in the more unimportant branches this is far from being the case — to do away with all those minor grievances which aggravated the workman’s fate during its earlier stages.” 

Moreover, Engels in his Critique of the Erfurt Programme, and in various comments in Capital III, sets out the way that the replacement of private capital with socialised capital, in the form first of the joint stock companies and later the giant trusts and corporations, also leads to the ending of the “planlessness” of the early form of capitalist production. In the twentieth century, that process of introducing ever greater planning into the functioning of capitalism both at the level of the enterprise, and of the national, and even international economy, has proceeded further. In agriculture it is reflected in the introduction, for example, in Britain, after WWII, of the Milk Marketing Board, and later by the introduction of the Common Agricultural Policy in the EEC. It is seen in the various agreements to preserve fish stocks, by imposing quotas on the amount of fish of varying types that can be caught in particular waters.

Similarly, Marx has set forth the way capital was able to apply science and technology to agriculture, as much as to any other industry. The development of machinery enabled land to be ploughed, drainage to be introduced,, as well as livestock to be improved and so on. In fact, there is at least, if not more evidence of human activity in the past, causing despoliation of the land, and desertification than has capitalism, which, especially in the form of large agribusinesses has an incentive to protect the land over the longer term, as a valuable asset, just at it learned not to allow unchecked competition to lead to a destruction of the working-class.

Back To Part 25

Forward To Chapter 48

Back To Volume III Index

Capital III, Chapter 47 - Part 25

Marx is right, however, that the price of land, and with it rent, acts as a limitation of production. But, the same is true of interest, as a price of loanable money-capital. Neither interest nor rent are value adding, but they do form a part of the cost of production, and thereby reduce surplus value. They reduce the amount of value/social labour-time that can be allocated to increasing productive capacity, because they represent a diversion of that value away from capital to revenue, i.e. they finance the unproductive consumption – including speculation - of the rentier, be they a landowner or owner of loanable money-capital.

However, the question for a post-capitalist society would still be whether these prices fulfilled, at least in the transitional period, a useful function in ensuring a rational allocation of resources. We have seen repeatedly that where interest rates are low, this leads to malinvestment of capital, as well as speculation.

The latter may be avoided or reduced in a transitional economy, but there is no reason to believe the former would be. Similarly, if land were free, the same question arises of determining which of all the contending alternative uses for any piece of land, provide the greatest benefit.

In a fully planned economy, that question still needs to be addressed, because its use for one function precludes its use for all others, and some means of comparing costs with benefits, value against use value is still required.

It may still, in the transitional period, where commodity production continues, undertaken by numerous worker-owned co-operative enterprises, be required to retain such prices, but for all rent and interest to be paid into a central fund, initially in the hands of a co-operative federal holding company, and later the hands of the workers' semi-state. In that way, these prices can continue to play a role in preventing misallocation of capital, but the value itself can be accumulated and used for productive investment.

Back To Part 24

Forward To Part 26

Differential Rent I

Differential Rent I arises, because the land in cultivation has different levels of fertility. This applies also to things such as mining, where different mines produce more or less output for any given amount of employed capital and labour.

In orthodox economics terms, this equates to the marginal productivity of land. Indeed, the marginalist analysis that Marx undertakes here, building on the work of Ricardo, who himself took his theory from Anderson, essentially forms the basis of the development of marginalist analysis by the neo-classical economists.  Its unfortunate that Marx did not have the mathematical tools that the later marginalist school developed, because, if he had, it would have avoided some of the weakness in the conclusions he develops, out of his examples, in terms of resultant market prices.

The difference between Marx and the marginalists, in this respect, is as follows. The marginalists identify an amount of additional product that arises from adding an additional unit of some factor of production. This is called the marginal physical product. They then multiply this marginal physical product by the price of the commodity to arrive at a marginal revenue product, which they claim is thereby the amount of value which this additional unit of input has added to the end product. The most efficient point is reached when the price of the factor input is equal to this marginal revenue product.

Marx agrees that a factor such as land can be more or less productive. Land A might be less productive/fertile than land B, which might be less productive than land C, and so on. But, this productivity is only in terms of use values. In other words, a given amount of labour employed on land C, will produce a greater quantity of corn than the same amount of labour applied to land B, which in turn will be greater than the quantity of corn produced on land A. However, suppose that 10 hours of labour is applied to each type of land. If we ignore any constant capital, the amount of value produced, in each case, will be 10 hours.

However, this 10 hours of value will be embodied in a different quantity of use values in each case. Let 10 hours of value be equal to £100. Suppose, that land A produces 1,000 kilos of corn, B 1,500 kilos, and C 2,000 kilos. The consequence is that the individual value of a kilo of corn produced on A is then £0.10, on B it is £0.07, and on C it is £0.05. The point is that the value of corn, for Marx, is determined by the labour-time required for its production. More fertile land, means that labour can produce any given quantity of wheat in less time, and so the value of that wheat is thereby reduced compared with wheat produced on less fertile land. The same would apply to a machine that enhances the productivity of labour. In fact, rather than such a machine, or a more fertile type of land, contributing additional value, as the marginalists suggest, they reduce value, because they reduce the amount of the value creating substance - labour - required to produce any given quantity of use values.

The marginalist error arises, in this relation, because they have inherited the error of Adam Smith, the “absurd notion”, as Marx describes it, that the value of a commodity can be reduced to the factor inputs – land, labour, and capital – and that, therefore, the value of a commodity is equal to the revenues received by these factors, in the shape of rent, wages and profits. Like Smith, therefore, they end up with a cost of production theory of value. 

The basis of Differential Rent I can be seen in the following example. The average rate of profit is determined in industry. An average rate of profit of 25% is assumed.

Land Type	Cost of Production £	Output	Price of Production £	Income £	Profit £	Rate of Profit %	Surplus Profit/ Rent £
A	4,000	4,000	1.25	5,000	1,000	25.00	0
B	4,000	5,000	1.25	6,250	2,250	56.25	1,250
C	4,000	6,000	1.25	7,500	3,500	87.50	2,500
	12,000	15,000	1.25	18,750	6,750	56.25	3,750

Unless capitals invested in land A can make the average rate of profit of 25%, they will not undertake production. That requires a market price of £1.25 per unit. At that price, however, capital invested on land type B, makes a surplus profit of £1,250, and on land type C a surplus profit of £2,500. These surplus profits are absorbed as Differential Rent I, by the landlords who own land type B and C.

Ricardo believed that it must be the case that capitals use the most fertile lands first. It was this belief that underlay his and Malthus' belief that the cost of producing food to feed a growing working population would continually rise, as less and less fertile land had to be brought into cultivation. It was the basis of Ricardo's faulty theory about the tendency for the rate of profit to fall, as wages had to rise to cover this higher cost of food.

Marx demonstrates, at length, that this view is false. There are numerous reasons why it is not the most fertile land, which is first brought into cultivation. The most fertile land may be distant from population centres, or means of transport; land may be fundamentally very fertile, but currently unused, because it requires large amounts of capital to first provide drainage etc. The development of technology may make possible the cultivation of land that was not previously cultivable. For example, the development of powerful steam engines was able to drive ploughs that were able to turn over much deeper, more fertile layers of soil.

Marx and Engels provide numerous examples of situations where it is first the least fertile soil to be developed, and only then the more fertile soil; then examples of where it is the most fertile cultivated first, moving to the least fertile; and then examples where a combined process may take place with first the more fertile soil cultivated, followed by a less fertile soil, followed by a more fertile soil, and so on.

In economic terms, the differential rent arises here because, the higher fertility of one type of land over another enables a surplus profit to be created, for capital employed on the more fertile land. But, it is the existence of landed property that enables this surplus profit to then take the form of the differential rent, which is pocketed by the landowner. If all land were of the same quality, whether that quality was good, bad or indifferent, differential rent could not exist. It does not arise as a result of the absolute fertility of the land, but only as a result of its relative fertility. Similarly, if there was an abundance of the most fertile soil, so that capital could always find some to cultivate, without the need to bring in to cultivation less fertile soil, differential rent could not exist.

This is an essential difference between agriculture and industry that gives rise to the existence of rent. In industry, surplus profits also exist, but they are competed away as capital from less profitable spheres enters those spheres where the rate of profit is higher. Within a particular sphere, an individual firm, might produce at a lower individual value than the market value, and thereby also make surplus profits, for example, as a result of introducing a new more productive machine, but again, other firms can then also introduce the same machine, and so reduce the labour-time they require for production, thereby reducing the individual value of their own output, so that again any surplus profit is competed away. But, in agriculture, capital can only obtain the benefit of more fertile land, if it first pays the differential rent to the landowner. Consequently, capital is prevented from freely entering agricultural production, and thereby increasing supply, reducing agricultural prices, and so competing away the surplus profit.