An editorial (run during the week of December 22, 2003 in the Notional Pest) by the noted international economist, Jeffrey Sachs, provides the occasion for a new topic in this series: the concept of an economic "rent".
Before turning to the topic itself, let me remark that it is significant that Sachs has chosen to weigh in on the side of "it's the oil, stupid" in the discourse on the motives for the latest Iraq war. Many on the left, right and plain wacko have made the same argument but Sachs is a charter member of the free-floating, largely Ivy League educated, cadre of economists who have the ear of the bigwigs at the World Bank, the IMF and sundry more local talkshops. We at NETWIT largely agree, to our surprise, with his view that the US is heavily motivated by oil interests and the importance of shifting away from oil as an energy source. Where we depart turns on this notion of economic rent.
A "rent" in economics is not restricted to landlord and tenant arrangements. The term is used to denote any payments to the owner of a resource that is greater than the minimum the owner would accept to make the resource available to the economy. First-year undergraduate economics texts love talking about the rents accruing to sports stars, for example. Wayne Gretzky, one may surmise, would have played for free; his actual multimillion dollar salary was pure rent. In landlord-tenant relations it is the "economic rent" portion of the (common-usage) rent that causes all the bother: the amount that's greater than mortgage, utilities and maintenance expenses.
So, what's so special about rent? Well, it follows from its definition. If you have money over and above the cost of the resource (whatever it is) you have complete discretion over what you can do with it. It doesn't have to go to defraying any costs. Here's what businesses learned to do with their rents: buy political influence to keep the source of the rents in pace or enhance it; buy lawyers to enforce the laws; buy judges to interpret the laws "correctly"; and buy the rest of the justice system, if necessary. Some took their rents overseas and bought compliant rulers. Now, see what's so special?
The media dumb down the concept as "windfall profits". This pleasantly bucolic phrase nicely obscures the legislative fence shifting and wind-assisted shower of "apples" that don't come about by accident.
One of many notable Austrian contributors to political economy is Joseph Schumpeter, who offered the most plausible account of the real nature of competition in modern industrial economies; viz. a competition for rents. While those conventional economists who recognize that actual economies are not composed of uncountable tiny firms but huge lumbering behemoths nevertheless smugly assert that most rents are dissipated by the rivalry among the oligopolists or the threat of market entry. This is not the place to prick this particular hot air balloon (a piece is in preparation.) Instead I focus on the two outliers: the champions of rent, which each garner their stupendous rents for very different reasons.
The two industries that have maintained the highest reported profitability for the longest period are oil (by which we mean oil and natural gas) and pharmaceuticals. The bulk of this piece will concern oil, so I'll talk about drugs first.
The rents available to the drug business are due to the patent system. Those who read the earlier "Let's Hear it for the Ignorance Economy" will have already become acquainted with the way economic jargon has come to serve the commodification of knowledge. That's at the heart of the modern patent system.
At its inception the patent system was a useful development which served the rapidly expanding industrial economy. But not for long. It became the plaything of the courts and, very quickly, a tool for the mighty rather than for the small innovator. Now, the front lines of the "globalizing" economy is the expanding sphere of "intellectual property" rights; this is where the action is. Genetic engineering and software will become increasingly the source of business value and rents while drugs will spiral ever upwards.
It's a wonderful spiral of money and influence. Using the rents from patent-protected drugs, which have a marginal cost of close to zero, and sometimes sell for multiples orders of magnitude higher than production costs, the drug companies get more and more favourable statutes and regulations, backed by an army of vicious lawyers and a complicit judiciary. This makes it ever harder for any new firms to break into the charmed circle and ever more difficult for the HMOs and physicians entrapped (but remuneratively) into the preferential prescription of patented drugs and their approval by clinical trials to break free (assuming they would want to).
As splendid a source of rents as the world of drugs is, it pales besides oil. This is not obvious in the financial reporting but consider: most of the world's oil has no production cost (geological pressure forces it out, once the underground pool is breached) and commands a substantial price as soon as it leaves the ground. Currently oil fetches about $20(US) per barrel; for most oil, which only requires geological pressure to spurt to the surface, that's $20 free and clear. Pipelines and other transportation, refining and sales of refined products are each their own centers of profit.
What about exploration? Isn't that costly? And those tar sands and oil shales? Those dreadful environmental regulations? Yes, but the industry has obtained from compliant governments over many years favourable tax treatments that mean that the industry only spends 5 cent dollars on these activities. The main dodges are "depletion allowances", whereby reductions in the value of the discovered oil can be subtracted from income, using suitably arcane and generous accountancy.
The final piece of the sham puzzle is the dodge known as 'transfer prices" whereby the "resources" side of an integrated multinational, like Shell or Exxon, charges the refining side the world price (plus transportation) not the costs of production. This would be like the old Ontario Hydro generating division charging the transmission and distribution division the highest world price for generated power rather than the actual costs of production (which is what was done - and what in fact, in a nutshell, the so-called Ontario market sought to do - go figure).
So, with a poker face, the oil industry puts those pie charts on the pumps showing all that tax and a tiny "profit" on the retailing of gasoline. Whereas the "crude costs" are themselves 90% profit, plus another 15-20% on the refining and transportation. Our guess is that per dollar of gasoline sold the integrated oil company accrues about 25 cents in rents, not the 1or2 cents their pie charts claim.
We pick two nits with Dr Sachs. First, don't call Dick Cheney naïve. Call him evil, call him nasty but naïve he ain't and we suspect Dr Sachs knows that. "Mr Cheney's view is technologically naïve and politically disastrous.", says Sachs. By technologically naïve Sachs means Cheney doesn't appreciate the availability of technical alternatives to oil. What Cheney does know is none of the other technologies generate anything close to the rents of oil. As to politically disastrous..to whom? The good old boys are doing ok.
Second, this matter of rent. And it's related. As mentioned, Dick Cheney and the other Texans that have become part of the US elite understand very well that nothing generates free money - rent - like oil. Using the bought political and judicial influence the US oil majors have effectively created a perpetual money-machine; depletion allowances and secret geological data mean that they spend 5 cent dollars on exploration with a leg up on any rivals; the crude production is almost pure profit; and, control of refining and transportation generates healthy profits from these parts of the business too. All that free money then buys yet more political and judicial and bureaucratic influence.
Technological alternatives to oil will never produce that kind of lucre! All of them are essentially manufacturing processes; these industries make money, sure, but nothing close to oil or drugs. Thus is why wind power, solar power, fuel cells, etc. etc. are always on the horizon and have been for thirty years but never quite get into the foreground.
The same goes for coal, except that coal held a historical foothold before oil swept all before it, and some types of coal are both relatively cheap and have labor union clout to keep the mines and pits open or still have unique metallurgical uses (mainly in steel production). The oil industry will only allow these to take a substantial share of the market when oil production goes into decline and they have developed enough market control to reap rents from the higher prices that the alternative sources will then command.
Forces much larger than Cheney are behind US foreign policy and always have been. Oil interests have loomed large in US foreign policy for a hundred years. We don't know exactly how this shadowy world works (if we did we wouldn't be both alive and gabbing about it on the 'net)…A dog's breakfast of factoids is available: oil pools in the Caspian basin rivalling the Middle East, pipelines East to China, south through Afghanistan and Pakistan west to Turkey, through Chechnya, a tottering house of Saud, Russian oil billionaires, mucho oil offshore of N Vietnam, etc.. Only the players know for sure what is known and what is fiction and they ain't saying. Won't ever be saying.
All we know is nothing greases the military and political wheels like oil rents. Speculation is an endless game; okay if you're paid for writing articles about it but useless as analysis. What, then, is a citizen to do? Fade the lights, cue the music, here comes Roy Harper: "If all of this supersale overkill world is for real/there's nowhere to go, you might as well start to free-wheel". Oh, that and keep a good chunk of major oil company stocks in your portfolio.
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