The Dynamics of Wealth Distribution
Land is needed for all production, and its supply is fixed. Therefore, whenever production increases, demand for the fixed supply of land will increase — and the proportional share of wealth taken by landowners will be greater.
We must remember the key distinction between land and wealth. When this distinction is lost, as it often is in modern economics, great confusion ensues. For example, if land and capital are considered together, we lose sight of the vital fact that rent varies inversely with interest. That is because the return to capital, like the return to labor, depends on the margin of production. When the opportunity at the margin diminishes, the return to both labor and capital decline, while rent increases.
Here is how Henry George states Ricardo's Law of Rent: "The rent of land is determined by the excess of its produce over that which the same application can secure from the least productive land in use" — or in other words, the margin of production. Thus, the Law of Rent is the basic law of wealth distribution in society.
What Does "The Same Application" Mean?
You might have noticed that the conditions of production at the "margin of cultivation" (simple farming and mining) are very different from those on the most valuable land (what goes on in, say, the Financial District). How can there be any such thing as "same application" of labor and capital"?
It will help to recall that the "same application of capital" is not the same thing as "the application of the same capital." That's because capital is fungible. It can be converted — with the convenient aid of money and banking — into whatever form is called for under particular conditions.
At the frontier, virtually no production is possible without the use of such simple capital as an axe, a shovel or a plow. Having those tools would make an individual's labor hundreds of times more effective than it would be without them! Doesn't that mean that the return to capital is actually much higher at the margin?
At the frontier, land is free, so the worker would use as much land as she could profitably use. But if she has any sense, she won't work that land with her bare hands. She will devote some of her labor to securing the capital she needs to make her labor more productive. Using those tools will make her labor, say, maybe, 1,000% more productive than it would have been without them.
Since capital is so important, won't the owner of capital demand an exorbitant payment for its use? No — because capital isn't a monopoly. If our settler can't get it from one greedy capitalist, she can make it herself, or borrow it from someone else. The capital owner has to decide which would benefit him more: to use the tool himself, or to loan it. If the capitalist decides to loan his capital, he has decided that the wages he'd earn by working in some other way will be higher than what he could earn by using his capital himself. He will be willing to loan out the tool at the general rate of interest.
Why can't he charge more? Well, he could if he had a monopoly — if no other capital were available to do the job. But that would be an extraordinary situation. Capital is produced by labor — and in the real world, suppliers of capital goods compete to get labor to pay for their use.
Perhaps the capital owner could take his capital to the city, and in that highly-productive environment, it would enhance labor's productivity much more than it could at the frontier. Ah, yes, but he would have to pay for land on which to use it — and land in the city is pricey. That is why the laws of distribution tell us that the return to capital at the margin will be the general rate of return to capital everywhere else. Capital may be cast into different forms or put to different uses, in different amounts — but the rate of return to capital will equal the optimal return that it could get where the land is free.
As long as there is any viable opportunity at the margin of production, that is where the return to capital is determined.
And when there is NO viable self-employment opportunity at the margin, do the laws still remain in effect? Indeed they do — but in that case there is one difference. Even if the marginal alternative drops to zero, wages and interest cannot fall that low. Labor has to stay alive, and capital must be maintained in usable condition. So if there is no self-employment opportunity at the margin of production, then wages and interest fall to the lowest level that labor and capital will accept, to get them to come to work.