Embedded rents

From The Daily Mail:

High street chains are operating a North-South ‘price apartheid’ on everything from a cup of coffee to a visit to the cinema. Many items are considerably cheaper in a northern city such as Hull compared with somewhere like Hammersmith, West London. The Greggs chain, for example, charges 85p for a large sausage roll in Hammersmith, which is almost 30 per cent more than the 66p it charges in Hull...

Official figures make clear that people earn considerably more in the south, but housing costs are also vastly more expensive. The typical median public sector salary in London is £610.70 a week, which is around 50per cent higher than in Hull. However, the average house price in Hammersmith of £550,000 is some 417per cent higher than the Hull average of £106,250. Consequently, someone with a 60per cent repayment mortgage is likely to be paying £1,829 a month in Hammersmith, compared to £356 in Hull.

Ho hum. Wasn't there other research which showed that retail prices were pretty much flat across the UK, with a difference of only 3.5% between the cheapest and most expensive areas? Yes there was, so how do we reconcile this, short of assuming that at least one of the sets of results is completely wrong?

Answer: the price of goods which can be easily transported is the same more or less everywhere because if retailers in one area tried charging higher prices, this would be competed away by people shopping elsewhere (extreme case: booze cruises to France or Belgium). Conversely, the price of goods and services which have to be consumed at the point of sale (cafés, restaurants, pubs, cinemas, health clubs, hotels etc) includes a large element of 'embedded rent', i.e. in wealthier areas, people can pay more, so prices go up and then rents go up to soak up the extra profits.

Retailers who sell easily transportable goods and services can't hike prices, so they can only meet the higher rents in expensive areas by selling higher volumes per square foot of retail space, so mass market retailers do not make higher net profits (or pay higher wages) in their store on Oxford Street (with a million shoppers a week) than from their store on High Street, Anytown (with ten thousand shoppers a week) because the benefit of the extra volumes goes into landlord's pockets. This is of course a function of population density (or accessibility or public transport) rather than incomes (and to compound/confuse this, wages tend to be higher in areas with higher population density etc.).

Once the higher rent level has been set, all cafés etc have to charge higher prices to be able to afford those higher rents (or they go out of business and are replaced by a new tenant), and as consumers in that area have more to spend and nowhere else to go (this applies in particular to tourists), they pay the higher prices, all of which goes straight into the landlord's pocket: Greggs do not make higher net profits in their Hammersmith shop than in their Hull shop.

And of course all this reaches its inevitable conclusion with the fact that residential rents soak up most (i.e. at least two-thirds, possibly more) of the difference in average earnings between poorer and wealthier areas, as mentioned in the article.