This is the first half of a two-part series of posts. It summarises a few ideas that have been banging around the back of my head for a while – basically, an attempt to answer the question: “What can economics do for cities?” In this part, I discuss a couple of important concepts: agglomeration economies, which underpin cities’ existence and ongoing success, and the potential role of pricing mechanisms for managing urban ills.

What do cities do?

Cities mean different things to different people. They are places to work, places to play, places to invest, places to consume, places to conduct politics, places to realise one’s individuality, places to blend into the crowd. (And many, many more things beside.)

In fact, one of the features of a successful city is that it can mean different things to different people, and attract and retain them for different reasons. Cities exist because they are efficient and diverse.

Economists use the term agglomeration economies to describe the advantages of urban scale and density. If you operate a business, locating in a city will allow you to access more workers, more customers, and more new ideas. But even if not, an urban location still offers advantages – more restaurants and retailers, a larger dating pool, better access to education and healthcare, and more choices about how to work, live, and get around.

New research from the Netherlands finds that agglomeration economies in both production and consumption are important, albeit to a different extent in different cities. Furthermore, ignoring agglomeration economies is a risky proposition for cities:

As history has shown (see, for example, what happened to Detroit or the decline in the population of Amsterdam and Rotterdam referred to above), current successes provide no guarantees for the future. This is what Gibrat’s law tells us, growth is independent of current size. Future growth is therefore largely independent of past success. The chances for policymakers that try to row against the tide are small. A successful policy requires to ‘go with the flow’. Large investments in infrastructure in a declining city do not satisfy any real demand but lead to large financial burdens for the local population, making these cities even less attractive. However, policy can make a difference in growing cities. In order to remain on the short list of hot spots, policymakers in these cities have two margins to work on.

  • First, the city has to be attractive for innovative entrepreneurs and enterprises to locate their business.
  • Second, the city has to be an attractive choice for high-educated top talent as a place to live in.

In other words, urban success is a dynamic process. Cities can’t stand still – they must be capable of attracting new people and generating new ideas and opportunities. Simply identifying some things that people like about a city and then freezing them in amber is a recipe for long-term urban failure.

1. Incentives and prices matter, so it’s important to get them right

We need change, but we don’t necessarily need change at all cost. Most development is good, but some has deleterious side-effects. A new factory may contaminate local air and water quality. A coal-fired power plant will damage our climate. A new subdivision may pump traffic onto congested roads. A new retailer may attract more people to park on already-crowded streets.

Policy responses to these challenges can heavy-handed and inefficient. While negative (and positive!) spillovers are abundant in cities, some cures may be worse than the disease. A good example is minimum parking requirements, or MPRs, which require new developments to provide a defined minimum amount of parking. The aim of this policy is to prevent parking from spilling over onto neighbouring streets and properties.

Unfortunately, MPRs tend to be both inefficient and ineffective. They are inefficient because (a) there is usually poor evidence for choosing minimum ratios, meaning that many businesses and households are compelled to purchase more parking than they need and (b) they tend to be more costly than alternative approaches to parking management. Furthermore, they are often ineffective, as people continue to complain about a lack of parking even in places where MPRs have led to a major oversupply.

Better pricing is often a better alternative to blunt policy instruments. As any economist will tell you, if you want less of something, put up the price! This approach is applicable to a wide range of policy areas, especially in cities. For example:

There are several important advantages to using prices, rather than regulations or construction, to discourage negative spillovers. First, pricing respects people’s ability to make good choices. If we had a carbon tax, it wouldn’t prevent someone from burning petrol or farming cows. But it would make them pay the full social cost of those choices.

Second, prices can change in response to new information. AT’s new parking policy is a good example of this – they will monitor demand for on-street parking and tweak the prices up if occupancy is too high. This reduces the risk of screwing things up due to forecasting errors.

Third, and most importantly, prices provide governments, businesses, and households better information, which can enable them to make better decisions. Over time, this will result in significant dynamic efficiencies. For example, congestion pricing will help transport agencies plan infrastructure upgrades. Rather than having to guess whether people will value expanded roads – which frequently leads to errors – they will be able to measure the actual value that people place on travel.

Tomorrow: Part 2.

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  1. Thanks for the interesting piece Peter. I’m interested in the pricing discussion, but don’t think you can have it without addressing the equity issues. If one of the drivers of pricing over regulation is ‘choice’ then surely we need to recognise that in reality, some will have choices and some will not. Price can also be a blunt policy instrument if you’re subsisting on the minimum wage. I’m open minded on this, but want to hear whether there’s any thinking around this issue?

    1. Hi Michael – good question! I think you’re right to highlight the fact that the choices available to people are often a function of their income. That’s a concern for attempts to use pricing to address problems like climate change and parking demand. However, remember that the same concern already exists throughout most of the economy. For example, food and electricity are priced – and they’re certainly more fundamental than parking!

      That being said, my personal view is that:
      1. Other policies are used to address poverty and inequalities in income and opportunities. I’m not an expert in this area, but people have proposed various mixes of increased minimum wages, earned income tax credits (e.g. Working for Families), increased unemployment/domestic purposes benefits, and universal basic incomes. I am open to any of these options and I’d be willing to pay higher taxes to fund them.

      2. Revenue from congestion prices / carbon taxes / etc should generally be returned to households, either through an annual lump sum payment, a progressive tax cut, or funding for programmes to allow people to reduce the costs they face. For example, if Auckland had a congestion charge, the majority of the revenues could be distributed as an annual payment to households – a “congestion dividend”. (Stu Donovan and I explored this concept in a 2013 post.) Another example would be using some of the revenues from a carbon tax to subsidise insulation or fuel-efficient vehicles for low-income households – thus allowing them to reduce their exposure to the carbon tax.

      1. Alan Davies has a good blog post on the equity implications of road pricing:

        His main point is that we pay the same price for most things regardless of income: food, electricity, and public transport so why should road pricing be any different? It is more important to consider the overall equity of the policy – rather than looking at the equity of paying to drive in isolation.

        Our current system of limiting development as a way of controlling the effects on unpriced roads has pretty bad equity implications due to housing unaffordability.

      2. Congestion toll revenue should go towards:
        1) paying for new infrastructure – that’s what users are paying the congestion toll for
        2) paying the PT cross-subsidy
        3) after that there should not be anything/much left otherwise it is a “tax” and inefficient load on transport users.

        1. I respectfully but firmly disagree. The economic rationale for congestion pricing is to charge people for the *delay* they inflict on other travellers by using busy roads. Like a carbon tax, it is a policy designed to internalise negative externalities and thus prevent individually rational decisions from becoming collectively irrational.

          There is no logical connection between implementing a congestion charge and building roads, just as there is no reason to recycle the revenues from a carbon tax into building more coal-fired power plants.

          1. Hi Peter,
            I understand what you are saying but I totally disagree. On the back of population growth not providing additional infrastructure would lead to insane congestion tolls in the case that no new infrastructure is provided (it would be economically inefficient to either use all the revenue for PT or refund citizens). I have no problem with new infrastructure being PT as appropriate. As a user pays system the tolls collected should be recycled back into the transport system. In many cases the most efficient use of the revenue will be to provide additional infrastructure.
            The comparison to a carbon tax is not relevant.

          2. I never said that we should stop building new transport infrastructure after implementing congestion pricing.

            However, keep in mind that congestion pricing revenues would be *additional* to existing sources of funding, such as petrol taxes, rates, and PT fares. Consequently, spending those *additional* revenues on more infrastructure would imply that we would increase spending on transport infrastructure… immediately after adopting a measure to manage/reduce demand on congested portions of the network.

            That seems extraordinarily counterintuitive. If anything, congestion pricing would allow us to spend a bit less building infrastructure.

  2. Peter you put a lot of trust in local government being able to charge a market clearing price for what is essentially a commons good. Certainly there is no evidence that Auckland Council or Auckland Transport have ever been either smart enough or industrious enough to do so for any type of good or service. I have come to the conclusion that there will be a huge opportunity for the private sector to step in and expand the existing malls into privately owned Metropolitan Urban Centres where their single ownership will let them maximise profit while the rest of the centres die a slow death of cheap and shitty retail and no parking. Evidence of this is the CBD where parking buildings regularly have the full sign out due to commuters so shoppers cant get in.

      1. Interesting. But that is a huge shift for AT to make. Remember they see parking buildings as cash cows and lease out as many spaces as they can get away with. The idea of relating parking management to transport objectives is just beyond them as was beyond the last Auckland City and the Auckland City Council before that. The problem is they see money coming in or forgone versus a soft benefit to others. By contrast private centre owners see the cost of providing parking as money out of their pocket versus the money they make out of the other activities. The private owners have an incentive to make efficient decisions, the Council never will.

        1. It’s a significant change for AT, but they’ve committed to a new parking strategy and started implementing it – e.g. in Upper Queen St and Kingsland. Thus far, they have shown that they are willing and able to deliver on their policy.

          1. I think there’s an opportunity to use parking pricing to shape behaviour.

            Let’s have 24 hour parking buildings, with sharply curved pricing…
            E.g. before 0615, all day parking is say $10
            Between 0615-0630 it’s $12
            Between 0630-0700 it increases to $15
            0700-0800 it’s $20
            0800 forward, it’s $24

            What does this do? Well, it benefits those who need to drive because PT isn’t yet good enough at those times, and it then deincentivises those who drive when there IS good PT from driving.

            Net benefit overall

  3. “If we had a carbon tax, it wouldn’t prevent someone from burning petrol or farming cows. But it would make them pay the full social cost of those choices.”

    If we apply a fuel carbon consumption tax, we would have to incorporate jet fuel and bunker fuel on imported goods to make it work. Would that be legal with our agreements under the UN Climate Change convention in Paris giving these fuel a universal exception?

    1. Except of course farming cows would be exempt a carbon tax. Every country gives a dispensation to their favoured industry, here it is dairy, in Australia mining in the US it will be weapons, oil, sugar, wheat and anything produced in a state that has a small population. But at least a carbon tax raises money that will be spent here rather than sending $ to some other country that used to produce a lot of carbon before 1991 but doesnt anymore because their industry collapsed.

  4. Third, and most importantly, prices provide governments, businesses, and households better information, which can enable them to make better decisions.

    By putting up the price of land, we provide good information to businesses and households that they would be better to build anywhere but here.

    1. That’s one effect of high land prices – lower-value, land-intensive activities get the message to move elsewhere and free up the space for different uses. To put it another way, high land prices encourage people to economise on land by building up. (Or otherwise raising productivity.)

      As an economist, the question I prefer to ask is not “are the prices high?” but “are the prices distorted?” Distortions in prices – such as setting the price of parking to zero – are damaging. Tomorrow’s post takes on the question of how we can identify when prices are distorted by bad policy.

  5. Do you think that congestion taxes, road tolls, petrol taxes, parking revenue etc could be used to subsidise public transport? Not just infrastructure construction but fares for passengers as well. Therefore those that can/must use the roads are paying for those that can’t/don’t. Because at the moment a lot of trips are cheaper by car than by public transport (provided you own a car already). Maybe making driving more expensive and PT cheaper might drive demand for improved PT infrastructure and reduce congestion at the same time.

    1. Unpriced congestion is one of the rationales for offering PT operating subsidies. I looked at this issue in two posts last year. Consequently, I would expect congestion pricing to reduce the need for PT subsidies, not increase them.

      Congestion pricing would have two positive effects on PT cost recovery:
      1. It would encourage some people to switch modes to avoid congestion charges, which would increase cost recovery
      2. It would increase the speed of bus services by reducing overall traffic congestion, which would reduce operating costs and increase the attractiveness of buses.

      1. Wouldn’t the use of congestion pricing revenue to fund additional services increase the coverage of PT and therefore increase its utility/attractiveness?

        There would be some point at which additional investment in PT services would not increase utility, but given the latent demand demonstrated with increased patronage after recent improvements in service, I think we’re a ways off this tipping point.

  6. What is success? Interesting question…
    Is it city economic growth – or contribution of the city to overall national growth? If a city becomes cancerous is this bad/good?
    Should it be measured differently – arts, sports, culture?
    Should it simply be “satisfaction of residents”?

    Re: the point about “low value” activities, how are these defined? Yes, from a purely commercial perspective it makes much more sense to build an office tower in the CBD than to build a sports field for community sports (or even a police station), but value is more than dollars and cents. One of the things that drove me batty about the Eden Park arguments was that “Eden Park could be sold off for higher value housing” ignoring the values and culture it represented in its current location.

    I think the starting point has to be a national Cities Strategy. Government sets goals.

    1. Its not the government, it is our council.

      The strangest thing about any Eden Park / Chamberlain Park / Unitec Campus type kerfuffle is that this locale is not lacking for housing areas. There are thousands of low density houses in the area that could easily be upgraded to high density if this was an economic thing to do. Unfortunately, because we have a very constrictive MUL and distorted high land prices, it is not economic to develop these houses into high density.

      Under our restrictive MUL and highly distorted land prices, we need to find “vacant” land that we can flog off to developers at a discount. So we are soon to be building in a disused quarry, bulldozing a campus parkland and are looking at levelling a golf course.

      1. No Angus you are still confused. The MUL doesn’t prevent more density in these areas, restrictive planning regs do. They also push up the cost of building, for example parking minimums, the Productivity Commission concluded that the regulatory constraints on adding homes within the existing urban areas are greater than any land supply restrictions.

        1. Patrick you are technically correct, the problem is we need to find somebody willing to do the building. The MUL restrictions add to the cost of building. Therefore we need to find people who are willing to invest in Auckland and gain a lower return than in any other place in Australasia. The supply of morons in Australasia appears to be smaller than anticipated by our urban planning department (confirmation bias?), so we are very slow to construct dwellings in Auckland.

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