Continuing Education... Alex Tabarrok on Private Cities

EconTalk Extra
by Amy Willis
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Alex Tabarrok on Private Citie... Luigi Zingales on the Costs an...

This week, we want to further the learning associated with Alex Tabarrok on Private Cities. We can learn a lot from one another.

So this week, choose from one of the prompts below the fold, and post your reply (250 words or less, please!) in the comments. We'll highlight some of our favorites (and maybe even send some surprises your way). We also hope you'll comment on each others' replies.

future cities2.jpg

1. How are charter cities, as envisioned by Paul Romer, different from private cities? Which has greater potential for encouraging entrepreneurial investment? For reducing transaction costs? Explain.

2. In his postscript (1:03:09) to this week's episode, Roberts suggests that while he thought Tabarrok "got the economics right," he preferred a different version of what exactly the Coase Theorem is. How do Tabarrok's and Roberts's explanations of the Coase theorem differ? Revisit Roberts's conversation with Coase shortly before he died. Whose explanation would Coase be more sympathetic to? What evidence from the conversation supports your answer?

3. Given the successes and failures of Gurgaon, explain what might be a good dividing line for what cities achieve through municipal government and what should be left to emerge from the bottom up. How might such a description be used to suggest policy changes to make existing cities with active municipal government better?

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COMMENTS (11 to date)
Ajit writes:

prompt 3.

Guests in prior podcast have conceded that government does a terrific job when it comes to building major infrastructure: Water systems, electric grids, bridges, etc. My impression from Alex is at the very least, this should fall under the minimum scope of government. The rest I think we need more data on, such as police, roadways, schools, etc.

That said, I'm not really sure we can change municipal governments without a Detroit style collapse causing a complete re-evaluation of the system itself. There are too many vested local interests and too much economic illiteracy of the kind Bryan Caplan has talked about. (eg: progressive cities like NY and SF still favor minimum wage and zoning laws. And sports teams still dupe the public into building new stadiums)

Ideally, we need to fix education before we can see any real traction into changing bad politics.

Rob writes:

I love Econtalk and Russ is 98% amazing, but sometimes "experts" forget basic theory. I know Russ often derides Macro and quantitative measures, but they do have some validity. What exasperates me is when some of the guests condescend econometrics, but then demonstrate only a partial understanding of the topic.

Regardless, in reference to private cities versus public goods & services: It is quite accepted that if Tobin's Q ( http://en.wikipedia.org/wiki/Tobin's_q ) is:

* Greater than 1.0
Then there is a positive return of investment such that a supplier can earn a profit. Thus, this should be an open market subject to competition. The supplier has incentive and will invest in capital infrastructure to increase and maintain their RoI as well as competitive advantage.

* Less than 1.0
This should be a public good, period, end of discussion. Then there is a direct negative return on investment such that there is low profit from investing in capital. Colloquially called the sum of the parts is great than the whole.

Classic examples are sewers, water supplies, and roads where the capital inputs separately (cement, tarmac, digging, labor, etc) have more profit potential than when they are used to build the infrastructural.

Infrastructures are expensive and necessary, but low profit. If every road was a toll road, not many people would drive due to the high time & financial transactions costs of paying tolls. Better to have a public system that all can use and drive on efficiently for thousands of miles where public money maintains and builds the capital investment.

* = 1.0
This depends upon who benefits from the infrastructure. If a private entity can decrease risk and control costs by owning the infrastructure, then the private entity has incentive to invest. Carnegie and his railroads to supply his steel plants.

If there is not a clear benefit as to who derives the return of capital, then probably the infrastructure should remain public. Electric companies are a good example, Enron did not help California with electricity supply or prices after deregulation. ;-D California suffered, Enron profited to the point of illegal market manipulation.

How many times does the English water supply or a national railroad need to transition between phases of nationalization & public reinvestment followed by deregulation & private rent seeking?


The arguments and observations presented by Tabarrok were clear. Take waste treatment and electricity, within the private entities sphere of control (Q great than equal to 1.0), they had great infrastructure and invested heavily. Even if the generators were diesel and not efficient, it was for their direct customers benefit.

Outside of the private entities sphere of control (Q less than equal to 1.0) they did not cooperate with each other and did things like having trucks illegally dump waste. Tragedy of the commons argument.

There is no shock or news in observing this. Basic mid-level to early masters Macro econometrics.


On the education argument, of course there is a mix of public and private schools. Parents most certainly have a Q >> 1.0 when dealing with and educating their children. It might come as a shock, but poor parents love their children just as much as rich parents do! Amazing that. So yes, parents in slums will pay for education and in this case, demand creates supply.

So the past few Econtalks have been interesting to listen too, but cannot say they were shocking in any way much less presenting something "new."

August writes:

One of the problems I had with this discussion were assumptions hidden in the term 'economies of scale.'

How do you approach economies of scale?
Isn't it making marginal revenue equal marginal cost?
What is a subset of marginal cost?
Government costs, whether they be regulatory, taxes, or indirect costs-legal costs for instance.

So it is assumed, hey look, these private cities aren't achieving economies of scale and dealing with utilities and sewage in the nice neat way governments do, but the equation leads me to believe the governments force businesses to get much larger than they otherwise would.

Instead, I would be looking at integration between the city and its countryside. A city's waste stream can be local agriculture's fertilizer- this was done, for instance, in London, before the government got in the way and caused a lot of problems (I got this from the book Ghost Map).

We must be aware that our opinions about certain subjects have been formed by government standards, and as such, when we see those standards not being met, we are not necessarily seeing a market failure. We may be seeing a more honest assessment of the cost of such things, and/or the existence of government interference in other areas (again, is the city able to integrate properly with its hinterlands).

Linda Greenberg writes:

I thought the comparison between the two Indian examples interesting but how can you compare either with urban development in America or Europe. The norms for government control are so different. Plus, in India, I could -- sorry if my preconceived ideas are showing -- imagine land developers not caring that the sewage system was only cosmetic.

Question about education. Great to learn of the private schools educating youth. But are there jobs when these bright young things graduate? I thought it was hard for those who were well-connected to find employment. How will those with lesser or no connections gain work?

Cal Abel writes:

I enjoyed this podcast immensely as it raised many important issues that pertain to some sort of minimal initial structure needed to allow cities to emerge. Before considering the Russ's three questions there are two points that are not addressed and are relevant to the issues of power and sanitation, which affect the conclusion of needing some minimum size to internalize these externalizes.

The two points are the restrictions that India has on thermal electricity generation and the method for enforcement of property rights.

Power Generation
India has fully committed to renewable energy sources so much so that new grid level thermal generation carries significant penalties. This is done through several mechanisms. First is that only non hydro RE sources can own their own land, thermal and hydro generators have 30-year leases form the state and must concede the land back to the government or reapply their lease at that time. Second is that new thermal generators must concede 12% of their power generation for a period of something like 10-years to the central government. The government uses this power to buy votes. This creates an interesting bootlegger and baptist problem as established thermal generators are exempt from this concession and are made more valuable as the barrier to market entry is that much higher. Coincidentally the owners of those stations are of the sort depicted in the Learn Liberty B&B YouTube video. There are also the traditional milieu of subsidies, tax breaks, and artificial interest rates given to RE.

These regulatory and structural burdens due to the conditions surrounding the cities are why the power generation looks the way it does and why larger cities like the one started by Tata can have better power, they don't have to access a public grid to sell power, they have a large enough private grid (market) to capture greater economies of scale. I am also sure that Tata was successful in tailoring the law to ensure that it would not be applicable to them (I have not verified this and it is pure conjecture but is a plausible B&B scenario given the fact that city was established before the modern regulations took hold).

Rule of Law
There are two relevant Econ Talk episodes where Russ talks with Barry Weingast and Terry Anderson. What we have in India (I am not picking on just India here) is a situation where the laws are not laws but rather enforced rules which inhibits the establishment and enforcement of property rights and finding free market solutions to environmental problems.
Weingast
Weingast identified characteristics that make a law a law as being "generality and [sic] universality and prospectivity, I think. They apply to everybody; they apply to a general set of circumstances; and of course you have to know them in advance." To establish a property right (finding a Coasian solution) you have to have these attributes. Weingast goes to show how these attributes can emerge in places with absolutely no government, e.g. CA in 1848. What is in India, as in many countries, is where artificial and selective enforcement of governmental rules inhibits the rule of law weakening property rights.
Anderson
Terry Anderson's talk carried special relevance as it pertains to developing market solutions to commons problems by the creation of property rights and the use of "free market environmentalism". Sewage is one of the older tragedy of the commons problems as you can dump the waste in the river or on someone else's land and the problem is no longer yours. Poop is really the original pollution from urbanization. If property rights are inhibited the incentives to develop market solutions are also weakened as the predictability of a return on invested capital is unpredictable necessitating a higher ROI to incentivise taking on that risk, precluding market based solutions that carry a lower ROI. Taking a step back, I can see why governments want weak property rights, it affords them the ability to arbitrarily dictate a set of rules that maximize political rents, e.g. Weingast's Violence Trap.

To answer Russ's questions
1. I don't see any real substantive difference between the concept of Charter Cities and Private Cities. I've studied Honduras' Ley Organica de la ZEDE in fairly great detail, Romer was in part behind this, but latter left for various reasons. What Honduras did was to create legal zones where the concept of property rights and legal code could be set to what ever the developer wants subject to the approval of a select committee, CAMP. The structure of the governance of the ZEDE is established in a set of "norms", a constitution or charter of sorts. This structure allows the creation of what amounts to city states under different regimes within the Republic of Honduras. These zones can have various forms of governance, they can be public companies, private companies, trusts, or conventional public entities, subject to the approval of the CAMP. So from this context of what one country has in place, there is no real difference, and any difference that exists is entirely an artifact of our own world view.

2. Alex differs from Russ on the topic of the "Coase Theorem" significantly. Here is an excerpt form Russ's interview with Coase:

"...and I was taught this by Deirdre McCloskey when I was in Econ 300 at the U. of Chicago--was that the real lesson of your paper was that because transactions costs are not zero, you should assign the property rights very carefully. And ideally you should assign them to the party--you should assign property rights so that the person who has the least cost of bearing the externality does so, because they might not be able to reassign the rights. It might be too expensive to renegotiate. So that the assignment of property rights is very important. That's what he told us the Coase theorem was. I know you don't like the phrase, but it's not so bad if at least he gets the insight right. I think the problem in the literature use the first part--if there are no transactions costs as a straw man, to say that you were wrong. Because of course, if there were transactions costs--but you knew that. It was a terrible, unfortunate turn of events in the literature. Guest: Yes. It was a discussion at cross purposes which the [?] had a completely wrong idea of what I was getting at. It took a whole evening of all these economists to get it right. But then in the end they didn't get it right, because they amended something called the Coase Theorem, which I don't like."

The difference is in Alex blames the failure of property rights because of transaction costs, when Russ's basis (Coase agreed with) is that it is because there are always transaction costs the the rights be carefully established. This goes back to my earlier point about the structure of India's legislative and legal systems.

3. This is a topic that I am very interested in. I am one of the engineering advisors to the Seasteading Institute. What I am trying to understand is how to create an initial Stead and what is the minimum level of governance needed to achieve the greatest plurality of possible outcomes without presuming to know those outcomes a priori. Some attributes that become apparent are the following:
1. That the governance cannot restrict entry/exit to the city. This includes membership (citizenship) within the city. Here I think of Nozick's "Tale of the Slave", what is the defining characteristic of the slave? I think it fundamentally comes down to the ability to leave. If the government enacts artificial restrictions on entry into or exit from its jurisdiction, including citizenship, that that society is no longer free even if it is prima facie elected democracy. To each degree that government is granted authority or control over entry and exit represents an incremental loss of freedom. Considering government as a market, if it is not competitive then it is not a market and what we need is competitive governance. Randy Hencken, director of the Seasteading Institute, said that there are 196 governments and that for 7 billion people that they should have the ability to choose from more governments. I agree. Thus we need to create a more liquid market for government, and we do this by minimizing the barriers to market entry and exit. To this point the type of government becomes irrelevant if people can vote with their feet. Thus codifying and enforcing free entry and exit as a right is critical. It is the individual that is ultimately sovereign. Here is an interesting Dutch documentary Cybertopia, mostly in English, that goes into these concepts.
2. That property rights and right to contract are enshrined and rigorously enforced. Without such respect to individual sovereignty, there can be no predictability in a legal regime without this fundamental aspect. Thus the role of the government should have no ability to dictate the terms of these agreements and rights. Such right allows the government to use coercion to elicit political favors. And if such arbitrary authority exists and is abused if the people don't like it they can leave and take their land with them. So to accomplish #2 we limit the exclusivity of legal jurisdiction to an arbitrary and forced geographic area.
3. In thinking of government as a trust and the citizens as beneficiaries of that trust, the government should hold the same status as the beneficiaries. This meaning that government, group of individuals, holds no special right above the other beneficiaries. This goes back to Weingast's concept of universality.

James Liu writes:

The postscript has the better, more nuanced understanding of the Coase Theorem, and Coase's contribution. After all, Coase's work on the theory of the firm flows directly from the more nuanced version of the Coase theorem: firms exist because transactions costs are high. That is, if only the first insight in the Coase theorem -- that in the absence of transactions costs, resources find their highest and best use -- why should firms -- with top down instead of bottom up decision making -- exist at all?

This is belied by Alex's own solution to the problem of transactions costs that he proposes: that several firms should each own large swathes of a private city. That is, let's cut down on transactions costs by having several organizations that can be top-down instead of bottom up so that we can avoid transactions costs.

I'm not all that sanguine about that solution, especially in light of Alex's comments about home owner associations. HOAs are smaller than the municipalities they are part of, but they also micro-manage their residents lives much more than cities do (rules about when holiday lights may be put up, about clotheslines, the sort of colors a house may be painted, so on). It's sort of the worst of all possible worlds.

Warren writes:

1. How are charter cities, as envisioned by Paul Romer, different from private cities? Which has greater potential for encouraging entrepreneurial investment? For reducing transaction costs? Explain.

I thank Cal Abel for the information he provided about Honduras’ Free City’States (not Nicaragua), which I have copied.

“I've studied Honduras' Ley Organica de la ZEDE in fairly great detail, Romer was in part behind this, but latter left for various reasons. What Honduras did was to create legal zones where the concept of property rights and legal code could be set to whatever the developer wants subject to the approval of a select committee, CAMP. The structure of the governance of the ZEDE is established in a set of "norms", a constitution or charter of sorts. This structure allows the creation of what amounts to city states under different regimes within the Republic of Honduras. These zones can have various forms of governance, they can be public companies, private companies, trusts, or conventional public entities, subject to the approval of the CAMP. So from this context of what one country has in place, there is no real difference, and any difference that exists is entirely an artifact of our own world view.”

To me the Private Cities described are private (separated from) at most only from other members of the public. Charter Cities are private from the government of their nation/state. They may or may not be private from other members of their State or their City/State. They may or may not provide their own government.

I think the Charter City would have the greater potential for encouraging entrepreneurial investment and for reducing transaction costs because the new Charter City could make its own laws and norms. I should add though that I don't see encouraging entrepreneurial activity as a goal of city creation. Being entrepreneurial is a quality of people not of cities.


3. Given the successes and failures of Gurgaon, explain what might be a good dividing line for what cities achieve through municipal government and what should be left to emerge from the bottom up. How might such a description be used to suggest policy changes to make existing cities with active municipal government better?

I think that Chris gave a good description of an emergent city in his description of St. Paul, which has been emerging for 200 years. A city which is ‘planned’ is not emergent, it is designed and built top-down. Therefore I disagree with this question.
A more direct answer might propose a public or private planning (agency or company) be contracted by either the existing government or a group of all the builders to design and build the main trunk facilities, often but not necessarily commonly (publically) owned. This might include electricity, wi-fi, sewer plant(s), land fills, dumps, streets, roads, highways, water, flood control, school buildings(s), open space, park(s), libraries, police stations, fire stations, play grounds, ball park(s), etc.
Each builder would own one or more pieces of land contiguous to these trunk facilities and could build on his land and hook up to the trunk facilities as he wished. The builder could build out as a tract his entire parcel of land and put it up for sale. Alternatively a bulder/owner could divide his land into individual parcels for sale privately, and after purchase the new owner could build himself or hire a competing builder. This latter action would permit a much greater price range of buildings.

Sri Hari writes:

Russ, Alex,
Thank you for another informative podcast. I would like to bring to your notice that the Metro system in Delhi is a government enterprise. It's was built by then head, a 75 year old Railway Technocrat , Sridharan. He is reputed for his engineering expertise, building a fantastic project management team and extreme transparency and honesty. Delhi Metro is a world class project with high quality and time bound execution. Engineering team from Hyundai of Korea commented, the quality of Metro was best value for money for any similar project in the world.
The new 100 smart cities being planned by the current federal government will have all necessary infrastructure. It will be built by private enterprise with master planning with adequate infrastructure by government agencies.
Sri Hari

Michael Byrnes writes:

I didn't really see any daylight between Roberts and Tabarrok on the issue of transaction costs.

Tabarrok argued that transaction costs were standing in the way of more efficient use of resurces. The "Coase Theorem" states that under a system of well-defined private property rights, resources will flow to their highest value use if transaction costs are low. His observation was that, in Guragon, transaction costs were too high to allow that to happen.

Roberts' clarification, which was excellent (offhand I cannot think of a more important and useful postscript than this one), was to point out that Coase's key insight was that transaction costs are a barrier that prevents resources from flowing to their highest valued use. It would thus be very appropriate to cite Coase's work as the reason why Tabarrok saw what he saw.

It just seems to be a weird historical oddity that when people talk about the "Coase Theorem", they are usually focused on the "low transaction costs" case where allocation of resources is efficient, whereas Coase himself articulated the concept of "transaction costs" to explain why inefficient allocation of resources occurs so frequently in the real world.

Earl Rodd writes:

One example in the US which I thought would have added to the discussion is "The Villages" in central Florida. While nominally a "senior housing development", it is so large that as it transitions from a purely private fiefdom of the developers to "normal" status, the population dominates the county so that anything that is in the common interest of The Villages vs. the rest of the county wins elections! But lots of interesting issues there, both economic and political.

Henry writes:

Prior to listening to this I held the view that cities are largely emergent phenomena that can't be created and that the failure would be due to Hayek's Knowledge problem, i.e. all of the relevant information and preferences to properly design the perfect city would not be available to apply logic to. After listening to Taborek, I came to the view that cities are a bit like plants and/or ecosystems. If one can put in place a good set of "initial conditions" in particular public services, internalize such services by paying for them with rent (which requires sufficient scale), one may actually be in a position to create a flourishing metropolis from scratch. Dubai is a case in point, the initial conditions were set top down by a benevolent dictatorship. The added benefit of zero taxes (and regrettably for the workers) loose labor law didn't hurt either. However it serves as another good example where the experiment worked. It would be interesting to look down the line what proportion of the Russian entrepreneurs in Africa actually succeed i.e. whether there is a Romeresq formula that works consistently and predictably or that post the initial conditions being in place, the outcome is fairly random.

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