Finding Equilibrium: What Makes a City Powerful?

Content based on Edward Glaeser’s work: Economics Approach to Cities.

Cities are an area of economics focus because they represent a clustering of people where government policy cannot be avoided due to externalities outside the market mechanism so these policies generate economics discussions. Cities are a special type of equilibrium where people are part of the equilibrium with all their considerations. Externalities are when your voluntary transaction with someone impacts someone else, such as a neighbor. Externalities in other words are a separation of consequences from prices which reflect the intentions at the time of purchase.

Market failures include the effect of externalities necessarily imply and in urban settings people are so close to one another that they highly impact one another through their transactions which leads to externalities because of the economic and literal pollution so governments are bound to intervene. Governments are intervening anyway because of disease that afflicted cities in the nineteenth century and traffic congestion and related pollution.

city wellfare and economy

The dichotomy of the government role in the urban economy

Externalities can justify government intervention and then we call this agglomeration economics since the conglomeration of people’s behavior creates its own economics. But in practice, people when they deal with the government always wonder what might have been if they had been able to solve the problems themselves even aside from questions of government benevolence or competence.

In the UK, during the Scottish Enlightenment people began to question their sovereigns. In America there is corruption in politicians focused on the predominance of special interests common in politics as well as a lack of resources in government which may neglect to solve some problems as a result such as the re-training of highly skilled corporate executives who have since become long-term structurally unemployed after a technology bubble. We have proof in some studies that government actions are hard to justify and may not be following a benevolent metric behind the scenes while presenting a façade at the surface. For example proper studies have shown that Japan’s investment ministry doesn’t invest in successful firms looking back in time, so one questions their methodology at the time of investment, and moreover, the ministry doesn’t predict the future well either so it can’t be justified that they are predicting the future when they invest.

Some people believe no one can predict the future with any degree of reliability without simultaneously changing the future which some people also deem is impossible to do without predicting the future which they deem impossible. The result of all this is if one were to take the perspective of a monarch in the Scottish Enlightenment is that the people must learn to govern their own economics to allow for banks to function and form the societies based on relationships that run separate of the government, which has a proper role as a night watchman in a libertarian sense, but at the end of the day, is not equipped to making decisions for its people as much government does not intervene in the playground disputes of students but merely is there to provide a safe framework for students to work together.

To build or to control?

Modeling cities with economics is meant to find buttons that can be pushed or in other words exogeneous, or independent external, causes of endogenous, or inter-related internal, outcomes that we want to manipulate such as increasing wages, increasing housing prices, and increasing the size of the city. Models in economics thus identify levers between exogeneous variables and outcomes. Economists focus on improving the outcomes of people rather than the outcome of a place when making policy, because if we improve a neighborhood and all the people move out, those people’s lives did not improve and it is merely the downside of gentrification that we’ve done. This is a reflection of a historical reality in housing projects.

how government affects city economy

Governments traditionally have made poor decisions or at least decisions that don’t always represent the constituencies of the people displaced by housing. For example just confiscating a lot of land by fiat and building a nice housing project would displace the people who used to live there who would move elsewhere and continue to suffer in poverty. The response by economists has been to create competition among governments for this aspect of encouraging development. This type of thinking led to some politically treacherous places: governments exist for a reason and that is maintain the order of a society, and efforts to discredit the actions of governments merely on the basis of fiduciary duty are misguided because government creates the framework that allows the concept of fiduciary duty to be enforced by law. Government may be the problem per Reagan but he is speaking of problems inherent in the governing of people, not primarily of the institution of government which has been shown to be a historical necessity that drives much of the history of the world and including the economic history of the world that links bank accounts to the decisions of government executives, legislators and judicators.

The people and the system: what is fair?

In the United States, a lot of money was spent in the 1960s to rebuild cities and contractors arguably benefited more than the target populations, assuming the populations were targeted, because cost and benefit couldn’t even be calculated for the populations as they moved out. Focusing on people rather than place is what economists noticed well ahead of the societal mainstream which focused on individual achievement and was clouded on how other people’s welfare affects one’s own welfare. We sink together and swim together just as in a corporation as in a city that is well-run with a government responsive to the people as after all, government is just a service.

The same people who would justify government staying out of the picture because of their incompetence or wrong-headed aims: these economists would also point out market failures are everywhere in urban settings. The trouble when thinking about government is market power: the legal system for example has no rivals and cannot be ignored. People are quick to blame the legal system for everything as a result in modern United States where a court case against you may fuel grudges for years against the system in abstract, but the reality is the legal system works to enable transactions to be made between people and this enables the construction of society. It is not always about fairness in a locality but greater fairness in creating the means by which fairness can be implemented.

maintaining balanced economyThe formula to productivity and happiness

Economists try to improve utility, which can be seen as the value of optionality, and is not a psychological measure of happiness in that we give people means to make themselves happy and don’t worry about whether their happiness goes up or down in every decision we make which would take away from them the decision of using means to make themselves happy. Economists study cities via studying people as rational optimizers who respond to incentives, and then make conjectures from an equilibrium that they presume exists without arbitrage. That is when everything has settled down, no one can take advantage of the settled state. This is not a statement about whether the settled state is reached immediately or through time but simply that when an equilibrium does arise, it needs to have certain qualities.

For example, the indifference of settlers across the city in equilibrium means effective wages must exceed effective housing costs in every location, and moreover they must exceed by about the same amount or housing costs or wages would be driven by supply and demand to change until people are indifferent. A very desirable neighborhood gets bid up in price. For example, city center locations have short commutes and high wages nearby and thus there are high housing prices. City center locations have these higher wages because of high productivity from their location of being physically closer to the supply chain and desirable customers as well as even being closer to imports into the city of natural resources. Housing is thus expensive in cities but the high prices may also be due to simply the higher cost of construction. Builders as well as residents must be indifferent so builders observe housing prices and will build when they exceed the full costs of construction, but builders have their own considerations in their own equilibrium and so prices do not always come down from supply. Wage differences are accounted for by differences in productivity assuming free and fair exchange of value between what is produced and what is received in return. Employers expect high productivity from the higher wages paid in cities.

The cost of success

There’s a field called agglomeration economics which studies how productivity exactly drives income differences. For example, some cities rise to become more productive than other cities, yet there are still ghettos and some cities are denser than others. Cities originate perhaps due to favorable climate but then in places like Bangladesh, the climate became a hindrance after the economic retreat of the British Empire which actually made Bangladesh much worse off economically because Bangladesh was leveraged well for an empire that created wealth.

American cities like New York City sometimes have sky-high wages which can be explained by a scarcity of talent due to the difficulty in training for example. a neophyte into a financial executive and how few make it that far in the process.

costs affecting city economy

Transportation costs should be a big driver in reverse correlation to housing costs: higher transportation costs would lead to lower housing costs in compensation from a demand adjustment. But instead we see school quality being more important to in determining home prices. Transportation does seem to affect prices as subway routes dictate a rapid drop in housing prices as transportation costs rise, but then it doesn’t seem to matter when people switch to cars so distances become relatively irrelevant at further distances where all people are using cars. We have been speaking in terms of common patterns instead of nuance because of sheer amount of data that economists work with. We do see poor cluster at the city centers despite the higher productivity, higher wages, and higher cost of housing. The rich seem to leave cities perhaps because they want to own more land. It is evident that that the poor do most of their living in the cities as poverty rates rise around subway stops. In our research, we can use big data to estimate models which we then manipulate to imply different conclusions, or we can study exogeneous shocks such as rivers or politically charged boundaries in cities: in other words, a disturbance that shifts some factors around and makes relationships clear. Formal economic models do imply that when certain assumptions are met, competitive markets often give the most optimal outcome for society, but income distribution is not something that has been proven to be optimized by free markets. Warren Buffett even said our system is very fair except for the very rich and very poor.

Prices always reflect the marginal resident’s willingness to pay and is not a polling booth for what the fair price should be. Some people compare valuation to being a weighing machine not a voting machine, and the reality is prices are set by the last person willing to pay that high of a price which may have nothing in regard to valuation. For example very expensive apartments offer a few benefits such as park views and it is not the average person who desires a park view so much that he bids up prices to that level, but a few very wealthy people who are willing to pay for such a price.

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