Economics

Response to Romer on private cities

Paul Romer has commented skeptically on private cities in two recent interviews. Having written on private cities I thought I would take a second to respond.

First, in his own words “And my rule is that I will not support any public policy initiative for a new city if it is not the kind of place that I would be willing to go live or where I would want my children and grandchildren to live.”

I think this is the wrong criteria for judging public policy initiatives. A better way to judge public policy initiatives is whether they improve the lives of those who are targeted by the initiatives. There are many cities throughout the world that I doubt Paul Romer or his offspring would want to live in. However, those cities are inhabited by hundreds of millions of people who want better lives for themselves and their children.

Romer does argue for experimentation and does not seem wedded to a particular organizational structure of a Charter City. I agree that openness and experimentation is necessary in creating new cities. Unfortunately, Romer specifically contrasts his vision to that of private cities, suggesting private cities should not be allowed. Before specifically answering Romer’s critique I will offer a few comments defending private cities.

The basic argument is that profit encourages the effective provision of goods and services. A private city that fails to provide those goods and services would quickly go out of business. Romer correctly notes that this analogy is somewhat lacking. Moving to a new city is high cost. As such, exit in governance terms is always more costly than exiting a grocery store, as new grocery stores are easier to substitute.

One advantage of private cities is that the initial construction of a city is very costly. A private city would mean the cost of infrastructure would be provided privately, possibly saving a government billions of dollars.

Another advantage is the distinct organizational structure. One of the primary benefits of a new city, be it Charter or private, would be to create a new bureaucracy to escape corruption in the home country. A private city would have a strong incentive ensure the bureaucracy is entirely separated. Old bureaucratic influence would be more likely in a public vs. private partnership.

Romer’s primary critique comes down to police. I will quote him in full.

The track record of private police forces and private judicial proceedings is very bad. We have some of these in the United States run by private, but non-profit, universities. If the university has a sports program that generates lots of revenue and prestige, the university tends to protect athletes, typically men, who commit sexual violence, typically against woman. They do not offer anything like “equal protection under the law.” It is a telling illustration of how police and judicial proceedings can be bent to support the mission of the organization, even one like a university that we usually think of as being well intentioned, and fail to protect the people it is responsible for.

First, I think it is odd that in critiquing private, for profit cities, he uses the example of non-profit universities. However, I agree his point stands and must be thought about. Many informal sources I have read suggest similar things happen at hotels, petty crimes by wealthy patrons are somewhat ignored. That being said, I think Romer overestimates the police, in first world countries and especially in the developing world.

As the events of Ferguson and Baltimore illustrate, police have rarely lived up to the ideal of equal protection under the law. Freddie Gray likely died because of a nickel ride, a procedure where police do not strap a suspect in a police van and then drive recklessly. Chicago PD had a black site, and before that they literally tortured people. Stop and frisk, done by several major cities, but most prominently by New York City, is essentially the continual harassment of minority males. I would recommend Radley Balko’s excellent book if Romer is interested in modern policing in America.

However, Charter Cities and private cities can do the most good in the developing world. Unfortunately I am unaware of much literature on law enforcement in the developing world. That being said, it is assuredly worse than in America. Some friends from Honduras, which is the murder capital of the world, have told me stories which illustrate how bad law enforcement can get. I heard from several people that they fear the police more than they do the maras, the gang members. Other people have told me that women being arrested are usually sexually assaulted, if not raped.

Now, given the level of violence in Honduras, I imagine the police force there is more corrupt than average. However, when thinking about how to improve the world it is important to understand the world as it exists. And the world is currently filled with terrible poverty and predatory institutions. Private cities seem like they could reasonably be better than many of those institutions.

Romer then comments, “Unless someone is willing to specify whether there is a local police chief and how he/she is appointed and held accountable, any suggestion they make about private cities can be dismissed as frivolous.”

This question does not strike me as particularly difficult. The obvious answer is the police chief would be appointed by the owner of the city, though I imagine Romer would consider that a frivolous response. They would then be accountable to the owner of the city, who would be accountable to the residents to the extent the owner would want to maximize revenue.

There are a number of other mechanisms which could be used for police. First, the police can be controlled by a non-profit. The board can be controlled by a mix of the owners, politicians, and other prominent individuals.

Another scenario, if there is a proliferation of private cities, is to unbundle the goods provided by each. Perhaps a firm dedicated to policing services will arise, and be contracted by the city itself. It has happened in Sandy Springs Georgia, among other places.

Another possible scenario is for an accreditation body to emerge which would rank various police departments. They would only give high scores to those police departments which taught best practices.

A private city would also likely lack sovereign immunity. It would be subject to lawsuits if it broke it’s founding charter. The charter could specify equal application of the law and due process procedures. Failing to follow these procedures would guarantee a loss in revenue.

Ultimately, I don’t know whether a private city would provide these goods and services or whether it would devolve into a corporate dystopia. I suspect Romer does not know either. Given our collective ignorance I would recommend, as Romer does, creating a set of meta rules for changing institutions on a local level. I would not limit the institutional experimentation, so long as the experimentation is not imposed on anyone. I would hope that Romer would not either.

The age of exit

I wrote a piece for the Freeman arguing that we are in The Age of Exit.

Instead of ideological battles, the 21st century will be defined by political decentralization. Rather than enforcing a single political model as ideal for all of humanity, people will instead choose from a sort of political menu. Political decisions will be made on a more localized level, encouraging experimentation and innovation.

I think my thesis is broadly true. However, for a short article I was unable to discuss several challenges, namely, China, Russia, the Middle East, and the EU. China has SEZs, however they are unlikely to allow the same amount of political autonomy as European nations facing independence movements. China is also pursuing assimilation policies to wipe out the Uyghur population in Xinjiang that would be untenable in Western countries. Russia is recently aggressive, however the drop in oil prices makes them less dangerous. The Middle East is having their borders redrawn. They are largely tribalist but have a unifying element in the Muslim faith. The EU has centralized some functions lowering the cost of independence movements in Europe. My thesis is overstated to the extent I do have not accounted for these counter trends.

Ultimately changing geo-political trends are very complicated and will remain so. Humans will try to draw patterns out of limited data and extrapolate into the future without fully understanding the causes of the changes. I am certainly guilty of it. However, the mainstream narrative is currently missing an important trend, one that should be included in discussions of geo-politics, that of the increased power of political autonomy on a local scale.

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Market nudges and discrimination

When it comes to the corporate version of systematic discrimination, the type based on preference for gender, sexual orientation, race, or some other generalized variable, businesses can employ the practice in two main ways.  Labor discrimination refers to employment preferences on said grounds.  On the other side of the spectrum, discrimination can also manifest in barring potential customers from transacting.

Markets, in all their unplanned, decentralized glory, inherently punish those who choose to discriminate.  Those skeptical of the efficiency and utility of the market routinely gloss over this point, yet its logical truth is as sound as they come in the sphere of economics.

On the employment side, routinely discriminating against a certain group or demographic has the effect of shrinking the potential pool of labor.  A smaller labor pool is a more expensive labor pool.  If you really needed to fill a key position and there were only 2 or 3 candidates qualified to take on this important role, their bargaining power, and thus negotiated salary, would be quite high.  Now imagine the same role, with the same crucial nature attached to it, yet picture 10 or 100 or 1,000 qualified candidates interested.  The wage really only has one direction to go.

Categorically refusing to hire competent labor, for whatever non-economic reason, results in a financial hit relative to the counter-factual alternative.  As a firm moves away from precisely zero discrimination to some positive amount, this will almost always be the case.

Similarly, slicing off discriminatory chunks of would-be customers has the obvious effect of shrinking one’s market opportunity.  Less customers means less sales and therefore less profit.  For unprofitable companies, discrimination means less time treading water and covering fixed costs and therefore quicker financial distress and bankruptcy.

From both angles, discriminators see their bottom lines lessen compared to what they otherwise would have been.  This is very much a good thing, assuming that you believe discrimination on the aforementioned arbitrary grounds is not a nice thing to partake in.

Not to be missed here are a few key characteristics of the procedural market mechanism that “punishes” discrimination and “rewards” its inverse on any number of corporate axes.  First of all, this perpetual nudge or disincentive is not designed by anyone.  The only preconditions here are a few key tenets of private property, such as the institution itself as well as a reasonable and stable rule of law.  No matter what might be consciously drawn-up to fix business discrimination, such proposals are not competing against an alternative that rewards or even allows these practices.  In fact, it is the opposite.

Second, the market mechanism requires no acknowledgment of its existence on behalf of the person responsible for the discrimination.  The process operates impersonally and in the background, constantly pushing back against discriminatory behavior.  While this system doesn’t thrust the prejudice or shortcomings into the face of those harboring them, such a process has its benefits.  It should, all else equal, result in less discriminatory active businesspeople, rather than a legally-enforced anti-discrimination regime which may remove some of the behavior from its midst but not the persons themselves, whose tendencies will tend to pop up in other areas, even if they might have to hire you or sell you goods (e.g. customer service, hostile workplace environment, promotions, reviews, etc…)

Moreover, confronting people about their politically incorrect and widely condemned behavior is often a good strategy for causing the confronted to double-down and retrench rather than the opposite.  Now you might say they deserve that, but it’s not clear if this is a benefit from a results perspective.  So the impersonal market nudges have their advantages.

This is not to say that a legislated approach to abolishing discrimination is not an effective or even preferred way of going about the issue; it certainly can be on various grounds.  In societies or areas with large amounts of deeply-rooted prejudice or skepticism of out-groups, such behavior may go on for long periods of time and can, indeed, be rewarded instead of punished, temporarily reversing the laws of economics where this behavior is praised or intentionally reinforced.

Nevertheless, government is a blunt tool and legislating problems away never quite goes as planned.  Imagine, for instance, the pendulum swinging too far to the one side, where salaries and wages are mandated to always be equal regardless of race or gender or even age.  Such a policy would be disastrous for economic efficiency and corresponding standards of living.  Women, as a whole and thus on average, make different educational choices and still shoulder different burdens in terms of household responsibilities like child-rearing (although this gap is closing).  They enter into less-risky professions, usually work less hours, and have career trajectories punctuated by maternity leave.  These things affect productivity: when you control for as many variables as possible and really isolate gender in econometric studies looking at wages, the large pay gap shrinks from those CNN-headline figures of 25-30% to almost nothing.

A comparable dynamic goes for minority groups and different races that are disproportionately concentrated in urban areas, such as blacks.  Policy failures including terrible public schools, the war on drugs, minimum wages, restrictive market regulations, and prejudiced law enforcement can disadvantage groups in many ways and job skills and productivity aren’t going up as a result.

Pure unfettered markets allow for the pricing of different productivity levels without fear of government fines or lawsuits.  If different groups display different relevant characteristics on average, regardless of why, monolithic legislative impositions will do more harm then good.  Meanwhile, the impersonal nature of the market helps ensure that what should be priced differently is, while simultaneously guarding against and nudging away true discriminatory, non-productivity based screening.

The left would have you believe that discrimination runs rampant in business today, parading around with impunity.  There is no corner of American capitalism untouched by it.  The truth is that it exists, yet it’s not all that common or meaningful.  If it was a widespread practice, on either the employee or customer front, then bloodthirsty capitalists have one of the largest pieces of low-hanging competitive advantage fruits floating before their very noses: don’t discriminate.

Bigger pools of labor and customers mean lower expenses and more sales and profits.  If women or homosexuals or Latinos were systematically under-compensated today in the U.S. economy, a surefire way to get a leg up on the competition would be to exclusively hire only these groups.  How, exactly, do the critics reconcile their market-skeptic indictment of the profit motive and greedy property owners with these big free lunches persisting all over the place?  I have yet to see a good explanation.  We are supposed to believe that all profit opportunities are exploited to the utmost in capitalist society, except, of course, for those that conveniently fit the ideological narrative of people who are just so certain they exist.

Until a better explanation (send me them if you’ve seen ’em!) emerges, don’t forget that markets provide a real incentive to avoid discrimination.  It might not be the best that can be done, but it is something after all, and no one had to think it up or continually maintain it.

The business person who acts on their racist, sexist, or homophobic views generally won’t do as well as they could have, they won’t escape unscathed, especially in today’s America.  The ballot box, however, offers no such impersonal push-back.  And that, if nothing else, is a distinction worth remembering.

Georgism and proprietary cities

The Economist’s newest issue is dedicated to urban land and space. The most widely accepted critique of Piketty is based on the importance of land in inequality. Henry George is proposed as a solution to Silicon Valley’s housing woes.

The common thread to these ideas is, well, Henry George. George is a figure who is very difficult to describe in modern terms. He was a combination of JK Rowling, Milton Friedman, and Ralph Nader; JK Rowling because his book, Progress and Poverty, was the most read book second only to the bible,  Milton Friedman, because he founded an intellectual movement, Ralph Nader because he entered politics as an outsider, coming in second running for governor of New York City.

Even this combination fails to do justice to George. His book was a dense treatise on political economy, hardly a bestseller today. And while Friedman was the public face of libertarianism, the movement came with a rich history and many other scholars. Further, George’s influence was so high that several communities were founded on his principles.

Looking back, the man who George most resembles in terms of influence is Karl Marx. Both wrote hugely influential treatises on political economy, inspiring both political movements and actual communities. The difference is, George’s influence waned sharply after his death, to the extent he is largely a footnote today.  People have forgotten the immense cultural influence he once was.

Unfortunately today George is only remembered for his idea of a land tax. He was also a staunch advocate of free trade. According to Tyler Cowen, one of his books, “Protection or Free Trade remains perhaps the best-argued tract on free trade to this day.” In fact, both Frank Chodorov and Albert J. Nock, now integrated into the libertarian tradition, were both heavily influenced by George.

George is coming back into the foreground primarily because of the increase in housing prices over the last few decades. After decades of land falling in importance compared to other factors of production, it is making a comeback. The rise of the knowledge economy has coincided with a rise in the importance of networks. As in person meetings are valuable for networks the land on which those networks exist rose in value as well.

The rise of property values is not the only factor sparking an interest in George. With crypto-currencies and the sharing economy income is becoming harder to track. Such factors raise the marginal cost of taxing income forcing governments to look for alternatives. As land is easy to appraise and tax, as well as necessary to live, expect governments to tax land to make up for lost revenue from taxing income.

As others have taken up the mantle for free trade, George’s legacy remains land. George argued for taxing only the unimproved vale of land, not the value of a building or agriculture on the land, only the land itself. His arguments for a land tax are relatively straightforward and can be split into economic and moral arguments.

In economic terms, land is inelastic. While taxing labor decreases the supply of labor, and taxing capital decreases the supply of capital, taxing land leaves the supply of land unchanged. His moral argument is that ownership of land is unjust because land is not created. If people own what they mix their labor with, they cannot own land as land exists independently of whether humans mix their labor.

George’s economic arguments have found a degree of popularity among well-known economists. Milton Friedman called the land tax the least bad tax. Joseph Stiglitz showed spending on public goods could increase the value of the land by the same amount as the spending itself. Even Adam Smith wrote sympathetically.

Ground-rents are a still more proper subject of taxation than the rent of houses. A tax upon ground-rents would not raise the rents of houses. It would fall altogether upon the owner of the ground-rent, who acts always as a monopolist, and exacts the greatest rent which can be got for the use of his ground. More or less can be got for it according as the competitors happen to be richer or poorer, or can afford to gratify their fancy for a particular spot of ground at a greater or smaller expense. In every country the greatest number of rich competitors is in the capital, and it is there accordingly that the highest ground-rents are always to be found. As the wealth of those competitors would in no respect be increased by a tax upon ground-rents, they would not probably be disposed to pay more for the use of the ground. Whether the tax was to be advanced by the inhabitant, or by the owner of the ground, would be of little importance. The more the inhabitant was obliged to pay for the tax, the less he would incline to pay for the ground; so that the final payment of the tax would fall altogether upon the owner of the ground-rent.

Now, before continuing it is worth noting some of the flaws of George. He did not believe he was advocating for a more efficient form of taxation.  He thought a land tax would stop business cycles and end poverty, a rather tall order. Further, a land tax is second to a pigouvian tax in efficiency terms. A pigouvian tax limits negative externalities, optimizing the level of production.

Granted, knowing the ideal level to impose a pigouvian tax is virtually impossible. Being able to differentiate between the value of a building and the value of the land on which the building is constructed is done every day by insurance companies.

The difficulty in implementing a land tax is that it is inherently redistributive. Landowners lose and renters win. As landowners typically have stronger roots in the communities they also tend to have more political power, ensuring their ability to block taxes which primarily burden them.

Land taxes would also not solve the primary problem of expensive housing, which is regulations. Nimbyism leads to onerous building codes, raising the price of housing several fold, 800% in London and 300% in Paris and Milan. The Economist reports “lifting all the barriers to urban growth in America could raise the country’s GDP by between 6.5% and 13.5%, or by about $1 trillion-2 trillion.”

The other problem that a land tax fails to solve is public choice. Even if a land tax is more efficient at generating revenue, governments rarely spend their money wisely. Spencer Heath, a follower of George, realized this. Turning Georgism on its head, Heath argued for proprietary communities, where a single owner would provide public goods. A shopping mall is a prime example of a proprietary community, providing security, lighting, public spaces, and other public goods.

The broader argument for proprietary communities is Disney World, arguably the best run city in the US. With tens of millions of annual visitors, it manages to remain clean, safe, and fun. I doubt there is major metropolitan area in the US with no dangerous parts.

Of course, Disney World is a resort, but the logic applies more broadly. Disney does a very good job taking care of Disney World because their profit depends on it. If someone is hurt or has a bad experience, Disney loses customers. The link between actions by the governing body and outcomes is much more direct than in most city governance structures.

A proprietary city would be able to gain revenue by enacting policies which increased the value of its land. While not necessarily desirable in the US, a proprietary city would likely be able to outperform many third world cities. I lived in Tegucigalpa Honduras the last five months so I will use the dysfunction there as an example, though it is hardly unique.

Tegucigalpa had several very nice bike lanes on major roads. Except they were not bike lanes, they were bus lanes. However, the buses the city had bought were too big to fit in the lanes, so the lanes were taken over by bicyclists and pedestrians. A large minority of the cars were also missing license plates. Apparently the budget for license plates ran out a few years ago and now new cars come with a letter which is stored in the glove compartment and gives the car permission to use the roads. Public schools are also atrocious, some are controlled by gangs and the leaders of several student protests were recently murdered.

Ultimately, the real problem in Honduras is the security. It remains the murder capital of the world. Having your phone stolen is an expected occurrence. Some people do not buy smartphones for this reason. Single murders are barely reported any more, there have to be two or more dead. And many people fear the police more than they do the gang members.

It is important to keep in mind the reasons above when considering proprietary cities. They do not need to be better than the first world, merely better than the competition, which in many countries is not a very high bar.

Security can be used as the most basic example. It is simple to imagine a proprietary city offering far better security than exists in Honduras today. First of all, private security tends to be more trustworthy than government police. If a private security guard is corrupt, they can be easily fired. Second, carefully monitoring the entrance and exit, as is done in all hotels and apartments already, ensures anyone committing a crime can be easily caught.

Of course, this remains speculation for now. No land developers I know of are creating open access privately administered cities on the scale I am considering. However, given the history of George’s influence. It is not unreasonable to think that a version of his ideas is revived and used to improve the living conditions in the third world.

Typology of property and anarchists

I wrote two pieces arguing for a typology of property rights. Short story shorter. Because property is a relation among men with respect to an object, we can classify property according to the relationship the property owner has with other people. The other people can be family/friends, anonymous strangers, and government. Property can also be distinguished by contracts and personal property which has the threat of violence and theft. These distinctions result in this chart.

Contracts Violence/theft
Family/friends 1 2
Anonymous strangers 3 4
Government 5 6

Below is a quote from Further typologies of property rights. 

The second part is more interesting, how to enforce contracts among anonymous strangers, 3 in the table, and how to ensure there is no violence and theft against anonymous strangers 4. Most economists are unclear on the distinction between the two options, however it is an important one. There is much evidence, international trade being the primary one, that state enforcement is unnecessary to protect contracts among anonymous strangers.  However, as Gurri pointed out, the state is likely necessary to protect against violent expropriation from anonymous strangers.

As such, the state exists less to protect private property per se, and more to protect against a specific type of encroachment on private property. In fact, given that many major American cities did not have police departments until the mid 19th century, it seems state exist primary to prevent large scale violence.

I would like to use this framework to critique academic anarchists. They tend to focus on 3 in the table, whether the state is necessary to enforce contracts among anonymous strangers. Some academic anarchists also investigate whether stable rules can emerge in chaotic situations. However, both research agendas miss the hard question 4, whether a non-monopoly of force can prevent theft and violence by anonymous strangers in a modern city like environment or larger.

To the extent anarchism is a normative project, whether it is a desirable alternative to modern first world governments is an important question. This requires a mechanism to protect against anonymous third party theft and violence. David Friedman provided the theoretical mechanism, as well as an important case study. Unfortunately, there has been little focus on this question since.

The future evolution of proprietary cities

We live in the era of urbanization.  Currently 54% of the World’s population lives in cities, up from 34% in 1960.  Such urbanization combined with political decentralization has led to the increasing importance of cities.  Cities have been inserting themselves into conversations which earlier only included nation states.

With that in mind I would like to examine the potential growth path of proprietary cities, cities where the land on which the city is built is owned by a single proprietor.  Such cities offer two advantages.  The first is better administration.  Many developing countries are riddled with corruption.  New cities can start with a blank slate in such areas as education and public safety, escaping often dysfunctional government bureaucracies.  The second is institutional change.  Proprietary cities can offer an island where there exists rule of law and property rights protections in countries that sorely need them.

So, why would a country offer a private developer institutional autonomy?  There are a number of reasons.  The private developer could show how increased economic activity would generate more taxes.  The private developer could guarantee the creation of a certain amount of jobs.  The private developer could ensure a certain amount of investment, alleviating the need of the state to build infrastructure.  Perhaps the state realizes territorial change is far easier than country wide institutional change.

Regardless of the reason why proprietary cities are spreading, the fact remains they are spreading.  However, proprietary cities are spreading under different institutional arrangements with their host states.   There are three categories of such arrangements.  First, some are being built as joint ventures with the host state.  Second, other proprietary cities have contractual arrangements with the host state.  Lastly, some host states create a legal framework for the creation of competing proprietary cities.

A public private venture, like King Abdullah Economic City in Saudi Arabia, has several advantages.  First, governments typically have deeper pockets than private developers.  This allows greater initial investment.  Second, government involvement in the project could allow for greater institutional autonomy as the city is not entirely private, diminishing potential fears about a corporatist dystopia.  The downside is that greater government involvement means greater government involvement.  This will likely slow down any project with bureaucratic delays, as well as increasing the likelihood of further government intervention in the future.

While I do not expect public private ventures for proprietary cities will go away, they will not be the dominant form of proprietary cities either.  They will likely occupy a middle ground, used by corrupt governments to showcase a big project as well as to hand out favors to politically connected cronies.

Honduras has taken the furthest step in creating a legal framework for the creation of proprietary cities with ZEDEs.  While not proprietary cities, ZEDEs will be run by a technical secretary appointed by a government established committee, they do come close.  The ZEDE law allows for the creation of numerous competing zones.  Different developers can try different strategies to attract residents, the best strategies winning.

If Honduras sees success with the ZEDEs, similar laws will likely multiply throughout Central America.  Successful ZEDEs being copied along with the law.  It is possible other parts of the world, Africa for example, could notice the ZEDEs and copy them.  However, ultimately I am skeptical ZEDE style laws will grow beyond Central America.  Drafting such laws so as not to be corrupted by the political process is extremely difficult and there is no interest group which would push for the passage of such laws.

The most promising long term strategy, but likely the most difficult short term, is proprietary cities having exclusive contracts with their host states.  A city developer could draw up a contract and offer it to several different governments, promising increased tax revenue and the creation of new jobs.  The developer in return would ask for a degree of institutional autonomy to help the city flourish.  The main stumbling block is there does not exist any developer with enough experience or expertise to credibly offer such a contract.

However, as proprietary cities achieve success in other areas, such as Honduras, the skills necessary to create such a contract and credibly offer it will emerge.  Companies investing in ZEDEs and similar autonomous zones will begin to acquire the skills necessary for large scale expansion.  Eventually, private companies will competently be able to offer hundreds of millions to billions of dollar investments in new cities.  Such potential investments will give them strong bargaining power in asking for institutional autonomy.

Proprietary cities are likely to continue to compete with traditional city governments.  The success of proprietary cities will depend on the degree of institutional autonomy they obtain from host countries which in turn will depend on the mechanism by which they are able to exist in the host country.