Cities, property, and positive externalities.

AuthorParchomovsky, Gideon
PositionII. Of Cities, Shopping Malls, and Externalities through Conclusion, with footnotes, p. 236-261
  1. OF CITIES, SHOPPING MALLS, AND EXTERNALITIES

    Building on the theoretical discussion in Part I, in this Part we present the economic literature on cities and shopping malls. By contrast with their neglected role in legal scholarship, positive externalities hold pride of place both in urban economics writ large and in the much smaller body of economic writings on shopping malls.

    Urban economists believe that positive spillovers are key determinants of the success of cities: spillovers--especially, but not limited to, those arising from human capital or expertise--account for the very existence of dense urban areas. (112) Following Alfred Marshall, economists have identified agglomeration effects--positive spillovers arising from spatial proximity--as a key variable affecting economic growth. (113) The economic literature on shopping malls also positions positive spillovers among stores at the heart of the analysis. (114) However, as Peter Pashigian and his coauthors demonstrate, malls are specifically designed to capture positive externalities, and it is the ability of developers to internalize them that determines the performance of shopping malls. (115) Combining the two literatures points to the conclusion that cities should borrow a page from shopping mall developers' book in designing commercial areas.

    1. The Economics of Cities

      Although property theory and law undervalue positive externalities, the same cannot be said for leading theories of economic geography, according to which positive externalities are crucial to the very existence of cities. Such externalities can take many forms, but their existence is a necessary condition for agglomeration of economic activity.

      Paul Krugman received the 2008 Nobel Prize in Economics in part for his work in economic geography, which offers an explanation for the growth of cities. (116) Positive externalities are a key to this work. The prize committee summarized Krugman's contribution by noting that "[t]he new economic geography initiated by Krugman broke with ... tradition by assuming internal economies of scale and imperfect competition. Agglomeration is then driven by [positive] pecuniary externalities mediated through market prices[,] as a large market allows greater product variety and lower costs." (117) Krugman's model starts from the assumption that "consumers have a taste for variety." (118) That taste can be satisfied either by local production or by goods brought in from somewhere else, although the latter are more expensive due to transportation costs. (119) Some goods will be too expensive to import but can be produced locally. As there are some fixed costs in production, however, there are economies of scale--larger markets will be able to produce goods at a lower unit cost than smaller ones. (120) Moreover, larger markets will also tend to have more goods, and hence, a greater variety, than smaller ones. (121) Given that consumers desire additional variety, the greater range of goods, in combination with cheaper prices, gives cities an advantage in attracting residents. (122) Importantly, that advantage gets larger as the city grows in size; there are increasing returns to scale, so growth in size begets further growth. (123)

      Tests of the Krugman model have proven difficult, in part because of problems with measuring the prices of relevant goods across cities with sufficient precision. However, a recent paper by Jessie Handbury and David Weinstein provides empirical support for Krugman's theory. (124) The paper aggregates tens of millions of precise observations on prices across cities--prices for "identical products sold in the same store chain [and purchased] by the same type of shopper" (125)--and concludes that with appropriate controls, the prices of identical goods do indeed fall with an increase in city size. Conversely, the variety of traded goods increases. (126)

      Empirical work by Joel Waldfogel is also supportive of these general patterns, although not necessarily of Krugman's precise model. (127) For example, Waldfogel shows that because of high fixed costs, larger cities can support more radio stations and offer more programming variety than smaller ones. (128) When people differ in their tastes in music, as Waldfogel shows to be the case for various racial groups, (129) significant positive externalities arise from being located near others who share one's preferences. (130) Black radio listeners get access to significantly more variety in the kind of music they prefer when they live in cities with large black populations as opposed to those with small black populations. (131) In general, "people get what they want only if [they are located near] others [who] are also prepared to pay for it. As a result, consumers benefit from participating in a product market with others who share their preferences." (132) Waldfogel terms this effect a "preference externality." (133)

      Krugman's elegant mechanism is far from the only one that invokes positive externalities to explain why people bunch together in cities. Rather than focusing on the consumption externalities Krugman stresses, other theorists have focused on externalities in the production of goods and services. More than one hundred years ago, the English economist Alfred Marshall proposed that new ideas diffused more rapidly when firms are located in physical proximity to one another, because employees can easily move between employers or otherwise exchange ideas. (134) That, in turn, means that firms in the same industry benefit from colocation because their presence lowers information costs for the group as a whole. (135)

      Whatever their source, some sort of positive spillovers are at the heart of economic theories of why cities exist in the first place. Without such benefits to colocation, we would expect economic activity to be randomly dispersed across the landscape. Instead, however, at "the end of 2008, one-half of the world [population] ... live[d] in cities." (136)

      It is important to note that agglomeration effects--whether in consumption or production--are different from the positive externalities we have discussed so far. In garden variety positive externalities, a firm or consumer provides benefits for others who are located nearby, without being able to capture any of these benefits for itself. When Amy cultivates a beautiful garden, for example, she provides an uncompensated benefit to passersby, but--crucially--receives no symmetric benefit from their presence as viewers of her garden. In the case of agglomeration effects, however, the spillover benefits are mutual: by colocating, each firm provides--but also receives--benefits from all others situated nearby. (137) Thus, agglomeration effects are dynamically reinforcing: the larger the population, the greater the effects, and the more attractive it becomes for a firm or consumer to locate near others. (138) No such mechanism is at work in standard positive externalities.

    2. The Economics of Shopping Malls

      The economic literature on shopping malls is also centered on positive externalities. Here, however, the story takes an interesting turn. Unlike cities that evolved organically over a long period of time and have been shaped by multiple forces and pressures, shopping malls grow out of careful and discrete planning. (139) Moreover, they are designed with one goal in mind: commercial success. (140) Finally, whereas the composition of stores in a particular mall changes over time, the overall layout and combination remain fairly constant. (141) As a result, shopping mall owners must be very circumspect about selecting the optimal mix of stores; one means by which they do so is to adopt a pricing mechanism that enables them to take account of the relative contribution of each business to other stores. The use of differential rents--which often diverge significantly--allows mall owners to attract businesses of all sizes and come up with a mix of stores to make the enterprise attractive to both businesses and patrons. (142)

      Here is an example that illustrates the basic economics of mall development. Shoelace Shack (Shack) is a small retailer that, unsurprisingly, sells shoelaces. In deciding whether to make a purchase at Shack, its customers have to factor in two separate but related kinds of costs. The first is the cost of the shoelaces themselves. But in addition, because customers live at varying distances from Shack, and transportation is costly, customers must also take account of their travel costs, in terms of both time and money. Assuming that all customers have identical tastes for shoelaces, this means that there is some maximal distance a customer is willing to travel to purchase his shoelaces from Shack. Beyond that distance, the costs of travel outweigh the utility gained from buying shoelaces, making a visit to Shack uneconomical. (143) At any given price for shoelaces, then, Shack will face a spatially constrained demand.

      Imagine that Spears Roadblock (Spears) is a large retailer, selling clothes, tools, washing machines, TV sets, and so on. Like Shack, Spears has customers who are spatially dispersed and who must incur some transportation costs to visit the store. Note, however, that because Spears sells many big-ticket items, its customers' willingness to incur transportation costs are larger than Shack's; they are willing to drive farther to buy a $750 TV set than the distance Shack's customers will drive for a $2.50 pair of shoelaces. Thus, Spears has a wider catchment area within which it can attract customers than does Shack.

      Consider what will happen if Shack and Spears are located on immediately adjacent and independently owned plots of land. Some customers, who would not patronize Shack if it were located by itself, are willing to drive to Spears. While these customers are at Spears to buy a TV set, the marginal cost of stopping by Shack to pick up a pair of shoelaces is essentially zero...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT