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Wednesday, October 14, 2009

Why The “Best Places to Live” Are Often The Worst: The Law and Economics of Cities (Part 3)

In my posts last week on the “Best Places to Live” rankings generated by leading financial magazines, I argued that these lists have some weird features.  They take the price of housing and treat it as a negative quality, instead of a sign of demand.  They then include variables related to public policy and the general job market in the region, which affect housing values, offsetting part of the information they put in relating to housing prices.  What’s left is all the qualities cities have that affect the demand for housing but that aren’t included in their list of variables (and maybe some inefficiencies in the market due to search and transactions costs, as commenter Elan notes).  Further, the lists do not address supply restrictions on housing.  Although this probably isn’t worth its own post, the cost-of-living variable used in the studies isn't a pure demand variable as it is distorted by the existence of massive supply restrictions in many metropolitan areas – zoning and other limitations on building – which according to this paper, contribute as much as half of the cost of housing in some regions.  This is why, for instance, Houston does so well in the lists, because it hasn’t distorted its housing market by imposing a high “zoning tax" (or have the benefits that come with zoning.)  This renders the lists even harder to understand.     

Probably the best way of looking at the rankings is, as Paul Gowder noted in the comments, as lists of cities that are undervalued based on the categories they use.  The question is which variables we should be used to determine a city is undervalued.   The variables the lists generally consider are largely of a type.  Specifically, they give high value to individual-level variables but exclude variables related to the richness and diversity of a city’s economy.   Things like the cost of living, the quality of public services, or average salary data are certainly very important to people – and are all given high weights in Best Places to Live studies -- but they are not the only variables that contribute to what makes a place a good (or undervalued) place to live. 

Take, for instance, the insurance and specialization effects of market size in consumption, labor and other markets, like dating markets.  Living in a city with deep markets in these areas increases the possibility for income growth during residents’ careers, provides insurance against firm/store/mate specific shocks, and reduces search costs for finding valuable goods, people and jobs.  These gains will not show up (or will only partially show up) in the variables used in Best Place to Live studies, but they will substantially affect residents’ wealth and happiness.  Similarly, the rate of informational spillovers, and resulting opportunities for human capital development (or, on the other side, non-rent congestion) are economically (and otherwise) relevant factors, but are absent from the studies.  These factors are determined by the other residents of the city, how numerous, how smart, how diverse and how chatty etc. they are, and clearly contribute to the demand for property in a city.   But the lists choose to ignore these variables.  The normative assumption of the lists is that that property-value increases induced by these agglomeration effects are somehow mistakes and hence that cities that are made more expensive due to their intellectual ferment or broad consumption opportunities are overvalued relative to their equally remunerative but less dense-and-active brethren.   The lists don't announce this, but that's the underlying message. 

What is particularly problematic about this value judgment is that these types of factors are increasingly important to the economic vitality of cities.  More thoughts on why this is so, and why the rankings exclude these variables, after the jump....

In a world where the predominant agglomerating force driving the growth of cities was a desire by firms to reduce shipping costs – which is why auto parts factories locate near car manufacturers – the economic vitality of cities is largely predicted by the feedback loops created by already having big firms.  However, domestic shipping costs are now a rounding error and manufacturing firms are more likely to locate in rural areas than they are in cities.  What cities provide, increasingly, are deep and vibrant labor and intellectual markets, and what they produce increasingly are ideas and services.  The things that make cities good at attracting talent, resilient to changes in market conditions, and predict growth (rather than merely reflect current wages) are the attractiveness of its human capital stock,  the rate of intellectual spillovers and the amenities cities provide.  Thus, the Best Places to Live studies ignore much of what makes cities useful in a modern economy.   

Why have these magazines decided that things like consumption market depth and intellectual spillovers are not as important as current wage levels and housing costs?  One is that they are harder to measure.  But I suspect something else is going on.  Most of the magazines that produce Best Places to Live studies are financial magazines, and these variables – human capital spillover rates, quality of consumption markets etc. – seem insufficiently hard-headed.  My guess is that asking how cool the consumption options in a city are, or how much residents learn from grabbing lunch with their neighbors, seems a bit silly or soft for business types, no matter how much they affect the demand for housing and the growth potential of cities.   

That’s too bad.  These “soft” variables are economically relevant and increasingly important for the future of cities.  Further, it’s not only magazines that have ignored the importance of agglomeration variables in determining when people move and why cities grow.  It’s legal scholars as well.  My next (and last) post on the subject will address how legal scholarship has ignored the importance of agglomeration in attempting to figure out the efficiency of local governmental laws, as I explore in my new paper, The City as a Law and Economic Subject.

Posted by David Schleicher on October 14, 2009 at 02:20 PM | Permalink


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Fascinating. Can you include a link to your previous parts? I missed them the first time around and they're off the front page (as far as I could tell with only one cup of coffee).

Posted by: Stephen C. Carlson | Oct 15, 2009 9:29:32 AM

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