Key message 3 – Urban policy: To achieve cities’ potential, policymakers must address key issues including land, transport, public finance, and regulation

Development of the city will be undertaken largely by the private sector, whose investments will be guided principally by the market. Nevertheless, there are two key roles for policy. One is to provide public goods, infrastructure and services without which a city cannot function. The second is to ensure that markets work effectively. This requires a combination of removing obstacles to the market, and appropriate regulation of situations where market failures can lead to socially damaging outcomes.

1. INFRASTRUCTURE AND PUBLIC SERVICES

The provision of utilities, public amenities, and services is crucial for both the productivity and liveability of urban areas. They provide direct benefits to households and firms without which the city is less attractive and less likely to prosper. In addition to providing these benefits, public investments play two further roles in shaping the growth of the city.

The first applies principally to transport. Good transport enables workers to get to firms, firms to reach markets, and facilitates interactions in clusters of activity. The full benefits of transport improvement are greater than those that accrue directly to transport users: it may benefit others by enabling the growth of clusters and consequent increases in urban productivity.

Second, public investments play an important role in coordinating expectations about the growth of the city. Since structures are long-lived, investors – residential developers and firms – need confidence that the particular place where they are planning to invest will prosper. The market is not able to provide this. It offers no certainty about future benefits in a district, and no way of hedging location-specific risk. Without confidence, investment right across the city will be deterred. An urban plan might be intended to provide such confidence, but often such plans are not credible. In contrast, investments in infrastructure are long run commitments to an area. For example, investors in the proximity of a new station or junction might expect that others will choose the same location, generating a cumulative virtuous circle of investment. It follows from this that infrastructure investment needs to lead, not lag behind, the growth of the city.

However, this creates an enormous urban public finance challenge. A local tax base is needed to finance these expenditures. A successful city generates a local tax base, as its economic advantage leads to appreciation of land values. Targeting urban land for taxation offers several advantages.

The first is ethical. Land value appreciation occurs because of the productivity generated by the city as a whole, so the enhanced value is not readily attributable to the actions of any particular land owner. However, much of the increase accrues to the owners of urban land who, while they may have constructed buildings, have not contributed to the overall rise in land values. Therefore, there are reasonable ethical grounds for assigning this value addition to a city authority as the representative of the residents who have collectively generated it. This can be achieved by the taxation of land value on a continuing basis, or by a one-off tax on increases in the price of land.

The second advantage is that a well-implemented property tax is an efficient way to raise revenue. It is relatively easy to collect once a comprehensive land registry is in place. It has little effect on decision making, particularly if the tax base is an estimate of land value, exclusive of structures built on the land. The appreciation of land values can finance all infrastructure required by an efficient city.

2. LAND MARKETS AND RESIDENTIAL INVESTMENTS

Low levels of residential investment are apparent in the squalid housing conditions of many developing cities. In part, this is a direct consequence of low income levels and capital scarcity. But in many cities it is also a consequence of institutional and policy failure.

Private investment in built structures (residential or commercial) requires an environment which has clarity and security of land tenure. This is particularly so as buildings are long-lived, so their development requires that investors have secure title of land for long periods. In many countries such rights are unclear and disputes surrounding ambiguity of title can be difficult and slow to settle. These weaknesses in land rights deter investment and encourage investors to economise on capital by building low quality structures, which are typically low-rise and hence support low population density. They make land and the property constructed on it less marketable, and also less able to function as collateral. An important role for policy is therefore to make sure that these rights are sufficiently clear and enforceable.

There is an important role for regulation of land markets and construction practices, but regulations are often set inappropriately. Regulation – typically controls on the type and quantity of building in a particular place – plays several distinct roles.

One is that regulation can enable markets to work better. For example, it is hard to inspect the construction quality of a building (e.g. its foundations) once the building is complete. Prospective purchasers of the building (or lenders, for whom the building is collateral) need this information. If they know building regulations have been complied with, they will be more secure in their purchase.

Another is to control negative externalities that can arise in cities. Pollution from factories to residential areas can be controlled by zoning. Overload on infrastructure and utilities, and the congestion or service breakdown that can follow, can be regulated by floor-area ratios or other measures to control the number of buildings or people in a neighbourhood. H

owever, appropriate is the key word here. Too often regulations are set at levels that are unaffordable, and zoning is too rigid. The effect is to deter the essential private investment that is needed. If building regulations and standards for plot sizes are set too high then they will simply be ignored. This matters because structures built outside one regulation may then lose other legal protections. In short, decent quality formal sector houses will not be constructed if regulations make them unaffordable: informal settlements will fill the gap.

Achieving appropriate levels of residential investment requires that other sectors and markets, as well as the land market, function effectively. Capital markets and financial intermediation are needed to provide ways of saving for house purchase and financing loans for both commercial and residential construction. Often capital markets fail to play these roles. The mortgage market is very thin as commercial banks are unwilling to lend and specialist mortgage providers have not emerged. High levels of inflation and associated high nominal interest rates have tended to make initial mortgage payments unaffordable. In many countries, particularly in Africa, the construction sector is weak: there are large firms (some of them international) and there is self-build, but small- to medium-size building companies are scarce.1 Associated with this, workers with building skills are often in short supply. Policy to address these issues must be joined-up across government, reaching financial regulation and macroeconomic policy as well as urban management.

3. BUSINESS INVESTMENT AND JOBS

A city’s success depends, ultimately, on its ability to create jobs, this in turn requiring a good business environment. Much of this environment is set by policy at the national level, but there is also a city level dimension. Many of the points have already been covered: infrastructure is needed for moving goods and workers; land needs to be available for development; regulation needs to be consistent with undertaking investment.

The city level business environment has particular importance as each city competes with others – in the region and internationally – for footloose (regionally or internationally mobile) sectors. These are the sectors that are needed for sustained job creation, which are most subject to agglomeration economies, and in which the benefits of scale and high productivity are best attained.2 A city that is high cost – because it fails to use land efficiently, has poor infrastructure and public services, or a poorly housed workforce – will not be attractive to investors in these sectors. Consequently the only economic activity is relatively low value and directed at serving local markets.

Many cities face a serious risk of being locked into these low value activities. The long life of built structures means that a city built around low value activities is ill-suited to provide the density needed for modern manufacturing or service jobs. Such a city has low productivity, incomes, and tax revenues, making it difficult to finance the infrastructure, services and other investments required. The implication is that policymakers need to act soon, and need to see the city as a whole and with a long-term perspective, if they are to realise the full potential of urban growth.

Footnotes

  • 1 For example, see IGC work by Professor John Sutton (LSE) on this issue – www.theigc.org/project/the-enterprise-map-series/
  • 2 See Gollin et al. 2015 for evidence on ‘urbanisation without industrialisation’.