Why are economic activities (e.g. businesses, houses, agriculture) located where they are?
This is the prompt of a reflection paper due Tuesday at 9:05 in Land Use Planning course and I’m going to take this blog-space right here to outline this paper. I am also taking some space within my living room with my roommate and soon-to-be long distance friend Charles and his girlfriend. I posed the essay prompt to them and Chuck’s first response was “Capitalism.” so I’m going to see where that takes me.
Capitalism commands a sweeping roll in the order of our society; that’s no new statement. The simplest anecdotes we tell of capitalism (the kind we hear in Econ 102 and from of our grandfathers) are something along the lines of buyers and sellers meeting in a market to exchange apples or bananas for some agreed upon storage of value (currency). We make all sorts of assumptions about full information and ceteris paribus and all sorts of other things which simplify the situation to convince suckers like myself to believe in the market. Generally, perfect competition works when we take a wide enough view and squint our eyes a bit, but mostly it’s about believing in the invisible hand in the first place.
Neoclassicalism, the broad definition for the set of heuristics and beliefs of rationality of individuals leading to the perfection of markets, is quite the entrenched tradition, especially in places where it ought to fail the most. Key assumption about perfect markets are large numbers of buyers and sellers, homogeneous products, full information, and free entry and exit into the market. For some reason, the asset which for most people becomes the most valuable asset and largest investment in their livelihood is property. It is so importantly and intrinsically valuable that we’ve taken to naming this investment as “real estate”. Real estate markets, this icon of neoclassicalism, is a great example of the bending of the rules of the free market.
Real estate markets largely are very thin markets. There is not an abundance of buyers or sellers like we have an abundance of both when selling bananas or other produce in our economic anecdotes. There is a very fixed amount of land in a given geographical area and there aren’t always willing buyer and sellers of the land. Real estate markets are highly segmented based upon the geographical features of a given area and a variety of individual tastes and preferences which are contingent upon a geographical features to some extent. Market segmentation and thin markets lend themselves to a variety of distortions which are especially compounded with lack of full information.
There’s a continuing list of breaks in the perfectness which are real estate markets which I will continue with in my paper, but the real kicker is that we used to ( and still technically still do and teach ) believe in what is called the Chicago School of City Planning. Chicago School is a general euphemism for neoclassical, but in this case Chicago School really dubbed it eponymously. Chicago School’s view of the city is that different segments of buyers of property had higher willingnesses to pay for prime real estate than other segments. Prime real estate in their model was the center of the city within the Central Business District, which higher rates going for as close to the CBD possible. Business and firms had higher willingness to pay than residential buyers who had a higher willingness to pay than agricultural buyers. That’s it. That’s pretty much their theoretical explanation for why cities are set up the way they are.
There’s a lot more to unpack here, and I’m really going to lean in to the legal economic nexus (my favorite nexus) about the wrongness of their assumptions. I’ll go into the intrinsinc ties between real estate and law and I’d like to end with some analytics on deductive versus inductive construction of the Chicago Theory. Are we creating self-fulfilling theories of cities as we cannot imagine a city breaking with the Chicago Theory, or was this theory built upon evidence?
We’ll see how the paper goes. It’s just an essay regardless.
it is just an essay. But what you’re describing around the imperfectness of markets is both enlightening and true. In labor economics, we describe it as your “imperfect exit-and-entry” power. The reality is, the markets aren’t perfect, because even though you can get more for your labor, you’re irrational. You’re lazy. You’re tired. And you don’t act smart about things. Or, like in real estate, the asset is so expensive that exit-and-entry power is weakened (the foundational assumption of all classical theories – that the markets will work because people will pursue reasonable alternatives). Nonetheless, I’d love to read. And, axe-throwing this week!