Suboptimal Density

Via Ryan Avent, Matthias Cinyabuguma and Virginia McConnell offer “Urban Growth Externalities and Neighborhood Incentives: Another Cause of Urban Sprawl?”

This paper suggests a cause of low density in urban development or urban sprawl that has not been given much attention in the literature. There have been a number of arguments put forward for market failures that may account for urban sprawl, including incomplete pricing of infrstructure, environmental externalities, and unpriced congestion. The problem analyzed here is that urban growth creates benefits for an entire urban area, but the costs of growth are borne by individual neighborhoods. An externality problem arises because existing residents perceive the costs associated with the new residents locating in their neighborhoods, but not the full benefits of new entrants which accrue to the city as a whole. The result is that existing residents have an incentive to block new residents to their neighborhoods, resulting in cities that are less dense than is optimal, or too sprawling. The paper models several different types of urban growth, and examines the optimal and local choice outcomes under each type. In the first model, population growth is endogenous and the physical limits of the city are fixed. The second model examines the case in which population growth in the region is given, but the city boundary is allowed to vary. We show that in both cases the city will tend to be larger and less dense than is optimal. In each, we examine the sensitivity of the model to the number of neighborhoods and to the size of infrastructure and transportation costs. Finally, we examine optimal subsidies and see how they compare to current policies such as impact fees on new development.

This issue has received a fair amount of attention in the Matthew Yglesias blog literature, so I’m glad to see some formal modeling to back it up. The point is that the addition of a dense neighborhood to an urban area brings both costs and benefits. But the benefits are more diffuse than the costs, so individual decision-making units opt for a level of density that’s below what’s socially optimal.

There are basically two things you can do about this. One is complain about NIMBYs. The other is offer subsidies to get people to accept an optimal level of density. The authors suggest that the needed level of subsidy might be quite high in large, multi-jurisdiction urban areas:

If there are a large number of jurisdictions able to make their own decisions about development density, then the private market outcome is likely to be farther from the optimum, and any subsidy will have to be larger. However, even with large numbers of neighborhoods, it is possible to offer a subsidy to the neighborhoods that will make each better off.

The point, though, is that this isn’t “we might need to pay a really high subsidy to make Matt happy.” The point is that we might need to pay a really high subsidy in order to make our metro area as economically efficient as possible. And this is a form of economic efficiency that would also be more environmentally sustainable than sticking with the sprawl-oriented status quo.