The national government’s role in urbanization: National governments have often tried to influence the pace or location of urbanization. Often these efforts consisted of shifting resources from agriculture to finance the expansion of modern economic sectors… usually manufacturing…
which were concentrated in cities. Urban workers in the formal sector benefited from food and housing subsidies and government sponsored unemployment and pension schemes, while rural populations received low prices for their crops and had little access to government support.
Such misplaced efforts are part of the reason Africa has seen so much urbanization with very little economic growth.
In other cases governments, alarmed at the growing population of ill-housed and underemployed citizens living on the periphery of cities, have attempted to halt urbanization.
In many developing countries, squatters were rounded up and trucked back to the countryside. In some socialist countries a system of permits restricted rural-urban migration.
And in some new others industrial firms were essentially prohibited from locating new plants in or near large cities. Policies to stem urban population growth have largely failed.
In many countries effort to evict migrants did not succeed and was later abandoned. Substantial internal migration occurred in many countries despite controls on population movements.
These efforts did, however, impose significant costs on both migrants and the economy. An overwhelming body of evidence shows that when the poor migrate, they are responding efficiently to economic incentives… notably higher wages…and generally are better off after they move.
Attempts to stop migration prevent the poor from improving their economic situation and can impose other costs on migrants.
Limits on migration to many capital cities, for example, made the poor more susceptible to extortion by corrupt officials.
Governments have also distorted urban growth through their choice of locations for state-owned industries and by creating special economic zones… decisions that are often influenced by political rather than economic considerations.
Countries that set up special development zones offering relaxed tariffs encourage economic activity to settle in one privileged area at the expense of others.
For example, if trade liberalization is introduced in one specific area of a country first, other regions may find themselves permanently disadvantaged.
Such policies foster dual societies, with cosmopolitan cities in one areas and disadvantaged areas in the outlying hinterlands.
The capital cities that were the early beneficiaries of open door policy have maintained their advantage, even though their special status was abolished long ago.
Similarly, if the spread of technology or the liberalization of capital markets is confined to certain areas, these areas will have a permanent advantage over others in the country.
Bureaucratic centralization is another, more subtle form of the government-induced distortions that can influence the choice of new sites for production. Government regulations, especially rules governing import and export licenses and capital markets, affect the economic life of firms.
Central government bureaucrats like to keep tight control over the process of allocating licenses or loans.
But an overly centralized allocation process causes distortions when firms are deciding where to locate production. Producers tend to locate in capital cities and other bureaucratic centers in order to be able to deal effectively with red tape.
In the early 1980s many developing countries liberalized capital and export-import markets, creating new opportunities for small and medium-size firms.
But the dispensing functions remained highly centralized, and the concentration of small and medium-size firms in larger metropolitan areas increased.
The unhappy record of past government efforts to prevent rural-urban migration or to steer urban growth to particular locations leads to a straightforward conclusion:
governments are not skilled at deciding where households and firms should locate. National governments can perform a more useful function by working to provide an environment conducive to economic growth regardless of location.
Macroeconomic policies that promote price stability and national institutions that enable firms and households to make binding contracts may be the most important factors in creating a growth-oriented environment, and national governments can provide them.
In matters of location the ideal government policy is to provide a level playing field so that large and small cities and rural areas can compete fairly with each other. Pursuing such a policy involves more than just eliminating subsidies and tax breaks, however.
Many government decisions have unavoidable spatial implications, especially decisions on sitting large-scale public infrastructure investments, military bases, and public enterprises.
As urbanization spreads within a country, investments in public infrastructure must follow. Industrial producers in remote cities and areas outside of cities require interregional telecommunications, roads, and electricity if they are to produce competitively, move products to major markets, and communicate with willing buyers and sellers.
The national government plays a key role in determining whether and when such investments take place.
One difficulty is that centralized state-owned industries or established businesses may resist hinterland infrastructure investment for fear of competition. Another complication may be that the central government fails to understand the needs of hinterland areas.
Industries in rapidly growing countries began decentralizing in the late 1980s after the government made massive investments in communications and transportation in regions outside urban centers and restored local government autonomy.
In principle, a centralized government can create a level playing field for locational decisions. In practice, however, resisting pressure to concentrate investment in the primary city requires institutional mechanisms that give other regions a voice in the allocation process.
Central governments are now under pressure to decentralize decision making power and resources to subnational governments.
In a decentralized system the central government’s role with respect to urban development no longer involves eliminating spatial biases in a centrally managed system of investment allocation.
Instead, the role of central governments is to provide the institutional structure for decentralization and coordination across all levels of government.
Local policies for urban economic growth: If cities are to exploit the benefits of agglomeration, they must provide efficient and attractive policies to do business.
This next section focuses on three cross-sectoral elements of this strategy: financing for infrastructure investment, land use policy, and municipal entrepreneurship.
Financing capital investment: Cities need to invest in infrastructure if they are to provide the basic services necessary for economic growth.
Pressure for investment will be particularly heavy during a country’s urban transition…. the years of rapid urban population growth fueled by rural-urban migration. In recent decades a boom in infrastructure spending has paralleled urban growth.
Absorbing the 2.4 billion new urban residents expected over the next 30 years will require further investment in housing, water and sanitation, transportation, power, and telecommunications.
The need for these new infrastructure investments comes on top of the backlog that already plagues the world’s cities. Providing universal coverage for water and sanitation alone in the cities of developing countries will cost nearly 5% of those countries’ GDP.
Public or private? Not all the necessary investment financing need come from government, as several alternative sources are available. Housing, which accounts for about 30% of gross capital formation in many poor countries (including the on-site costs of water, sanitation, power, and access), is often funded by private sources.
In industrial countries developers are frequently required to provide on-site infrastructure.
These costs are incorporated into the price of finished housing and are ultimately financed through the mortgage market.
In developing countries poor and low income households have to finance housing from current income, adding space and infrastructure as their means allow. In both cases capital is mobilized and allocated independent of the government.
The private sector can also finance off-site costs of power, water, and telecommunications. In fact, private firms are increasingly signing contracts to build such infrastructure and in many instances agree as part of the deal to finance the future expansion or upgrading of networks.
Central or local? In most developing countries, central governments have traditionally mobilized the resources for public infrastructure through domestic taxation and borrowing, forced savings schemes, external debt, and donor assistance.
These funds have been spent directly by central government ministries or government-owned enterprises. But pressure for decentralization is changing this pattern to allow subnational politicians to make investment decisions.
Sound economic arguments exist for pushing these infrastructure investment decisions to the subnational level. Centrally determined spending can produce arbitrary allocations across cities and tends to sever the links among investment, operation, and maintenance.
In contrast, municipalities that have control over investment decisions can respond to local priorities. High-income countries have apparently found this argument persuasive.
The central government’s share of public investment spending is generally below 50% in countries with a per capita GDP of more than $5,000. Growth in GDP per capita is generally associated with a declining share of central government spending in public investment.
Local governments can finance their new responsibilities in several ways. Development fees, connection charges, and local tax revenue can all generate funds that can be used for investment.
While such resources can make a significant contribution to investment financing, particularly in slow-growing cities, they may not be enough to finance all infrastructure investments at the peak of the urban transition.
In this case debt financing may be required and can make financial sense. Roads, schools, and pipelines have long useful lives, and debt spreads out the costs over their lifetimes.
But what options do local governments have for borrowing? The experience of industrial countries suggests two: municipal bonds and municipal funds.
In many developing countries, few of these conditions exist. Long histories of macroeconomic instability make long-term financial commitments extremely risky.
Information on potential borrowers is unreliable. The legal framework needed to provide investors with recourse in cases of default is underdeveloped and often untested. Municipal governments in these countries are viewed…
often correctly… as particularly unattractive borrowers because they lack the autonomy to raise revenues or reduce spending, particularly on personnel. Moreover, local governments often have no credible political commitment to long-term financial obligations.
Under these conditions, even if long-term private capital is available, local governments generally can borrow only at a very high rate of interest, if at all. Despite these shortcomings, municipal bond markets are emerging in many developing countries.
Conditions in individual countries determine whether the bond or the bank approach makes more sense. Both can operate simultaneously, as they do in the developed world.
The challenge is not to choose between them, but rather to establish an environment that gives local governments the opportunity and incentive to become worthy borrowers.
Such an environment emphasizes a stable macro economy, a legal framework that defines the rights and remedies of lenders and borrowers, and the creation of a supply of creditworthy borrowers.
Central governments especially need to concentrate on the legal framework affecting municipal borrowing, including bankruptcy procedures for municipalities.
They need to take measures to forestall pressure for government bailouts. Finally, they need to do their part to enhance municipal creditworthiness by stabilizing intergovernmental transfers and scaling back unfunded mandates and regulations that limit local governments’ flexibility in making spending decisions.
Local governments, for their part, can improve their attractiveness to borrowers by instituting accounting, auditing, and disclosure practices that are compatible with international standards.
They can also improve the quality of their collateral by allowing central governments to deduct debt service directly from intergovernmental transfers or by using a specific tax or other revenue source to pay debt service.
Loan contracts can specify that debt service will receive priority, prohibit new borrowing backed by the same revenue source until the debt is retired, or both. Actions, however, are more persuasive than words.
The most convincing evidence a local government can offer potential lenders is a long, unblemished credit history.
Land use: Firms and households must be able to make efficient decisions about where to locate within cities. Freedom of mobility, or the lack of it, profoundly affects urban economic growth.
Agglomeration economies, by definition, require proximity… firms to firms, households to places of employment and shopping.
The ability of firms and households to sort themselves into efficient location patterns requires an active real estate market in which land prices reflect the different economic values of various sites. Governments regulate the operation of land markets in several ways.
The most extreme approach is to ban the real estate market entirely and make location decisions by fiat. Zoning typically assigns various uses…residential, retail, commercial, industrial, and mixed…to land in different parts of the city.
It may also dictate the intensity of use by imposing maximum or minimum limits on lot sizes, floor space, or floor area ratios.
Zoning is intended to coordinate private configurations of land use with the public portion of the market, where the roads and plots are.
It is also intended to minimize externalities across uses by, for example, isolating landfills from residential areas. Even zoning can be taken too far, however.
If manufacturing is isolated from residential areas, commuting becomes difficult and expensive for industrial workers. Excessively high standards for residential development drive up housing costs and force low-income households to locate far from job centers.
Zoning can also be too static. Cities change, but redrafting land use plans can be a slow process.
Governments also influence the location of economic activity through their control over public land and transportation systems.
Up to half of urban land is in the public domain, including roads, highways, sidewalks, parks, and public buildings and facilities.
The way the government chooses to use the public portion of urban land determines the spatial configuration of a city: where industry locates, how congested the city is, how dense neighborhoods are, and how the city will develop.
Cities expand through progressive additions of transportation corridors and ring roads that allow economic activity to spread out in more or less concentric circles.
Failure to expand transportation facilities delays the movement of people and industry from city centers to suburbs, resulting in exceedingly dense core cities with poor living conditions and noncompetitive land and wage costs.
When Jakarta finally built toll roads into the immediate surrounding countryside in the late 1980s, population density in the city center fell from 42,000 people per square kilometer in 1980 to 30,000 in 1990.
Meanwhile, the suburbs around Jakarta, where wage costs were 25 percent lower than in the city center, increased their share of the metropolitan area’s formal manufacturing employment from 44% in 1985 to 65 percent in 1993.
Governments influence the efficiency of land use in a third way: through their role as a repository of claims to land ownership. Well-functioning land markets require clear title arrangements and a well-kept land registry, so that ownership rights are clearly established and all transactions are recorded.
The lack of such arrangements hinders private (re)development by jeopardizing the gains developers and individuals expect when they improve land. When a city has an informal sector where land use rights are insecure, redevelopment becomes even more difficult.
Finally, urban planners need up-to date information on land use and transactions in order to design and implement effective land use plans.