Working Paper No. 12-37:
The Location Market

Author(s):

Daniel B. Rodriguez, David Schleicher

Date Posted: April 2012

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Abstract:

Individual location decisions are not given much respect by local governments. Governments frequently use zoning and other regulatory rules to spread development across a city, claiming that the whole city, and not just one favored or disfavored part, should get the benefits and bear the costs of new development.  Local governments also create incentives to encourage certain types of development to locate in certain areas—using policy tools that range from non-cumulative zoning to outright subsidies—in order to create particular mixes of industrial, commercial, and residential development.   However, the arguments in favor of these policies frequently rely upon a specious depiction of the incentives of governmental decisionmakers on the one hand and private citizens on the other. That is, they fail to see the wisdom behind the old saying that the three most important factors in real estate are “location, location, location."

This paper focuses on the benefits businesses and residents get from being able to locate in specific places inside a given city.  First, it argues that agglomeration economics -- the study of why people locate in cities -- provides a useful tool for explaining exactly what is lost when a city government uses its zoning power to limit certain uses of land in specific areas inside a city.   The reduction in positive externalities like reduced transportation costs, market size effects and information spillovers stand as a counterpoint to zoning's effect in reducing negative externalities like nuisances and the like.   We explore the harms to agglomeration economies created by two Washington D.C. policies, a limit on the percentage of storefronts in a neighborhood that can be devoted to bars and restaurants and the federal Height of Buildings Act of 1910. 

Second, we argue that the mere fact that agglomeration economies are positive externalities does not necessarily justify subsidizing specific combinations of land uses.  Firms and residents have effective tools for creating and maintaining efficient clusters when the scope of agglomerative externalities is sufficiently local and when relocating is sufficiently easy.  We also explore the case for subsidies when agglomerative externalities are felt broadly across a city or region and when investments are more fixed.