Place-Based Policies for Development

Place-based policies for development Gilles Duranton and Tony Venables Wharton School and University of Oxford & International Growth Centre

Introduction: Place-Based Policies • Much development policy is inherently place-based • Where do you invest in utilities? • Where should transport links be improved? • What should be done about spatial inequalities? Many of these policies, need to concentrate investments not smear • Inevitably forced to ‘pick spatial winners’ • How should decisions about PBP be taken? • What are the objectives? • Delivery of eg transport services? • Wider impact on local economic performance? • What are the instruments? • Packages of policy measures • What are the market failures? • What is the evidence?

Introduction: Place-Based Policies • Spatial policies form a large part of WB activity: • Infrastructure: transport, utilities • Economic corridors • Intra-city transport • Urban policy • Special Economic Zones • GD & TV commissioned by WB to review: • Economics of PBP • Framework for project appraisal/ decision taking • Include study of selected WB projects & discussions with TTLs • Remarks on effectiveness of WB process • This talk: • Issues and framework: TV • Topic specific issues: TV/ GD • Conclusions and lessons for the WB: GD • NB: Project still in progress – draft for discussion

What is distinctive about PBP? • The spatial context • Market mechanism works imperfectly in guiding spatial choices • Main purpose of spatial policy is often its ‘indirect’ effects: • Direct effect: eg, time saving. • Indirect effect: induced private sector investment, job creation, productivity, regional growth • Timing: lagging or leading? • Policy in response to revealed or imminent demand (eg congestion) • Policy to act as a catalyst to lead economic change • Empirical evidence • Causality • Displacement: local vs general equilibrium effects • Context specificity

The spatial context • Proximity matters • Positive: agglomeration economies & clustering • Through ‘perfect’ markets (eg transp. cost saving, cheaper infrastructure delivery) • Through ‘imperfect’ markets (scale and specialisation, new varieties, learning, matching, risk pooling….) • Through externalities (knowledge spillovers) • Negative: Externalities of congestion and contagion • Complementarities and coordination failure • Returns to my investment increasing in what others do • The business ecosystem: suppliers, customers, workers • Location decisions are long run & non-marginal: sunk costs and expectations. • Hard to start new centres/ clusters • Lock in to low-level equilibrium (eg excess primacy) • Intra-country price and wage adjustment • Absolute advantage not comparative advantage • Little leverage from variation in prices of immobile factors (i.e. land)  Shocks not damped by price adjustment, but amplified by factor movement.

Analysis of PBP • Analysis of PBP requires two steps I: Quantity change: how does the policy change quantities? • Direct: delivery of services, time savings etc • Indirect: induced investment, jobs, output, productivity • Relative to some alternative • Local and national (partial and general equilibrium) II: Valuation: what is the value of changes in quantities? • Both of these are challenging, especially for indirect effects • Traditional CBA – assume no indirect effects, or they are of zero value • Include indirect effects: risk that ‘anything goes’: • Double counting: • Over optimism • Need framework that balances ‘relevance with rigor’: • Relevance: economic analysis that covers the strategic case & indirect effects • Rigor: challenge the double-counting, over optimism

Quantity change and induced private investment Will a PBP succeed in inducing a private investment response? Responses are hard to predict because: • Private sector response depends on many ‘necessary’ conditions. • Publicly provided services • Infrastructure, connectivity, regulation, tax, governance, • Private decisions: The ‘business ecosystem’ • Access to: Labour skills/ suppliers/ customers/ capital/ land,  Weakest link problem • Threshold effects and non-marginal change • Policy levers do not map continuously (or 1 – 1) into outcomes • Displacement or additionality? Quantity effects and general equilibrium • Displacement via product market (inelastic demand for output: eg just relocation) • Displacement via factor markets (inelastic supply of labour: eg draws workers from similar firm)  Have to look more broadly than proximity of project

Valuation: what are quantity changes worth? I: Seeking to measure social values not GDP. II: Benchmark: Efficient markets  marginal values of goods/ factors same in all uses  induced (small) quantity changes are of zero value • Where are the inefficiencies? • Jobs: what is the opportunity cost of labour (shadow wage)? • Displacement from where? / productivity gaps/ induced migration • Misallocation of factors: land, capital • Static • Dynamic: locked-in to increasingly inefficient equilibrium • Agglomeration (and congestion dis-) economies • Externalities and market failures • Non-marginal change • Investor does not capture full value of investment as prices change (eg consumer price falls, wage rate increases)

Quantity change and valuation: summary • Quantity changes – particularly of indirect effects – are hard to predict with confidence • Threshold effects, complementarities, coordination failure • Valuation: Multiple inefficiencies – some pulling in different directions • Eg, at margin of urban size, agglomeration or congestion? • Policy being considered is not a move to the first best: • Binary decision on one project – or decision over wider set of alternatives? Implications? • Hard to do the analysis: • But we know exactly what the analysis should be looking for • Need rigorous and systematic checklist • Breadth and realism on quantity changes • Identification of market failures/ inefficiencies in their valuation

Special Economic Zones: a checklist • Statement of objectives: • Private investment and job creation? • SEZ in a particular place is the chosen policy because? • Mechanism to overcome coordination failure in private investment? • Economies of scale in provision of infrastructure? • Constraints (financial or political economy?) on implementation everywhere? • Want to target a particular place (eg lagging region)? • Quantity change? • What instruments? Will they work to create jobs in the SEZ? • Multiple conditions to be met: • Connectivity, utilities, land, regulation, tax • Expectations: • Government commitment • The business ecosystem • Potential role of large developer • The evidence

Special Economic Zones: a checklist Quantity change …. outside the SEZ • Will it grow the local economy? • Development of suppliers/ capabilities outside the SEZ • Displacement: Where are the jobs coming from? • Tradable vs non-tradable sectors • Labour supply • Valuation? • What is the cost (infrastructure, tax revenue foregone?) • What is income generated NET of opportunity cost (shadow wage) • Are there externalities – eg learning by local firms – that can be identified? In summary: • Clarity of objectives. • Are there better places/ projects to achieve these objectives? • Realism about achieving narrowly defined success of the SEZ • Overall assessment includes looking outside the SEZ

Transport improvements and economic corridors • Large literatures on transport project appraisal techniques and on impact of transport on economic performance. • Clear tensions between: • Traditional narrow CBA • Claims about ‘transformative’ (or rebalancing) effects of transport improvement. • Empirics not connecting with valuation and needs of project appraisal Three remarks: I: Core of a transport appraisal should be estimate of direct effects • Quantity: transport users and traffic creation • Value: time and voc saving II: Indirect effects: Potentially important, but uneven • Better connectivity  good place to invest because of better access to suppliers and to customers • But: local market becomes more open to ‘import’ competition. • Outcomes depend on complementary measures

Transport improvements and economic corridors III: Other approaches to transport appraisal: UK DfT • Traditional narrow CBA • + ‘Wider benefits’ – in very tightly structured and disciplined way • Agglomeration and productivity: • Transport improvement increases ‘effective density’ (firms, workers economically closer together) • Agglomeration: elasticity of productivity wrt effective density • Productivity gain • Move to more productive jobs: • Labour productivity gaps: UK context due to marginal income tax rates • Gain to fiscal revenues. • Is this a good approach? • Attempt to address ‘relevance with rigor’ • Sometimes applied too mechanically • Permitted list of ‘wider benefits’ too constrained?

Urban transport: some preliminaries • We allocate large resources to urban transport and transport outcomes vary a lot across places • Urban transport is a funny commodity, more of a friction • The key metric should the total cost (monetary, time, and utility cost) of reaching destinations, not the unit cost per unit of distance Put differently, it’s about accessibility, not mobility • If we think of accessibility as the product of mobility and proximity, which one matters more? • Then, it’s not about the destinations we choose today. It’s about the choice set • How should we think about this beyond ad-hoc indices or econometric straightjackets that impose impossible data requirements? • We pay for travel in time and money but also in housing costs • A key complication: several technologies are available for urban transport

Urban transport improvements: quantity and price changes • In a simple demand and supply framework, a transport improvement is a downward shift in the supply curve • We can measure the direct effects through changes in consumer surplus • An improvement in one technology (e.g., roads) can affect another (e.g., public transport), perhaps negatively • Obviously, there are some externalities: congestion, pollution, and accidents on the negative side, access/agglomeration on the positive side • An apparent paradox: No increase in consumer surplus when demand is flat?

Zooming in on congestion • Congestion is easy to integrate to our simple framework: individual travel decisions are made on the basis of average costs, not marginal costs • ,, • mmm • We (economists) all say “tax congestion” but how big is the marginal vs average wedge? • The answer appears to depend on the unit of analysis: Roads vs areas • Regardless, the deadweight loss of congestion is a small (tiny) triangle, not a big rectangle • But there might be hyper-congestion • So should we care about congestion or capacity? Roadway capacity or “engineering” and other forms of capacity? • Static or dynamic congestion?

Urban transport improvements: effects on land use • So far, we have thought about transport improvement, keeping locations constant • Even in absence of new/re development, there may be residential re-sorting. Transit users moving close to a new, more efficient transit line will generate economic benefits even in absence of a change in mode choice • The destination of trips may also change allowing for instance workers to reach better work opportunities (or improving their bargaining powers) • These subtle effects are extremely hard to measure • Rely on LUTI models? • Very black-box • Only as good as the mechanisms they consider • Only as a good the (unidentified?) parameters fed to them • Rely on an access/effective density elasticity? Perhaps (not) – more on that later • Rely on another summary statistic? Land values? Some crucial limitations: • Imperfect mobility, residential heterogeneity, changes in land/housing consumption per capita • National “general equilibrium” effects. A BRT in a large city may affect land values in other cities

Housing and other urban infrastructure (brief) • Lots of policies: Enabling markets vs housing demand/supply subsidies • Enabling markets is tough: • Technical element (cadastre / land registry) vs. clear and fairly uniform definition of property rights vs. property right protection by the judiciary • Housing finance • Necessary, be it only for financing rentals • What about renting? Perhaps even harder • Many conditions to make it work • What about renting? Perhaps even harder to have well functioning rental markets • Given the difficulty of enabling markets, direct supply or demand interventions are highly alluring to many governments • Some countries have been “very successful” at changing quantities • Where / how should this occur: urban expansion vs retrofitting vs upgrading • Urban expansion will need to be part of the mix in most places and retrofitting will also occur in desirable locations • Valuing changes in housing quantities • Titles make it easier to borrow when credit constrained and move (though perhaps no extra borrowing for entrepreneurs) • Large externalities associated with better housing and housing related infrastructure? • Many complementary public goods: transport/ access, utilities, pavement • Unfortunately, these basic principles were forgotten by recent large-scale policies

Lessons for project evaluation: some disclaimers • These are personal opinions, derived from our reading of the literature, our thinking, our readings of (some) WB PADs, and interviews/meetings with TTLs (plus equivalents at ADB/CAF) • We are not claiming that the sample of projects we looked at is representative nor any kind of statistical significance • We are not claiming much originality either

Our view of current practice • Process: the PAD structure is rigorous and strong but • Sometimes the document is not taken seriously enough (box ticking vs. true engagement) • Substance: the treatment of indirect effects is often problematic • Indirect effects are simply absent sometimes • Double-counted or inconsistently-counted often • Lack of grounding in a well-defined framework/model • Exposition: the economic analysis is generally careful and rigorous but • No clear separation between direct and indirect effects • Opaque • No accessible “reduced-form” calculation • Suspicious bunching of economic rates of return around 13% • Context: political economy problems • When projects arrive from countries, it is often too late to ask for more than marginal changes • Moral hazard: no strong incentives to stop bad projects • Execution: management / HR problems • “Dumping” of projects on young TTLs • Day-to-day management is about calming fires • Weak transmission of skills/experience/practical expertise/”wisdom”

Our recommendations: general directions • The WB should empower itself to say no or make major changes to projects at various stages • Greater support for execution / implementation and the people in charge of these tasks • Improve quality of evaluation/appraisal (see next slide) There are complementarities between these three objectives

Our recommendations: some specifics about project evaluation • Engage with countries and local policy makers earlier and get them to think about problems first rather than solutions • Projects should be organised around a clear narrative – again what is the problem? (as opposed to a solution in search of a problem) • Careful description / projection of the quantity changes • Distinguish between displacement and creation • Description of the key expected mechanisms / channels of transmission • Careful valuation of expected quantity changes • In light of the market failure at hand • Obviously, displacements and creation need to be valued differently • Equity considerations (if any) need to be explicit • Thorough description of complementary measures • A clear main rationale does not mean a unique intervention • Clearly separate direct from indirect effects • Provide a “reduced-form” calculation that is easy to understand and transparent: be broadly right as opposed to precisely wrong… • Make the case for cost effectiveness – what could be the alternatives to achieve the same outcome? Is the project at hand the best one?

Place-Based Policies for Development