A Market Failure Case for Place-Based Policy

Economists have traditionally focused on policies aimed directly at low-income people, rather than at low-income places.

For example, programs like welfare payments, food stamps, Medicaid, and Supplemental Security Income are based on individuals. But there has been a push in the last few years for consideration of “place-based policies,” which focus on different rules for tax or government benefit, or for finance and regulation, rules within certain geographical boundaries. The sense behind advocacy of place-based policies is that individual-based policies are all very well, but when certain places within metropolitan areas or certain regions within countries have been lagging for decades, perhaps supplementing with other approaches may be useful.

Anthony Venables digs into these issues in “The case for place-based policy” (Centre for Economic Policy Research Policy Insight 128, February 2024). Venables starts by describing how a model of unfettered free markets would predict that economically distressed areas can bounce back, and how the forces in that model don’t seem strong enough.

For example, the standard market-oriented story is that if an area lags badly in economic terms for a time–say, in terms of business formation, employment opportunities, and growth–then several effects should occur. At least some people will migrate out of that area to find jobs elsewhere, which will in a mechanical sense reduce unemployment in that area. In addition, real estate in that area should diminish in value: as a result, firms should begin to see that area as a less-expensive spot to relocate, and people should begin to see that area as a less-expensive spot to live. Over some (not very clear) period of time, the local economy of the distressed area should rebalance itself.

Venables emphasizes several problems with this vision:

1) Not everyone will find it easy to migrate to another area of the city or the country. In fact, those who find it easiest to migrate will be those who have good job opportunities elsewhere–or more generally, those who have a personal and economic network elsewhere on which they can draw. Some people will also just have a degree of drive and determination that manifests itself in moving. Thus, out-migration from a distressed economic area means that the area will lose many of those that, for purposes of future economic development, it would prefer to keep.

2) While some prices will adjust when an area becomes economically distressed, not all of them will. For example, a minimum wage may apply across a given area, or various good and services may have a similar cost across areas, or interest rates will tend to rise and fall across areas. Indeed, other than real estate costs, it’s not clear the extent to which costs will be lower for firms or households in an economically distressed area.

3) The movements of firms and households in response to these price changes may not be large, either. For a firm, the potential benefits of a cheaper location in an economically depressed area need to be weighed against the benefits of locating in an economically more vibrant area where the pool of workers, suppliers, and ideas is likely to be deeper. For a household, a lower cost of housing is a nice thing in isolation, but living surrounded by other people attracted by the lower cost of housing may have tradeoffs concerning the qualities of the neighborhoods, parks, schools, and so on. Venables calls this a “low-level spatial equilibrium”: “Firms don’t want to move [to the economically distressed area] because other firms have not moved, or because workers do not have appropriate skills. Workers don’t want to acquire particular skills, as they do not see job opportunities arising from them, and so on in a vicious circle.”

Of course, none of this is to say that all economically depressed areas are doomed forever. Some areas do reinvent their local or regional economies. But when it works, it often takes a substantial time; and many times, it doesn’t seem to work at all.

One can concede and appreciate the reasons why certain places seem stuck in a “low-level spatial equilibrium,” but lack confidence in the ability of government to engineer a solution. A few tax breaks aren’t likely to cut it. An “all-of-the-above” approach that tries to address to address all of the concerns of firms and households about moving to an economically depressed area might work in some cases, but there aren’t any guarantees. One can imagine an “on-the-edges” approach that tries to at least shrink the economically distressed area around its geographic edges. In this essay, Venables doesn’t have much to offer here other than a very high-level discussion of “clear objectives,” encouraging “complementaries,” considering “alternative scenarios,” and the like.

At a baseline level, one can imagine governments making an attempt to relocate a substantial portion of their own operations and employees to distressed areas. If such relocation runs into problems–say, a lack of transportation infrastructure to get to the jobs, or concerns about the safety of walking, parking, or receiving deliveries in the neighborhood–then that helps the government understand what needs fixing for private employers and households to be willing to relocate as well.

Also, the Summer 2020 issue of the Journal of Economic Perspectives (where I work as Managing Editor), had a two-paper “Symposium on Place-based Policies” in the Summer 2020 issue.

”Using Place-Based Jobs Policies to Help Distressed Communities,” by Timothy J. Bartik
Place-based jobs policies seek to create jobs in particular local labor markets. Such policies include business incentives provided by state and local governments, which cost almost 50 billion USD annually. The most persuasive rationale for these policies is that they can advance equity and efficiency by increasing long-term employment rates in distressed local labor markets. However, current incentives are not targeted at distressed areas. Furthermore, incentives have high costs per job created. Lower costs can be achieved by public services to business, such as manufacturing extension, customized job training, and infrastructure. Reforms to place-based jobs policies should focus on greater targeting of distressed areas and using more cost-effective policies. Such reforms could be achieved by state and local governments acting in their residents\’ interests or could be encouraged by federal interventions to cap incentives and provide aid to distressed areas.

”Place-Based Policies and Spatial Disparities across European Cities,” by Maximilian v. Ehrlich and Henry G. Overman
Spatial disparities in income levels and worklessness in the European Union are profound, persistent and may be widening. We describe disparities across metropolitan regions and discuss theories and empirical evidence that help us understand what causes these disparities. Increases in the productivity benefits of cities, the clustering of highly educated workers and increases in their wage premium all play a role. Europe has a long-standing tradition of using capital subsidies, enterprise zones, transport investments and other place-based policies to address these disparities. The evidence suggests these policies may have partially offset increasing disparities but are not sufficient to fully offset the economic forces at work.