“When all voluntary transactions have been entered into by
market transactors, there still remain some interactions that ought to be
internalized but which the market forces left to themselves cannot cope with” (Carl
Dahlman, JLE, Apr 1979). There is
apparently no residual claimant. Add one and you get the following:
“In many economics textbooks, the presence of externalities
is invoked as a justification for government intervention in the marketplace.
Yet the private sector often finds its own solutions to externality problems.
This is the secret of the shopping mall’s success. Because a property developer
owns the entire shopping complex, its profits depend on the entire mall, not on
any particular shop. By choosing the right mix of tenants and charging rents
that reflect each store’s contribution to the mall’s overall revenues –
including the business it brings to other stores – the developer can
‘internalize’ the externality and maximize its profits” (The Economist
March 1, 1997).
I am prompted by a recent piece by Jason Potts, “Innovationis a Spontaneous Order” in Cosmos and
Taxis (full disclosure, I am a consulting editor). Potts discusses five spontaneous orders:
science, business models, co-operation, clusters and copying. It is, however, useful to differentiate
cities from clusters; Potts seems to use them interchangeably.
The shopping mall described above is a cluster, not a city. Cities
could be a collection of such clusters and one has to wonder if there are
interactions between the clusters that remain to be internalized. If so, by who?
Potts elaborates, “The basic units of a cluster are
nevertheless knowledge-using and knowledge-generating firms. Such firms will tend to co-locate to the
extent that knowledge externalities can be created and exploited. This is a property of the ‘absorptive
capacity’ of the firms themselves, not of the environment. (The ‘Coase theorem’ suggests that we would
expect firms to bargain and contract their way toward internalizing the
externality.) Innovation networks and
clusters simultaneously emerge as the network and special dimensions of this
growth-of-knowledge process. They are
the emergent consequence of firms
discovering and exploiting knowledge complementarities. Clusters and innovation are part of a
mutually constituting spontaneous order.”
I like the fact that Potts cites the exchange of knowledge.
He also cites possible Coasian bargaining toward
internalizing. The rest of the paragraph calls attention to my favorite
theme: we get innovation networks, spatial clusters and the development of
ideas as part of the same process. The right spatial arrangements are the key
to growth. What can planners do? Recognize that they are an unlikely residual
claimant and let the bargaining and contracting proceed.
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