Why I Would Like to Live in a Privately Run City

By: Mark Lutter - May 19, 2014, 10:24 am
Paul Romer, professor of economics, New York University. Source:

EspañolPaul Romer, on the shortlist for a Nobel prize in economics for his work on endogenous growth theory, has turned his attention to institutions and institutional change. He is now best known outside economic academia for his advocacy of charter cities.

The basic argument is that institutions, or the rules of the game, are the primary determinant of economic performance. Changing institutions, however, is extremely difficult. Romer’s innovative solution is to have countries with bad institutions invite countries with good institutions to govern an uninhabited region of their country.

While charter cities are certainly better than the status quo, there are alternatives that could outperform charter cities. One such alternative Romer recently attacked is private cities, but it’s possible a private city could lead to the institutional change Romer desires. It could also provide other public goods more efficiently, because the owners of the city would be residual claimants.

The type of private community I am most familiar with is proprietary communities. A common example is a shopping mall, in which case the proprietor leases store space to businesses. Because the income of the proprietor depends on the value of the space he is leasing, he is incentivized to provide public goods to increase the value of the land. Walt Disney World demonstrates that proprietary communities can provide public goods on a large scale.

Romer argues, however, that “the evidence shows that while the opportunity to vote is one difference between public and private systems of city governance, it is not the most significant one. In private systems, it is the lack of a separation of powers between an executive and an independent judiciary that is the more troubling weakness.” In other words, it is judicial independence that is the most important distinction between private and public cities, more so even than voting.

Romers argument suffers from two flaws. First, he implicitly commits the nirvana fallacy. He assumes public police and courts operate at a far higher standard than they do in practice. Second, he seems unaware of the large amount of evidence of successful private judicial systems.

Living in New York, I would have hoped Romer would be more realistic about public police. Under stop and frisk, New York Police have on average stopped 500,000 people every year over the last five years, the vast majority of whom are minority youths. Over 85 percent of them are never charged. An audio recording of one such incident shows the stops violate notions of basic decency, yet the courts have failed to stop these violations of rights.

In 2011, a New York cop was convicted of planting drugs on a suspect. Rather than being a lone bad cop, the judge attacked the entire unit, saying, “I thought I was not naïve,” as well as, “But even this court was shocked, not only by the seeming pervasive scope of misconduct but even more distressingly by the seeming casualness by which such conduct is employed.” A former police officer who did not know the cop on trial testified that the practice of planting drugs on criminal defendants was widespread.

Videos help illustrate the difference between public police and private security. The first video is of a dancing protest in the Jefferson memorial. A year prior to the protest, someone had been arrested for dancing in the memorial. The protest shown on video was simply about the absurdity of banning dancing. However, despite its non-violent and comical nature, the police slam one of the participants into the ground. The second video shows a protest at Target. The protest is aimed at target. Despite this, the security officers only ask the protesters to leave, never resorting to violence

Disparities in drug sentencing show that the problem extends beyond police to the judiciary. The ACLU writes that even though whites use drugs more frequently than blacks, blacks are sentenced at 10 times the rate of whites. State oppression of minorities, de facto instead of de jure, continues to exist.

It is still possible that a private city will act worse than the above examples. Romer challenges, “What evidence is there to support the claim that private entities are capable of avoiding the inherent conflict that executives face between their commitment to the enforcement of community rules in a way that applies equally to all members — and the many other objectives they seek to achieve?” As it happens, there is a plethora of evidence.

First, let us consider his three examples of failures of private law. The first two are religious, Jewish and Catholic, the third is University law. These are odd choices because none of the examples are private in a strong sense. They are not state run, but there is no residual claimant, and they are not run like businesses. More apt examples are private arbitration agencies.

The advantage of private cities over charter cities is the profit and loss mechanism. Private property internalizes externalities. Using examples of private arbitration without a profit loss mechanism illustrates a failure to understand the arguments for private cities.

Perhaps the best known example of private arbitration is the Maghribi traders, a trading coalition in the middle ages. Avner Greif, a Stanford economist, has several papers detailing how they developed a legal system. Merchants needed protection against the possibility that their trading partners would refuse to pay. Because the Mediterranean wasn’t unified, merchants were forced to develop their own legal system. Maghribi traders ensured that any merchant who violated a contract would be excluded from all future trade. This ensured the benefits to cooperation outweighed the benefits to theft.

A modern example is international trade. Companies often rely on private courts at their own expense because government courts are slow and lack expertise. Peter Leeson, an economist from George Mason, found that state enforcement increases trade by 15.38 per cent. This is a substantial increase, but nonetheless below the common perception.

Other examples include car insurance and credit card companies. Both industries have private dispute resolution mechanisms. They have relationships with other companies and standards of evidence necessary to make a decision. Even Ebay and Amazon testify to the possibility of private arbitration. Though there are some scammers, reputation is a powerful enough tool that most people have sufficiently good experiences to keep returning.

A private city that expropriates investors or does not apply rule of law is not going to attract many new investors. Further, because investment is going to be very elastic in a new city, the pressure to have rule of law is going to be even stronger. Any hint of injustice will scare investors and reduce the income of the owners.

Both Romer and I agree on the importance of rule of law for economic growth. I, however, believe that a private city is more likely to implement a strong rule of law. Because the income of the owners of the city depends on the economic activity in the city, and the economic activity depends on an independent and fair judiciary, private cities have a stronger incentive to have rule of law than guarantor governments.

That being said, private cities and charter cities are not mutually exclusive. We can argue about which is superior, but it will be impossible to know for certain until both are tried. While it is perfectly understandable to prefer Charter Cities, I hope Romer sees private cities as an ally and a complement, not a substitute.