“The City as a Distorted Price System” Psychology Today (1968)

Wilbur Thompson

EDITORS’ INTRODUCTION The subfield of urban economics is relatively new. Unlike urban geography, which has existed since the time that Aristotle (p. 249) was writing in the fifth century BCE, urban sociology, which originated in late nineteenth-century Germany and flowered in the 1920s and 1930s with the Chicago School sociologists like Ernest W. Burgess (p. 178) and Louis Wirth (p. 115), or the field of urban planning in which, as Peter Hall describes, university-level courses were first taught in 1909 (p. 431), economics departments only began to teach courses in urban economics after a remarkable book by Wilbur Thompson, titled A Preface To Urban Economics, was published in 1965.

Scholars from a specific discipline often feel people trained in the discipline will be the best decision-makers. Architect Frank Lloyd Wright had the fanciful vision that a county architect should be the key policy-maker at the local level (p. 388). Similarly, Thompson proposes the idea that cities should have a “city economist” to shape city policy. While cities don’t have a position like that today, economists within government and the private and nonprofit sectors now bring the theory and practice of urban economics and public finance that Thompson and other economists have developed to bear on decision-making. Three concepts Thompson introduces are fundamental in urban economics: the idea of collectively consumed public goods, merit goods designed to

encourage desired behaviors, and payments to redistribute income. Public goods are provided by government at no cost for the use of everyone. Air pollution control, police, and city streets are examples. Thompson sees a

place for this kind of good in private free-market economies. Public goods cost money. There is a price associated with providing them. But, unlike the cost of goods in the private market, the price of these public goods is often implicit, rather than explicit. While a consumer will weigh how much one shirt or a pot costs and is acutely aware of increases or decreases in the price of gasoline, he or she does not think how much it will cost (society) to drive from home to school on a public street or think, “Oh, it’s a hot muggy day, I’ll be paying a lot for government to control air pollution today.” Tax dollars are paying for the street and the air pollution control, but in complicated ways, invisible to the ordinary consumer, and little related to market realities. People don’t sum up the cost of highway engineering, asphalt, construction workers, maintenance, policing, and the myriad other costs of building and maintaining a highway and divide by some factor that accurately reflects one small trip in relation to the total number of users and the number of miles they drive over the life of the highway. They consider the trip a free good, rather than one that is really costing them something. The failure to think through intended policy and price public goods accordingly, Thomson argues, leads to muddled and sometimes irrational policy. An

example Thompson gives of how inattention to price can lead to bad public policy involves fireproofing. A rational public policy might be to encourage homeowners to invest in fireproofing their homes in order to reduce the risk of fire. This costs each individual homeowner money, and a fireproofed home will be worth more than it was before the fireproofing. Since homeowners’ property taxes are based on the value of their homes, property taxes will go up. Having his property tax go up penalizes the prudent homeowner, whose investment reduces the cost of firemen responding to a fire or the risk of a fire on his property spreading to adjacent properties. If another homeowner in the same neighborhood does nothing to fireproof his house and lets it deteriorate into a firetrap, he will be rewarded by lower property taxes. An alternative approach would be to reward the homeowner who fireproofs with some form of tax abatement or tax credit and to penalize the non-performing homeowner by increasing his taxes (and perhaps using the extra money to improve the fire department so it can handle the increased risk he is imposing on society).

Merit goods are goods that government provides for free because there has been a collective decision that they are so important that everyone should have them regardless of whether they would voluntarily choose them and without regard to ability to pay. Free polio shots are an example. With rare exceptions, governments provide children with free polio shots. Governments virtually everywhere want children immunized against polio regardless of their parents’ ability to pay because any child who gets polio is likely to be permanently crippled for life – bringing suffering to the child and his family and huge medical bills that someone will have to pay. The crippled child will probably never be able to work and will be a permanent burden on his family and the public. This tragedy could have been averted for a few pennies in a single, simple, painless vaccination. Thompson calls merit goods a case of the majority playing God, and coercing the minority by the use of bribes to change their behavior. This is extreme rhetoric, but it emphasizes his belief, shared by liberal Western economists, that only a few very important goods should be merit goods. This view is quite different from the view in socialist countries, which believe many more goods should be provided by the state rather than the private sector. Some people oppose some merit goods (even, in rare instances, polio vaccinations) on the ground that government has no right ever to play God and coerce a minority, but Thompson argues that merit goods should be used sparingly in situations where they are very important and command near universal support. Thompson argues that paying for merit goods, such as polio immunizations, is a legitimate governmental activity that should not be subject to market pricing in rare cases where the public interest requires the majority to force everyone to cooperate.

Payments to redistribute income are a third kind of payment that is not governed by price. The classic example Thompson gives is welfare payments to the indigent, such as a monthly payment to a blind, elderly person with no assets or income. One group (taxpayers) pays; another group (indigent, elderly, blind people) receives the good. In communist countries and countries with a culture that supports a large welfare state such as the Scandinavian countries and the Netherlands, government may pay for virtually all of the costs of health and education for everyone and provide a reasonably high minimum welfare payment to indigent people. The United States, United Kingdom, and most other countries have a much more restricted policy regarding income redistribution. They dislike large, cumbersome bureaucracies and distrust the ability of government to manage redistributive policies. Accordingly, they rely primarily on private market solutions to meet almost all basic human needs.

An overarching concept that applies to each of these three types of public funding is “market failure.” The idea is that to the extent possible good and services should be provided by private markets with no government bureaucracy overseeing who provides what to whom. The law of supply and demand will provide efficient solutions to human needs. Only when markets fail because individuals simply cannot individually provide a collective good such as a highway, poor or stubborn people put themselves and others at risk by not getting polio vaccinations for their children, or an indigent, elderly blind person will starve to death without government aid should government intervene.

Thompson feels that, if clearly identified and intended, each of these three types of goods – public goods, merit goods, and redistributive payments – can serve a useful role. Often, however, he feels that there is too little thought about the purpose of such payments and conceptual sloppiness about what is intended. If there were a city economist in a city, she might, for example, force a city council to think through just how much of a subsidy they care to give to a museum. While the city council may regard museum visits as a legitimate public good that should be supported by public tax dollars, a careful examination might lead them to decide that there should be a differential fee structure so that students and senior citizens can visit the museum free, but other museum visitors will have to pay an entrance charge that will help pay museum costs. They might conclude that free museum admission is just not as important as polio shots, road maintenance, or aid to the indigent elderly blind. They might conclude that people with resources, not government, should decide how much visiting a museum is worth to them. Alternatively, the city economist might convince the city council that a low museum entrance fee is necessary when the museum first opens in order to lure patrons, but once patronage is established, higher fees are in order. More extreme examples of public goods that Thomson argues should be carefully scrutinized, but often are not, include municipal golf courses and marinas. Does it make sense for taxpayers to subsidize golfers and yacht owners? Are these merit goods? Public goods? Goods worthy of redistributive policy? Thompson was an early advocate of using price to ration scarce goods – particularly use of highways and parking spaces. Since this seminal article was

written, congestion pricing has become common in many parts of the world. Tolls are set high during peak commute hours. People who value their mobility highly at certain times of the day, such as affluent commuters rushing to get to work on time in the morning, will be willing to pay the high toll cost and will appreciate the lack of congestion. People for whom mobility at that time is less important, such as friends planning to get together to work out at the gym, may choose to exercise after the morning commute rush hour and before the evening rush hour when congestion pricing is lower in order to save the higher toll. This selection appeared in the popular US publication Psychology Today in 1968. Thompson’s seminal urban economics book is A Preface to Urban

Economics (Baltimore: Johns Hopkins Press, 1965). Thompson also wrote An Econometric Model of Postwar State Industrial Development (Detroit: Wayne State University Press, 1959). The leading contemporary urban economics text is Arthur O. O’Sullivan, Urban Economics, 8th edn (Chicago: McGraw-Hill, 2013). Other urban economics

texts include Philip McCann, Urban and Regional Economics (New York and London: Routledge, 2012), Jan Brueckner, Lectures on Urban Economics (Cambridge, MA: MIT Press, 2011), John McDonald and Daniel MacMillan, Urban Economics: Theory and Policy (Oxford and New York: Wiley-Blackwell, 2006), Brendan O’Flaherty, City Economics (Cambridge, MA: Harvard University Press, 2005), and Robert W. Wassmer (ed.), Readings in Urban Economics: Issues and Public Policy (Oxford: Blackwell, 2000).

A large scholarly anthology of writings on urban economics is Ronan Paddison et al. (eds.), Urban Studies: Economy (Los Angeles and London: Sage, 2010). Jane Jacobs, The Economy of Cities (New York: Vintage, 1970) and Edward Glaeser, Triumph of the City (Colchester and New York: Penguin, 2012) are

readable, provocative contrarian books based on each author’s highly original approach to urban economics. Jacobs sees cities as incubators of new economic ideas and argues in favor of experimentation. Glaeser overturns many conventional assumptions in urban economics with lively examples from Dubai, Kinshasa, Detroit, London, Rio de Janeiro and other cities discussed in The City Reader.

The failure to use price – as an explicit system – in the public sector of the metropolis is at the root of many, if not most, of our urban problems. Price, serving its historic functions, might be used to ration the use of existing facilities, to signal the desired directions of new public investment, to guide the distribution of income, to enlarge the range of public choice and to change tastes and behavior. Price performs such functions in the private market place, but it has been virtually eliminated from the public sector. We say “virtually eliminated” because it does exist but in an implicit, subtle, distorted sense that is rarely seen or acknowledged by even close students of the city, much less by public managers. Not surprisingly, this implicit price system results in bad economics.

We think of the property tax as a source of public revenue, but it can be reinterpreted as a price. Most often, the property tax is rationalized on “ability-to-pay” grounds with real property serving as a proxy for income. When the correlation between income and real property is challenged, the apologist for the property tax shifts ground and rationalizes it as a “benefit” tax. The tax then becomes a “price” which the property owner pays for the benefits received – fire protection, for example. But this implicit “price” for fire services is hardly a model of either efficiency or equity. Put in a new furnace and fireproof your building (reduce the likelihood of having a fire) and your property tax (fire service premium) goes up, let your property deteriorate and become a firetrap and your fire protection premium goes down! One bright note is New York City’s one-year tax abatement on new pollution-control equipment; a timid step but in the right direction.

Often “urban sprawl” is little more than a color word which reflects (betrays?) the speaker’s bias in favor of high population density and heavy interpersonal interaction – his “urbanity.” Still, typically, the price of using urban fringe space has been set too low – well below the full costs of running pipes, wires, police cars and fire engines farther than would be necessary if building lots were smaller. Residential developers are, moreover, seldom discouraged (penalized by price) from “leap frogging” over the contiguous, expensive vacant land to build on the remote, cheaper parcels. Ordinarily, a flat price is charged for extending water or sewers to a new household regardless of whether the house is placed near to or far from existing pumping stations.

Again, the motorist is subject to the same license fees and tolls, if any, for the extremely expensive system of streets, bridges, tunnels, and traffic controls he enjoys, regardless of whether he chooses to drive downtown at the rush hour and thereby pushes against peak capacity or at off-peak times when it costs little or nothing to serve him. To compound this distortion of prices, we usually set the toll at zero. And when we do charge tolls, we quite perversely cut the commuter (rush-hour) rate below the off-peak rate.

It is not enough to point out that the motorist supports roadbuilding through the gasoline tax. The social costs of noise, air pollution, traffic control and general loss of urban amenities are borne by the general taxpayer. In addition, drivers during off-peak hours overpay and subsidize rush-hour drivers. Four lanes of expressway or bridge capacity are needed in the morning and evening rush hours where two lanes would have served if movements had been random in time and direction: that is, near constant in average volume. The peak-hour motorists probably should share the cost of the first two lanes and bear the full cost of the other two that they alone require. It is best to begin by carefully distinguishing where market tests are possible and where they are not. Otherwise, the case for applying the principles of price is misunderstood; either the too-ardent advocate overstates his case or the potential convert projects too much. In either case, a “disenchantment” sets in that is hard to reverse.

Much of the economics of the city is “public economies,” and the pricing of urban public services poses some very difficult and even insurmountable problems. Economists have, in fact, erected a very elegant rationalization of the public economy almost wholly on the nonmarketability of public goods and services. While economists have perhaps oversold the inapplicability of price in the public sector, let us begin with what we are not talking about. The public economy supplies “collectively consumed” goods, those produced and consumed in one big indivisible

lump. Everyone has to be counted in the system, there is no choice of in or out. We cannot identify individual benefits, therefore we cannot exact a quid pro quo. We cannot exclude those who would not pay voluntarily; therefore we must turn to compulsory payments: taxes. Justice and air-pollution control are good examples of collectively consumed public services.

A second function of the public economy is to supply “merit goods.” Sometimes the majority of us become a little paternalistic and decide that we know what is best for all of us. We believe some goods are especially meritorious, like education, and we fear that others might not fully appreciate this truth. Therefore, we produce these merit goods, at considerable cost, but offer them at a zero price. Unlike the first case of collectively consumed goods, we could sell these merit goods. A schoolroom’s doors can be closed to those who do not pay, quite unlike justice. But we choose to open the doors wide to ensure that no one will turn away from the service because of its cost, and then we finance the service with compulsory payments. Merit goods are a case of the majority playing God, and “coercing” the minority by the use of bribes to change their behavior.

A third classic function of government is the redistribution of income. Here we wish to perform a service for one group and charge another group the cost of that service. Welfare payments are a clear case. Again, any kind of a private market or pricing mechanism is totally inappropriate; we obviously do not expect welfare recipients to return their payments. Again, we turn to compulsory payments: taxes. In sum, the private market may not be able to process certain goods and services (pure “public goods”), or it may give the “wrong” prices (“merit goods”), or we simply do not want the consumer to pay (income-redistributive services).

But the virtual elimination of price from the public sector is an extreme and highly simplistic response to the special requirements of the public sector. Merit goods may be subsidized without going all the way to zero prices. Few would argue for full-cost admission prices to museums, but a good case can be made for moderate prices that cover, say, their daily operating costs, (e.g., salaries of guards and janitors, heat and light).

Unfortunately, as we have given local government more to do, we have almost unthinkingly extended the tradition of “free” public services to every new undertaking, despite the clear trend in local government toward the assumption of more and more functions that do not fit the neat schema above. The provision of free public facilities for automobile movement in the crowded cores of our urban areas can hardly be defended on the grounds that: (a) motorists could not be excluded from the expressways if they refused to pay the toll, or (b) the privately operated motor vehicle is an especially meritorious way to move through densely populated areas, or (c) the motorists cannot afford to pay their own way and that the general (property) taxpayers should subsidize them. And all this applies with a vengeance to municipal marinas and golf courses.

PRICES TO RATION THE USE OF EXISTING FACILITIES We need to understand better the rationing function of price as it manifests itself in the urban public sector: how the demand for a temporarily (or permanently) fixed stock of a public good or service can be adjusted to the supply. At any given time the supply of street, bridge, and parking space is fixed; “congestion” on the streets and a “shortage” of parking space express demand greater than supply at a zero price, a not too surprising phenomenon. Applying the market solution, the shortage of street space at peak hours (“congestion”) could have been temporarily relieved (rationalized) by introducing a short-run rationing price to divert some motorists to other hours of movement, some to other modes of transportation, and some to other activities.

Public goods last a long time and therefore current additions to the stock are too small to relieve shortages quickly and easily. The rationing function of price is probably more important in the public sector where it is customarily ignored than in the private sector where it is faithfully expressed.

Rationing need not always be achieved with money, as when a motorist circles the block over and over looking for a place to park. The motorist who is not willing to “spend time” waiting and drives away forfeits the scarce space to one who will spend time (luck averaging out). The parking “problem” may be reinterpreted as an implicit decision to keep the money price artificially low (zero or a nickel an hour in a meter) and supplement it with a waiting cost or time price. The problem is that we did not clearly understand and explicitly agree to do just that. The central role of price is to allocate – across the board – scarce resources among competing ends to the point where

the value of another unit of any good or service is equal to the incremental cost of producing that unit. Expressed loosely, in the long run we turn from using prices to dampen demand to fit a fixed supply to adjusting the supply to fit the quantity demanded, at a price which reflect the production costs.

Prices which ration also serve to signal desired new directions in which to reallocate resources. If the rationing price exceeds those costs of production which the user is expected to bear directly, more resources should ordinarily be allocated to that activity. And symmetrically a rationing price below the relevant costs indicates an uneconomic provision of that service in the current amounts. Rationing prices reveal the intensity of the users’ demands. How much is it really worth to drive into the heart of town at rush hour or launch a boat? In the long run, motorists and boaters should be free to choose, in rough measure, the amount of street and dock space they want and for which they are willing to pay. But, as in the private sector of our economy, free choice would carry with it full (financial) responsibility for that choice.

We need also to extend our price strategy to “factor prices”; we need a sophisticated wage policy for local public employees. Perhaps the key decision in urban development pertains to the recruiting and assignment of elementary- and secondary-school teachers. The more able and experienced teachers have the greater range of choice in post and quite naturally they choose the newer schools in the better neighborhoods, after serving the required apprenticeship in the older schools in the poorer neighborhoods. Such a pattern of migration certainly cannot implement a policy of equality of opportunity. This author argued six years ago that egalitarianism in the public school system has been overdone; even the army

recognizes the role of price when it awards extra “jump pay” to paratroopers, only a slightly more hazardous occupation than teaching behind the lines. Besides, it is male teachers whom we need to attract to slum schools, both to serve as father figures where there are few males at home and to serve quite literally as disciplinarians. It is bad economics to insist on equal pay for teachers everywhere throughout the urban area when males have a higher productivity in some areas and when males have better employment opportunities outside teaching – higher “opportunity costs” that raise their supply price. It is downright silly to argue that “equal pay for equal work” is achieved by paying the same money wage in the slums as in the suburbs.

About a year ago, on being offered premium salaries for service in ghetto schools, the teachers rejected, by name and with obvious distaste, any form of “jump pay.” One facile argument offered was that they must protect the slum child

from the stigma of being harder to teach, a nicety surely lost on the parents and outside observers. One suspects that the real reason for avoiding salary differentials between the “slums and suburbs” is that the teachers seek to escape the hard choice between the higher pay and the better working conditions. But that is precisely what the price system is supposed to do: equalize sacrifice.

PRICES TO GUIDE THE DISTRIBUTION OF INCOME A much wider application of tolls, fees, fines, and other “prices” would also confer greater control over the distribution of income for two distinct reasons. First, the taxes currently used to finance a given public service create implicit and unplanned redistribution of income. Second, this drain on our limited supply of tax money prevents local government from undertaking other programs with more explicit and planned redistributional effects.

More specifically, if upper-middle- and upper-income motorists, golfers, and boaters use subsidized public streets, golf links, and marinas more than in proportion to their share of local tax payments from which the subsidy is paid, then these public activities redistribute income toward greater inequality. Even if these activities were found to be neutral with respect to the distribution of income, public provision of these discretionary services comes at the expense of a roughly equivalent expenditure on the more classic public services: protection, education, public health, and welfare.

Self-supporting public golf courses are so common and marinas are such an easy extension of the same principle that it is much more instructive to test the faith by considering the much harder case of the public museum: “culture.” Again, we must recall that it is the middle- and upper-income classes who typically visit museums, so that free admission becomes, in effect, redistribution toward greater inequality, to the extent that the lower-income nonusers pay local taxes (e.g., property taxes directly or indirectly through rent, local sales taxes). The low prices contemplated are not, moreover, likely to discourage attendance significantly and the resolution of special cases (e.g., student passes) seems well within our competence.

Unfortunately, it is not obvious that “free” public marinas as tennis courts pose foregone alternatives – “opportunity costs.” If we had to discharge a teacher or policeman every time we built another boat dock or tennis court, we would see the real cost of these public services. But in a growing economy, we need only not hire another teacher or policeman and that is not so obvious. In general, then, given a binding local budget constraint – scarce tax money – to undertake a local public service that is unequalizing or even neutral in income redistribution is to deny funds to programs that have the desired distributional effect, and is to lose control over equity.

Typically, in oral presentations at question time, it is necessary to reinforce this point by rejoining, “No, I would not put turnstiles in the playgrounds in poor neighborhoods, rather it is only because we do put turnstiles at the entrance to the playgrounds for the middle- and upper-income groups that we will be able to ‘afford’ playgrounds for the poor.”

PRICES TO ENLARGE THE RANGE OF CHOICE But there is more at stake in the contemporary chaos of hidden and unplanned prices than “merely” efficiency and equity. There is no urban goal on which consensus is more easily gained than the pursuit of great variety and choice – “pluralism.” The great rural to urban migration was prompted as much by the search for variety as by the decline of agriculture and rise of manufacturing. Wide choice is seen as the saving grace of bigness by even the sharpest critics of the metropolis. Why, then, do we tolerate far less variety in our big cities than we could have? We have lapsed into a state of tyranny by the majority, in matters of both taste and choice.

In urban transportation the issue is not, in the final analysis, whether users of core-area street space at peak hours should or should not be required to pay their own way in full. The problem is, rather, that by not forcing a direct quid pro quo in money, we implicitly substitute a new means of payment – time in the transportation services “market.” The peak-hour motorist does pay in full, through congestion and time delay. But implicit choices blur issues and confuse decision making.

Say we were carefully to establish how many more dollars would have to be paid in for the additional capacity needed to save a given number of hours spent commuting. The majority of urban motorists perhaps would still choose the present combination of “underinvestment” in highway, bridge and parking facilities, with a compensatory heavy investment of time in slow movement over these crowded facilities. Even so, a substantial minority of motorists do prefer a different combination of money and time cost. A more affluent, long-distance commuter could well see the current level of traffic congestion as a real problem and much prefer to spend more money to save time. If economies of scale are so substantial that only one motorway to town can be supported, or if some naturally scarce factor (e.g., bridge or tunnel sites) prevents parallel transportation facilities of different quality and price, then the preferences of the minority must be sacrificed to the majority interest and we do have a real “problem.” But, ordinarily, in large urban areas there are a number of near-parallel routes to town, and an unsatisfied minority group large enough to justify significant differentiation of one or more of these streets and its diversion to their use. Greater choice through greater scale is, in fact, what bigness is all about. The simple act of imposing a toll, at peak hours, on one of these routes would reduce its use, assuming that nearby

routes are still available without user charges, thereby speeding movement of the motorists who remain and pay. The toll could be raised only to the point where some combination of moderately rapid movement and high physical output were jointly optimized. Otherwise the outcry might be raised that the public transportation authority was so elitist as to gratify the desire of a few very wealthy motorists for very rapid movement, heavily overloading the “free” routes. It is, moreover, quite possible, even probable, that the newly converted, rapid-flow, toll-route would handle as many vehicles as it did previously as a congested street and not therefore spin off any extra load on the free routes.

Our cities cater, at best, to the taste patterns of the middle-income class, as well they should, but not so exclusively. This group has chosen, indirectly through clumsy and insensitive tax-and-expenditure decisions and ambiguous political processes, to move about town flexibly and cheaply, but slowly, in private vehicles. Often, and almost invariably in the larger urban areas, we would not have to encroach much on this choice to accommodate also those who would prefer to spend more money and less time, in urban movement. In general, we should permit urban residents to pay in their most readily available “currency” – time or money.

Majority rule by the middle class in urban transportation has not only disenfranchised the affluent commuter, but more seriously it has debilitated the low-fare, mass transit system on which the poor depend. The effect of widespread automobile ownership and use on the mass transportation system is an oft-told tale: falling bus and rail patronage leads to less frequent service and higher overhead costs per trip and often higher fares which further reduce demand and service schedules. Perhaps two-thirds or more of the urban residents will tolerate and may even prefer slow, cheap automobile movement. But the poor are left without access to many places of work – the suburbanizing factories in particular – and they face much reduced opportunities for comparative shopping, and highly constrained participation in the community life in general. A truly wide range of choice in urban transportation would allow the rich to pay for fast movement with money, the middle-income class to pay for the privacy and convenience of the automobile with time, and the poor to economize by giving up (paying with) privacy.

A more sophisticated price policy would expand choice in other directions. Opinions differ as to the gravity of the water-pollution problem near large urban areas. The minimum level of dissolved oxygen in the water that is needed to meet the standards of different users differs greatly, as does the incremental cost that must be incurred to bring the dissolved oxygen levels up to successively higher standards. The boater accepts a relatively low level of “cleanliness” acquired at relatively little cost. Swimmers have higher standards attained only at much higher cost. Fish and fisherman can thrive only with very high levels of dissolved oxygen acquired only at the highest cost. Finally, one can imagine an elderly convalescent or an impoverished slum dweller or a confirmed landlubber who is not at all interested in the nearby river. What, then, constitutes “clean”?