Econ 156 - Fred Foldvary

Cities and the Wealth of Nations

by Jane Jacobs

Key concept: cities are the basic economic market units.

Adam Smith rejected mercantilist fallacies about national income, but he accepted without any analysis the mercantilist notion that countries are the key entities for understanding economies.

This has continued until today, with negative impact on development.

Many development officials and economists work to attract industries into stagnant economies which are not generating industries of their own.

One of the key strategies has been import substitution,

and this has failed.

Thinking in terms of national economies, officials think of import-replacing or import substitution as a process involving only foreign imports.

They are blinded to the fact that replacements of domestic imports are quite as important to the expansion and development of economic life, and often more so.

Import-replacing is not a national but a city activity.

The replacement of former imports is impossible to achieve in ways suitable to the time and place,

except in a settlement that is already versatile enough at production to possess the necessary foundation for the new and added production work.

City markets are at once diverse and concentrated.

These qualities make the production of many kinds of goods economically feasible in city but not in small towns.

These urban qualities don't necessarily require a metropolis.

It can happen in a dense network of medium sized cities.

Example: northern Italy, where there is a

giant cluster of industrial cities between Bologna and Venice.

There, new enterprises have formed through breakaways of workers from older enterprises,

and the economies of scale are obtained,

not as conventionally assumed, through huge organizations,

but through large symbiotic collections of small enterprises.

These firms practice spontaneously a fusion of conception and execution, applying practical knowledge, that elsewhere only a very large firms have been able to achieve on a grand scale.

This tremendous productivity overcomes the barriers that governments such as the Italian have erected which would otherwise stifle labor, enterprise, and investment.

Once import replacements start, they stimulate other enterprises which provide more replacements.

The process vastly enlarges city economies as well as diversifying them, and causes cities to grow in spurts, rather than gradually.

City import-replacing is at the root of all economic expansion.

The expansion that derives from city import-replacing consists of five forms of growth:

1. enlarged city markets for new and different imports, mainly of rural goods and of innovations produced in other cities.

2. abruptly increased numbers and kinds of jobs in the import-replacing city.

3. increased transplants of city work into rural locations

4. new uses for technology, especially to increase rural production.

5. the growth of city capital.

Cities' Own Regions

City regions are not determined by natural boundaries.

The regions are artifacts of the cities at their nuclei.

The boundaries change, moving out or halting with the economic energy of the city.

Tokyo's region, for example, has vaulted over mountains.

Boston's has expanded beyond the state boundary into New Hampshire.

Why did it extend into New Hampshire? Taxes.

Some cities do not generate regions.

Rome is large but has a tiny city region.

US cities without regions include Atlanta, Seattle.

L.A. and S.F., NYC and Boston have large regions.

Hong Kong has a large city region in China, in the adjacent province of Guangdong.

A city generates regions when it has the capacity to replace wide ranges of its imports repeatedly.

When a city at the nucleus of a region stagnates and declines,

it does so because it no longer experiences import replacing.

Supply regions

Supply regions provide specific resources to cities.

They are disproportionately shaped by the markets of distant cities.

Uruguay is a prime example of a rich supply region that degenerated. It supplied wool, meat, and leather to Europe for several decades. Uruguay was a democracy.

During the early 1900s the government of Uruguay built the world's most lavish welfare state, bigger per capita than Scandinavia.

Then in the 1950s, things changed.

Meat and wool production revived in Europe.

There was more competition from Australia and New Zealand.

Substitutes for wool and leather were invented.

Uruguay's distant markets dwindled in quantity and price.

Uruguayans could no longer earn ample imports.

The government embarked on a program of import substitution.

It built factories to build steel, textiles, shoes, electrical equipment. Government put the factories where unemployment was highest. The result was a fiasco.

What they produced cost so much more than equivalent imports

that people and other enterprise in Uruguay could not afford them.

To finance the program, the government bought the inputs on credit.

It then was unable to pay the interest.

The government of Uruguay became bankrupt.

The welfare benefits and transfer payments could no longer be sustained.

The government resorted to printing money.

Inflation raged, and civil strife broke out.

A military dictatorship took over and restored order.

A third of the country's earnings were then used to pay interest, and much of the rest pays for imported fuel.

Uruguay had merely been rich, rather than developed.

The difference between a rich backward economy and a poor one is not all that great.

Such supply regions are inherently overspecialized and unbalanced, vulnerable to losing their markets.

As time passes, formerly prosperous supply regions succumb to a fall in supply or demand.

Resources get depleted, or demand shifts to other products.

Supply economies are not efficient as whole economies.

Their specialities might be efficiently produced, but

the economy is not able to adapt to change.

Some supply regions were able to adapt and become import-replacing cities. A prime example is Hong Kong.

It went from being a distribution center to providing markets for supply regions.

Why was the economy of Uruguay so unadaptive?

What makes an economy adaptive?

Restrictions and imposed costs decrease flexibility and incentive.

The book Economic Freedom of the World studied 100 countries.


In 1990 Uruguay had an economic freedom rank of 6.5 out of 10.

It ranked low on money growth and the variance of inflation.

High and varaible inflation are bad for business.

Uruguay had price controls. It had a large government sector.

It still had large transfers and subsidies.

The relative size of the trade sector was very low.

In contrast, Hong Kong had low taxes and a small government sector.

The 1997 ranking for Uruguay is 7.7, an improvement.

Social Security has been cut.

External debt has declined.

inflation is still high (20% 1997)

Tariffs are lower.

per capita GDP $5100

Hong Kong ranked #1 at 9 out of 10.

Regions Workers Abandon

Since 1921, Wales has lost 1/3 of its population.

Its countriside is dotted with desterted cottages.

The rural Welsh left because of poverty.

Other regions with similar experience: Spain, Sicily.

Migrants send money home, but that does not develop the economy.

Remitances often the largest source of foreign funds.

The money just buys imports - better standard of living.

Example, village of Napizaro in central Mexico.

Depends on jobs in Los Angeles.

Mexico too stifles enterprise with restrictions and taxes.

Policy which does not confront the cause has little effect.