MARKET RESEARCH ARTICLE REVIEW ON SPATIAL ECONOMICS: THE DECLINING COST OF DISTANCE BY BAIN AND COMPANY (2016)

SPATIAL ECONOMICS: THE DECLINING COST OF DISTANCE

SPATIAL ECONOMIC 

Producers and buyers are dispersed in space, and overcoming the distances between them can be costly. Much commercial activity is concerned with “space bridging,” and much entrepreneurship aimed at making good use of locational opportunities and cutting the costs of transport and communication. Spatial economics is the study of how space (distance) affects economic behaviour. Throughout history, transport costs have hampered specialization, and improvements in transport and communications have been among the main driving forces of economic progress. In medieval Europe and China, most ordinary people never moved farther than twenty miles from their birthplaces, and before the advent of book printing, most people knew very little about what happened beyond those narrow horizons. Firms that depended on heavy inputs, such as steel makers, used to locate near the source of major inputs—coal mines, in particular. By contrast, firms that interacted intensively and frequently with customers tended to locate near the demand. Thus, gasoline stations are still found near busy intersections.

Spatial economics deals with what is where, and why. The “what” refers to every type of economic entity, i.e., production establishments, other kinds of businesses, households, and public and private institutions. “Where” refers basically to location in relation to other economic activity, i.e., to questions of proximity, concentration, dispersion, and similarity or disparity of spatial patterns. The “where” can be defined in broad terms such as regions or metropolitan areas, or in micro-geographic terms such as zones, neighbourhoods, or sites. The “why” refers to explanations within the somewhat elastic limits of the economist‘s competence. Location theory describes this kind of analysis when the emphasis is upon alternative locations for specified kinds of activities, such as industry. Regional analysis is concerned with groupings of interrelated economic activities in proximity, within specified areas or types of areas; and the theory of interregional trade refers to the economic relationships between such areas. 

The cost of distance is highly impacting both business and personal decisions. For example, it is one of the considerations companies are taking into account when deciding on the location of their production site(s). According to Bain research, the cost of distance will decrease sharply within the next decades whereas the majority of the companies have not yet thought about the implications for their business. On the other hand, it is also an important factor for families deciding where to live (e.g. proximity of the company they work for). The article gives a very clear overview on the main catalysts driving the drop in cost of distance and can be summarized as follows: 

 1) High-speed connectivity will increase productivity of working at a distance (think about the cloud-based collaboration) 

 2) The cost of physical transport will drop. New technologies, such as autonomous vehicles and drones will improve transportation efficiency 

 3) Increasing efficiency in small-scale production. Increased automation in the production process (robotics, 3-D printing,..) will decrease labor cost, lowering the number of households to be served to break even 

URBAN PLANNING THEORY AND SPATIAL ECONOMIC 

Many urban planners believe that population densities can be fixed by design as cities expand. Many urban development plans aim at compact cities growth. However, compact cities are possible only with very high land prices produced by constraints on land supply. My view that the spatial distribution of land prices and densities are closely correlated and that they follow a predictable pattern produced by market forces. By using models developed by economists, planners could better understand both the pattern of densities in existing cities and how these densities are likely to respond to changes in size of population, households’ income, and transportation speed and cost. 

Concerns for an over-consumption of land by cities are best addressed by identifying possible distortions in the land market caused by an abusive use of eminent domain that under-prices agricultural land. Setting arbitrary spatial barriers to urban expansion, such as green belts and urban growth boundaries, results in higher land and housing prices. Land prices and population densities are closely related and are produced by market forces. We have also seen that there is no optimum density for urban development and that within the same city densities may vary by order of magnitude from the centre to the periphery. The population density in a particular neighbourhood is determined by trade-offs between households’ desire to consume more land and floor space and the commuting cost in time and money. 

Households with different preferences and incomes make different trade-offs. Some low-income households prefer to reduce drastically their land and floor space consumption in order to reduce commuting costs. Other households with similar income may make different trade-offs. Planners cannot possibly know the reasons that households may have in selecting a specific housing location and land consumption. Therefore, planners should abstain from arbitrarily fixing densities through regulations. Neither should they try to distribute population according to a designed spatial pattern no matter how clever the geometric arrangement appears to be. Planners should use the standard urban model to better understand how markets work in the city they are managing. They can use the model to anticipate the effect of regulations and infrastructure on land prices and rents.

They can plan, finance and build the infrastructure that would increase the supply of land and therefore decrease housing cost. They can design transport systems that decrease commuting time and cost, another way of increasing the supply of land and increasing mobility. They should design transport systems that are consistent with the densities set by the land markets rather than design densities that would make a preselected transport system feasible. In general, fixing minimum consumption for land and floor space through regulations such as minimum plot size, maximum floor area ratio, and maximum number of dwelling unit per hectare introduces rigidities in the market that have negative impacts on poorer households for whom these regulations are binding. Urban planner should therefore, abstain from using these regulatory constraints on minimum land and housing consumption as they hurt the poor the most and trigger the growth of informal markets.

Only after they have a good understanding of how local real estate markets function can planners anticipate future land market values to plan infrastructure networks that will be consistent with anticipated densities. Constant monitoring of land prices and rent could provide planners with feedback that could help them amend their infrastructure plans if their projection appears to diverge from reality. Unaffordable housing is a plague affecting many large cities. Monitoring the ratio between median income and median housing price allows us to constantly measure housing affordability. When the price to income ratio becomes higher than 4, planners should take immediate action. This action could be to increase land supply through new infrastructure development or to audit land use regulations and building permit practices that may make developed land and housing prices abnormally high.  

Urban planners should be held responsible for unaffordable high price/income ratios in the same way that public health officials are held responsible for infectious disease epidemics, or police are held responsible for high crime. The standard urban model is a very crude instrument that provides an understanding of the basic movement of land prices and rent when income, transport costs, and land supply change over time. Planners could design more complex models to anticipate price movements or commuting patterns in cities with specific constraints, in particular topographical constraints like bodies of water or steep mountains. However, no infrastructure or regulatory design decision should be taken without accounting for its impact on the land market.