Monday, February 9, 2015

Outdated zoning policy misallocates resources

Zoning that restricts certain land uses can lead to a misallocation of resources, especially if it is not updated to reflect changes in the highest valued use of that land. To demonstrate what I mean look at the picture below (click to enlarge).

The top part of the graph shows the land rent/acre on the Y axis and distance from the city center on the X axis. The different colored lines represent different demand curves for land for different uses. The blue line is the office demand curve for land, the red line is the manufacturer demand curve, the green line is the residential demand curve, and the flat black line is the agricultural demand curve. The demand curves can be thought of as the different willingness to pay that each potential owner has for land closest to the city center. The bottom circles represent the size of the city, with each circle representing a different land use.

Let's pretend the picture represents a city in 1950, prior to the interstate system being built. In this picture, developers who want to build office buildings place the highest value on the land closest to the city center. This is due to the fact that CEOs and top level executives rely on the quick transportation of information in order to make decisions. Often this information needs to be transmitted face to face and so locating in the middle of the city minimizes the distance that executives, both internal and external, have to travel to meet with one another. The higher willingness to pay for land results in the small, light colored inner circle being filled with office buildings.

Next are the manufacturers. They like to be near the city center because that is where the transportation hubs are located. Prior to highways and trucking goods that needed to be shipped over land used trains and large train stations were often located in the middle of cities. Also, rivers were used to transport manufactured goods and cities were built around rivers to facilitate transportation. The gray circle will be filled with manufacturing firms in this city.

Next comes the residential section. Homeowners want to decrease the distance they have to travel to work so they want to locate near the city center as well, but they do not value the land as much as the executives or the manufactures do. The charcoal colored circle is where the residents of this city live.

Finally the farmers live and grow food outside the circle in the surrounding white space. Since land closest to the city center has no particular value to them they end up in the rural area to minimize their costs.

This is a representative mono-centric city, meaning that there is one city center and it is surrounded by other areas used for various purposes.

Often land is zoned for particular uses, and if this zoning does not align with the actual highest valued  uses the land is used inefficiently. For example, suppose the light gray inner circle was zoned for residential use only. This would prevent office developers, who actually value the land the most, from using it. Thus the office buildings would have to be located elsewhere. This would increase the costs of transmitting information, likely resulting in firms being run inefficiently as well since their executives would not have as much information when making key decisions.

Another way zoning can lead to inefficiencies is if it doesn't adjust over time; the zoning might exactly align with the highest valued uses at one point in time, but then over time, as technology alters things, the highest valued uses may change while the zoning remains the same. Perhaps manufacturers valued the gray ring more than residents did in 1950 so zoning that limited that area to manufacturing was not a problem. But if manufacturers changed their willingness to pay after the highway system was built because truck transportation became cheaper, then residents might have the highest valued use for that land. If the zoning does not change residents will be unable to locate there even though they value the land the most.

Zoning policy that does not take into account the different demand curves for land will misallocate land and waste resources. Also, even if zoning policy did at one time allocate land appropriately, that policy may no longer be optimal if the demand curves for the different uses have shifted differently for different users due to technological changes that impact the costs of substitutes and complements for inner city land. I am not a proponent of restrictive zoning, but if zoning is going to be used it should be frequently evaluated and updated when necessary.

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