Jacobs' Ladder to Prosperity

Cities and the Wealth of Nations: Principles of Economic Life, by Jane Jacobs, New York: Random House, 251 pp., $17.95

Just over 20 years ago, Jane Jacobs took on the urban-planning profession in The Death and Life of Great American Cities. A few years later, she penned The Economy of Cities. Not surprisingly, her latest book, Cities and the Wealth of Nations: Principles of Economic Life, again looks at cities, this time as the focal point of political and economic life—more important even than the nation-state. In Cities and the Wealth of Nations, Jacobs sets out to show why this is so and why the wealth of nations is dependent on the well-being of its urban agglomerations. Because urban areas manifestly haven't been doing so well recently, she suggests that the outlook for nations also is bleak.

It's hard not to see something terribly malevolent at work in such cities as Detroit (to pick a city familiar to this reviewer), where urban decay has reached almost apocalyptic proportions. And it's natural to fear that the decline of some of our major cities portends badly for the country as a whole. The worst of the urban decline coincided with the debilitating economic stagnation of the last 15 years or so. It is Jacobs's thesis that our cities have turned into stagflationary lumps threatening to metastasize through the body politic as a whole.

It's an intriguing and provocative thesis. In the end, however, Jacobs fails to make her case. Not the least of her problems is that she may have written her book a year too soon. The stagflationary beast has been slain, at least for the moment. Inflation is down; economic growth robust. And this was brought about not by fancy new urban-based views of the way the world works but by policies that have their base in…Adam Smith, that preeminent economist of the 18th century.

The economic climate could change, of course, and Jacobs's theory may find easier acceptance. Yet policymakers aren't likely to find it of much practical help. Ultimately, Jacobs is forced to confess that she is baffled by what she finds. As a solution to stagflation and urban decay she has little more to suggest than "drift"—stumbling along as best we can in the hopes that something will turn up to reverse the tide. Indeed, "drift" is the depressing title of her last chapter.

That's not to say there isn't much of value in Jacobs's book. The basic error of modern economics, she asserts, is to think of the nation-state as the primary engine of the wealth-creation process. The real engines of wealth are what she calls "the import-replacing cities." These are cities in which people learn to fabricate products in place of goods that had previously been imported from other manufacturing centers. As a city's populace develops the skills to do this, it develops export markets of its own and begins to generate a surplus with which to import other goods, which are then consumed or fabricated into yet other export goods, which generates more surplus, and so on.

"Any settlement that becomes good at import-replacing becomes a city," writes Jacobs. "And any city that repeatedly experiences, from time to time, explosive episodes of import-replacing keeps its economy up-to-date and helps keep itself capable of casting forth streams of innovative export work.…The process feeds itself, and once under way, does not die down in a given city until all the imports that are economically feasible to replace at that time and in that place have been replaced."

The import-replacing process sounds faintly reminiscent of the mercantilism of post-feudal Europe, wherein industry was actively promoted to attain a favorable balance of trade. But it is not mercantilism that is at work here, Jacobs insists: "An import-replacing city does not, upon replacing former imports, import less than it otherwise would, but shifts to other purchases in lieu of what it no longer needs from outside. Economic life as a whole has expanded."

Jacobs characterizes the nonurban hinterlands as "supply regions," areas capable of efficiently producing commodities such as grain or minerals but whose economies are too limited to build up the skills and diversity necessary to sustain the wealth-creation manufacturing process. Supply regions can be whole nations, such as Third World countries that export raw materials to the industrialized countries, or such areas as the farm states of America that ship food to the cities in exchange for manufactured goods. In either case, they live a precarious existence. They have little to fall back on if there is a crop failure, a sudden shift in demand, or other uncontrollable event.

Efforts to diversify and modernize a supply region or a decaying city by force-feeding economic development are almost certainly doomed to failure, Jacobs argues. Here she takes a leaf from the pathbreaking work of British economist P.T. Bauer. Loans, aid, and welfare help only as long as the funds are flowing. When they stop, economic activity once again stops or resumes its decline. The provider of the welfare, meanwhile, has been weakened by this misallocation of capital—what Jacobs terms "transactions of decline."

The only answer to this zero-sum game, in Jacobs's view, is to strengthen the cities. They are the true incubators of wealth, where capital, information, and entrepreneurial skill combine to move civilization forward. Societies that don't show a strong regard for their cities are doomed to slip back into colonial status, selling their raw materials or labor to societies that are still growing and vigorous.

But there's the rub, according to Jacobs. Nation-states are fated to smother their city-states. They do so, she argues, because the nation-state reserves to itself a monopoly on monetary policy.

A nation's currency is more than a medium of exchange, Jacobs correctly points out. It is also a form of "feedback"—that is, a basic barometer of economic health. If an economic unit's currency is appreciating in value, it means the economic unit is doing well, because it is generating (or can be expected to generate) a surplus of exports over imports. If the economic unit persistently imports more than it exports, the currency will tend to decline in value. Seeing this, the constituents of the economic unit will react with appropriate policies and investment decisions to rectify matters and achieve equilibrium. They use monetary feedback as a fundamental measure of how they're doing.

But when the currency is controlled at the national level, it may not reflect local realities or give the correct "feedback" to decision-makers. As a result, businesses may not realize soon enough that their products are becoming uncompetitive, and politicians may be shielded from the evils that their policies do. Because a national currency by definition averages out nationwide needs and trends, including those in supply regions, the needs and trends in individual import-replacing cities are in danger of being overlooked.

The logic of this analysis, of course, is for each city to have its own currency. That way New York Mayor Ed Koch wouldn't have to go out on the streets to ask his famous question, "How'm I doing?" He'd get all the feedback he needs by calling his currency traders. Jacobs notes that today's city-states, such as Hong Kong and Singapore, which have their own currencies, have enjoyed tremendous success even while urban centers in much of the rest of the industrialized world have been deteriorating.

But she admits that a return to the city-state isn't likely. People aren't about to give up the national identities they have spent so much blood and treasure to acquire. She also acknowledges, but doesn't explore, the problem of whether carving up, say, the United States into dozens of city-states would really be efficient economically, much less politically. What individual cities or areas may lose in "feedback," they gain in having a common market and an effective national defense.

Besides, what guarantee is there that city regions will do any better at managing their currencies than nation-states? There is no reason to think that city monetary authorities would be any less prone than national authorities to debauching the currency to serve short-run political needs of politically potent constituents. If Jacobs really is concerned about feedback, she would be better off arguing for a completely privatized currency, as suggested several years ago by the Austrian School economist F.A. Hayek. Good currency could then drive out bad currency, at least in the Hayekian dream of things.

But of course it's nonsense to suspect that cities don't get feedback. One has only to look around our cities to get all the feedback one needs in order to know that in most of them something has gotten badly out of kilter. Indeed, it has been a matter of high national policy for decades to do something about these declining cities. The problem is that we have been pursuing solutions—"transactions of decline," in Jacobs's phrase—that only make matters worse.

The primary beneficiary of these efforts at wealth redistribution is the capital city. "Historically, in nations where city economies are dying and where, as well, cities are drained in service to transactions of decline, one city remains vivacious longest: the capital city. This is because capital cities thrive on transactions of decline. When a city's principal function is being a capital—like the city of Washington in the United States or Ottawa in Canada—it is obvious that the more transfer payments, subsidies, grants, (and) military contracts, the greater the work and prosperity in the capital city."

This is good stuff, as far as it goes. Apart from questions about the validity of some of the distinctions Jacobs tries to make—as, for instance, between city regions and supply regions—her real problem is more fundamental. The "import-substitution" process Jacobs describes is, at bottom, a mystery to her. She makes no real attempt to figure out what brings it about. It just happens. People get together, form a city, and bang, "import-substitution" begins.

Thus Jacobs can suggest no practical way out of the blind alley to which her analysis leads her. She describes cities, but she can't explain them, other than through a sort of Big Bang theory of wealth-creation. That's too bad, because everything she describes is perfectly compatible with one of the oldest explanations for how wealth is created: incentives.

Her description of the "import-substitution" process is an apt summary of what we know about entrepreneurial behavior. Her description of the urban role in this is consistent with what we know about the capitalizing process, in which information, labor, and capital come together to create the periodic explosions known as material progress. And her insight that government intervention tends to make matters worse rather than better is the beginning of wisdom.

It's ironic that an author who has styled her title after Adam Smith's masterwork, The Wealth of Nations, should ignore this obvious possibility. And particularly so at a time when "supply-siders" and others are busily reinventing classical economics and its incentive-based principles. They would have benefited greatly from Jacobs's great fund of knowledge. Our urban areas still don't receive the attention they deserve, least of all from an administration in Washington that has the right instincts but whose vision often doesn't seem to extend much beyond the country club.

Thomas J. Bray is editorial page editor of the Detroit News.