The Future of Urban Research: Non-Market Interactions

Modern growth theory argues that intellectual spillovers--idea flows among individuals that are not mediated by the market--are a linchpin of economic progress. In Paul Romer's seminal work, endogenous economic growth requires increasing returns. ¹ Without nonmarket intellectual spillovers or some form of externality, increasing returns and economic competition cannot coexist. In Romer's now canonical model of growth, idea flows are seen as the basis for economic progress; the robust relationship between human capital and economic growth has been taken as support for the importance of these intellectual spillovers.

Social capital theory argues that "social capital, connections, social networks are much more correlated with human happiness than is financial capital." ² In large surveys such as the General Social Survey (GSS), measures of social connection (such as churchgoing or membership in organizations) are more strongly connected with self-reported happiness than income is. This body of research also claims that nonmarket social interactions (for example, membership in choral societies) are an important factor in determining the success of governments and societies at large. Social ties among individuals are thought to be critical in overcoming citizens' apathy and "making democracy work." ³

These two large, separate literatures have independently concluded that nonmarket interactions are extremely important. Only an economist could be surprised by such a deduction. The tendency of economists to ignore these interactions has led us to disregard critical segments of the economy. Over the next ten years, I believe that nonmarket interactions will be at the forefront of economic research.

There are isolated examples of research on nonmarket interactions in urban economics, including Alfred Marshall's famous analysis of human-capital transfers in agglomerated areas and Jane Jacobs's discussion of idea flows among innovators in cities. Work on ghettos and discrimination has indeed often addressed the existence of nonmarket interactions. ⁴ But traditional urban economics, such as research on real estate, has been primarily oriented toward the market. ⁵ Papers on local public finance often address externalities but treat them usually as mere assumptions and rarely in depth. Even the seminal work of Paul Krugman in part derives its strength from its ability to explain economic agglomerations without resorting to ad hoc external effects. ⁶

Nonmarket Interactions and Cities

Nonmarket interactions occur when one individual influences another without the exchange of money. The first kind of these interactions involves voluntary participation of both individuals. Neighbors' doing favors for one another is an example of this kind, and this fits our usual paradigm--there is a cost for one person and usually a benefit for another. In some circumstances, such interactions could be done through the market (that is, you could pay your neighbor every time he lent you his rake). These interactions do not involve cash, mainly because they are sufficiently small and sufficiently common that reciprocity saves transaction costs. Occasionally they are done out of altruism (for example, caring for a sick friend). In some cases there may even be a social stigma attached to using or accepting money for a particular service (for example, donating organs).

In dense urban areas, where the extent of the market is great, these interactions may evolve from nonmarket interactions into market interactions. For example, in a small town a relative may serve as an amateur nurse for a sick outpatient because professional nurses are rare. In a large city, this service might more commonly be performed in the context of a market.

The second kind of nonmarket interactions are classic externalities--for example, the positive effects of role models, or acquiring human capital through the observation of a neighbor's successes and failures. ⁷ In these cases, it takes effort to stop the interactions--that is, unless the influencing party specifically works to stop the other party from observing, the interaction will...