Shruti Rajagopalan and I wrote about India's private cities, Guragaon and Jamshedpur in Lessons from Gurgaon, India's Private City. One thing we discovered was that transaction costs prevented private developers from coordinating on infrastructure such as sewage and electricity even though that was clearly the efficient solution and there was plenty of time to bargain. We suggested larger purchases--such as at Disneyland--were necessary to internalize the externalities.

In The Contractual Nature of the City, Qian Lu looks at Jiaolung, an unusual private city in China. Jiaolung is small, about 4.3 square km and a population of 100,000 but all the infrastructure including electricity, sewage, roads, apartments, shopping malls, aquarium, office buildings, and hotels have been built privately. The firm in charge, Jiaolung Co., has planning rights and crucially it collects 25% of all property tax which means it internalizes part of the increase in value generated by its investments.

Jiaolong is a city built and operated by a business corporation. This is rare in China because in most cases the local city government is in charge of urbanization. In almost all cities, government makes land and city planning, takes farmers' land, builds city infrastructure, sells land to housing developers and manufacturers, operates police stations, hospitals, schools and universities. By holding the monopoly power of coercion, the government is able to pool together resources by fiat and hold transaction costs low.

... The urbanization of Jiaolong is not based on coercive power, but by a series of contracts with Shuangliu government, firms, farmers, residents and other relevant parties. As the central contractor, Jiaolong Co. is able to simplify the contractual web and reduce coordination cost. The essential contracts are the investment contract with the county government to transfer planning rights, and a series of contracts with the government and firms to share tax. Tax sharing contracts define the income rights for Jiaolong so that Jiaolong could share the surplus of urban development and infrastructure construction. Sharing contracts also motivate Shuangliu government to provide public services including protection of property rights. A series of contracts transfer planning rights, land use rights, and income rights to Jiaolong Co., and thereby endogenize the externality of infrastructure building and urban development. From the perspective of institutional change, Jiaolong offers a case of contract-based rather than coercion-based urbanization, the latter being the typical approach in China.