Building the city: sunk capital, sequencing, and institutional frictions

We model the building of a city, estimate parameters of the model, and calculate welfare losses from institutional frictions encountered in changing land-use. We distinguish formal and slum construction technologies; in contrast to slums, formal structures can be built tall, are durable, and non-malleable. As the city grows areas are initially developed informally, then formally, and then redeveloped periodically. Slums are modelled as a technology choice and do not depend on property rights per se; however institutional frictions may hinder their conversion to formal usage. Using unique data on Nairobi for 2003 and 2015 we develop a novel set of facts that support assumptions of the model and calculate welfare losses of conversion frictions. We track the dynamic evolution of the city, where in the core city about 35% of formal sector buildings were torn down over 12 years and replaced by buildings on average three times higher. For slums in older areas near the centre, even after buying out slumlords, formalization would yield gains amounting to over $17,000 per slum household, 30 times typical annual slum rent payments.