developers or local governments. For example, town or village governments may decide that they want to become a more major urban center. As formulated in Henderson (1974), Helsley and Strange (2012) detail how formation of cities by self-organization of residents and firms without large-scale developers and institutions leads to cities of very inefficient sizes. They also show that industrial compositions may be very inefficient. Similarly, Behrens, Duranton, and Robert-Nicoud (2012) model significantly oversized cities under self-organization, though Henderson and Venables (2009) show that with sophisticated contracting and capital markets, in a dynamic context, cities will tend to be efficient sizes under self-organization.

Henderson and Becker (2000), building on Henderson (1974), argue that the potential poor outcomes under self-organization can be largely avoided with “free market” formation of new cities or with conversion of towns to cities led by private developers that can finance large-scale settlements. If existing cities become oversized or operate inefficiently, the threat of new, bettersized, more efficient settlements maintains market discipline. To establish new cities, small town governments must have the fiscal autonomy and ability to finance expansionary public infrastructure, and large land developers, in conjunction with private employers and housing providers, can effectively start new, large-scale settlements as demand requires. Garreau’s (1991) book on the U.S. development of “edge cities” details a large variety of partnerships between the public and private sectors, as well as purely private sector developments. Behind all these mechanisms lies the need for good local institutions—well-defined and enforceable private property rights (without risk of expropriation) and disciplined access to capital markets. Box 5 discusses aspects of the requirements as argued in World Bank (2012a,b).

# **Box 5. Essentials for timely city formation and expansion**

World Bank (2012a,b) analyzes issues of new city formation and city expansion and discuss the history of “planned cities.” Two general issues are important for a reasonable process: how cities can finance urban infrastructure, and how real estate markets should be structured to encourage private real estate development of urban land for residential or commercial use.

When cities borrow, they offer no collateral for loans: private banks or bondholders cannot seize public property. Ensuring repayment requires a strongly regulatory and sophisticated credit rating system whereby each city borrower is subject to regulation that requires transparency and full accounting and assurance of repayment. For example, if a local government is failing to pay its debts, a higher level of government may be able to intercept monies coming into the local government and force repayment of the debts. In many countries, capital markets and regulatory systems are not mature enough for the widespread issuance of local public debt. Instead, the national government can create substitutes.

World Bank (2012b, spotlight 4) discusses the FINDETER initiative in Colombia. FINDETER is a quasi-public financial institution that intermediates between commercial banks and borrowing localities. It offers subsidized loans to banks as an inducement to lend to localities and monitors and approves applications with an eye to the proposed venture’s quality. When the bank lends, it absorbs all the risk but has the right to intercept certain city revenues (in this case, intergovernmental transfers) in event of nonrepayment. FINDETER has a AAA local credit rating from Duff & Phelps. Also discussed is an initiative in Tamil Nadu, India, through which a public-private financial intermediary issues its own bonds and lends to localities with creative ways to limit risk, involve the private sector, and ensure that projects are producing revenue to help repay loans. Its loan recovery rate is 98 18