In 1992, Bed Bath and Beyond took a gamble and opened its first superstore on Manhattan”s Lower Sixth Avenue. This was at a time when other potential tenants, such as Barnes & Noble, were refusing to sign leases and the whole of New York real estate was in recession. But the opening was surprisingly successful, and the store immediately attracted large crowds. Since then, rents have risen rapidly and once-vacant lots have returned to retail use. Today, Sixth Avenue is in the midst of a rapid turnaround, well on the way to regaining its former status as a booming retail centre.
In the latest issue of the Economic Journal, Professors Andrew Caplin of New York University and John Leahy of Boston University explain this phenomenon in terms of the theory of ”information externalities”. In indicating how a depressed area can recover even in the middle of a recession, their theory has important lessons for policy-makers looking to encourage activity in other depressed areas or sectors of an economy.
Caplin and Leahy”s analysis focuses on the dynamics of information and market entry implicit in the pattern of location on Lower Sixth Avenue by Bed Bath and Beyond and subsequent superstores like Barnes & Noble and TJMaxx. The key issue is that the first ”entrant” to a location may release a great deal of information of value to other potential entrants, thereby providing an ”externality” that benefits later entrants.
This externality acts to discourage entry, since the first mover does not gain the full benefits of the information it releases. The end result can be a long delay during which time the resources remain under-utilised. When an entrant finally takes the plunge and enters the market, as Bed Bath and Beyond did, its success will lead to ”follow-the-leader” behaviour.
Of course, if it fails, there will be no imitators. This research has implications not only for efforts to revive depressed sectors of the economy, but also for efforts to attract financial flows to under-developed countries. For policy-makers, the key point is the need to design policies that encourage innovators to experiment as broadly as possible, and as early as possible.
”Miracle on Sixth Avenue: Information Externalities and Search” by Andrew Caplin and John Leahy is published in the January 1998 issue of the Economic Journal. Caplin is Professor of Economics at New York University, 269 Mercer St., New York NY 10003, USA; Leahy is Professor of Economics at Boston University, 270 Bay State Road, Boston MA 02215, USA.
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