Failures in Urban Capital Markets and Consequences for Project Funding

Urban areas are nowadays seen as the engines of economic growth and thus politicians rivet on problems connected to urban development. Most importantly, the question of how projects, which enhance urban life should be funded raised concern. The European Commission reacted to this topic by the introduction of the JESSICA (Joint European Support for Sustainable Investment in City Areas) Initiative. Within this initiative, resources can be invested in so called Urban Development Funds (UDFs) which should pass the money on to projects eligible for funding. In contrast to traditional grant financing, the JESSICA instruments have a revolving character (loans, equity, guaranties). This raises the question of whether and when the employment of these new funding types is appropriate.In general, public authority interventions are a justified means to remedy market failures. We apply this idea in the context of urban development projects by analysing the three main market imperfections, namely external effects, imperfect competition and incomplete information. For combinations of these imperfections, we derive suitable types of funding. Depending on the sensitivity to the respective imperfections, we categorise a range of urban development projects which are suggested to be appropriate for Urban Development Funds under the JESSICA initiative. This reveals that projects related to culture, tourism, retail as well as public buildings and spaces should get grant funding as they are mainly prone to market failures arising from external effects. Otherwise, projects in the fields of transport, energy, communication, education, research, business parks, and start-ups are indeed suitable for JESSICA-type funding. This analysis contributes to existing remarks on the advantages of the JESSICA Initiative by going beyond practitioners' argumentations. It seems to be extremely important to understand the mechanisms behind market failure corrections, because the appropriate funding type is crucial to not distort normal market functioning. Thus, the connection between the omission of project initialisation and market failures should always be carefully investigated before the selection of funding instruments.