The logic behind it came from the exchange between Nocole Kidman and Paul Bettany about the town in his new book:
"Why don't you just call it Dogville?"
"Wouldn't work. It needs to be universal,"
Albeit, living on a soundstage isn't universal, but I thought it gave the film an odd ability to allow the viewer to project his/her memories onto the blank backdrops. Despite the fact that this film takes place in America, I feel that not using American landscapes perhaps made the film more aesthetically accessible (after the initial shock of the sound stage).
It also has a funny sort of feeling that the physical walls we build up around ourselves are merely superficial, and it's the intangible walls that are all the more restricting (and that no one truly has privacy; they all see right through each other, but refuse to turn those analytical gazes inward).
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