Econ 522 Economics of Law Dan Quint Spring 2012 Lecture 8 (Two handouts in back of room)

1  Second homework due in a week (Thurs Feb 23, midnight)  First midterm a week later (Wed Feb 29) Logistics

2 Example: high transaction costs when many parties are involved

3 How do you establish, verify, or give up property rights?

4  Hammonds v. Central Kentucky Natural Gas Co.  Central Kentucky leased land lying above natural gas deposits  Geological dome lay partly under Hammonds’ land  Central Kentucky drilled down and extracted the gas; Hammonds sued, claiming some of the gas was his  (Anybody see “There Will Be Blood”?) Fugitive property HammondsCentral KY

5  First Possession  nobody owns fugitive property until someone possesses it  first to “capture” a resource owns it  Central Kentucky would own all the gas  Tied Ownership  ownership of fugitive property tied to something else (here, surface)  so ownership already determined before resource is extracted  Hammonds would own some of the gas, since under his land  principle of accession – a new thing is owned by the owner of the proximate or prominent property Two principles for establishing ownership

6  First Possession  simpler to apply – easy to determine who possessed property first  incentive to invest too much to early in order to establish ownership  example: $100 of gas, two companies drilling fast or slow  drilling slowly costs $5, drilling fast costs $25  drill same speed  each gets half the gas, one drills fast  75/25 First Possession versus Tied Ownership 45, 4520, 50 50, 2025, 25 SlowFast Slow Fast Firm 2 Firm 1

7  First Possession  simpler to apply – easy to determine who possessed property first  incentive to invest too much to early in order to establish ownership  Tied Ownership  encourages efficient use of the resource  but, difficulty of establishing and verifying ownership rights First Possession versus Tied Ownership 45, 4545, 25 25, 4525, 25 SlowFast Slow Fast Firm 2 Firm 1

8 Rules that link ownership to possession have the advantage of being easy to administer, and the disadvantage of providing incentives for uneconomic investment in possessory acts. Rules that allow ownership without possession have the advantage of avoiding preemptive investment and the disadvantage of being costly to administer. This brings us to the following tradeoff:

9  Meant to encourage settlement of the Western U.S.  Citizens could acquire 160 acres of land for free, provided  head of a family or 21 years old  “for the purpose of actual cultivation, and not… for the use or benefit of someone else”  had to live on the claim for 6 months and make “suitable” improvements  Basically a first possession rule for land – by living on the land, you gained ownership of it  Friedman: caused people to spend inefficiently much to gain ownership of the land A nice historical example: the Homestead Act of 1862

10 “The year is 1862; the piece of land we are considering is… too far from railroads, feed stores, and other people to be cultivated at a profit. …The efficient rule would be to start farming the land the first year that doing so becomes profitable, say But if you set out to homestead the land in 1890, you will get an unpleasant surprise: someone else is already there. …If you want to get the land you will have to come early. By farming it at a loss for a few years you can acquire the right to farm it thereafter at a profit. Friedman on the Homestead Act of 1862

11 How early will you have to come? Assume the value of the land in 1890 is going to be $20,000, representing the present value of the profit that can be made by farming it from then on. Further assume that the loss from farming it earlier than that is $1,000 a year. If you try to homestead it in 1880, you again find the land already taken. Someone who homesteads in 1880 pays $10,000 in losses for $20,000 in real estate – not as good as getting it for free, but still an attractive deal. …The land will be claimed about 1870, just early enough so that the losses in the early years balance the later gains. It follows that the effect of the Homestead Act was to wipe out, in costs of premature farming, a large part of the land value of the United States.” Friedman on the Homestead Act of 1862

12  First Possession and Tied Ownership are doctrines for how ownership rights are determined  Next question: when should a resource become privately owned?  Cost of private ownership: owners must take steps to make the resource excludable – boundary maintenance  Cost of public ownership: congestion and overuse  An economically rational society will privatize a resource at the point in time where boundary maintenance costs less than the waste from overuse of the resource. When should resources become privately owned?

13  First Possession and Tied Ownership are doctrines for how ownership rights are determined  Next question: when should a resource become privately owned?  Cost of private ownership: owners must take steps to make the resource excludable – boundary maintenance  Cost of public ownership: congestion and overuse  An economically rational society will privatize a resource at the point in time where boundary maintenance costs less than the waste from overuse of the resource.  (either because congestion got worse…  or because boundary maintenance became cheaper) When should resources become privately owned?

14  Branding cattle  Vehicle ID numbers on cars  States grant deeds for property, and keep registry of legal owner How do you prove ownership of something?

15  Branding cattle  Vehicle ID numbers on cars  States grant deeds for property, and keep registry of legal owner  No such system for apples  Too many apples – high cost of maintaining a registry  Apples inexpensive – not much of a problem How do you prove ownership of something?

16  Adverse Possession (“squatter’s rights”)  If you occupy someone else’s property for long enough, you become the legal owner, provided:  1. the occupation was adverse to the owner’s interests, and  2. the owner did not object or take legal action How do you give up (or lose) property rights?

17  Adverse Possession (“squatter’s rights”)  If you occupy someone else’s property for long enough, you become the legal owner, provided:  1. the occupation was adverse to the owner’s interests, and  2. the owner did not object or take legal action  Pro: clear up uncertainty over time; allow land to be put to use  Con: owners must incur monitoring costs to protect property How do you give up (or lose) property rights?

18  Adverse Possession (“squatter’s rights”)  If you occupy someone else’s property for long enough, you become the legal owner, provided:  1. the occupation was adverse to the owner’s interests, and  2. the owner did not object or take legal action  Pro: clear up uncertainty over time; allow land to be put to use  Con: owners must incur monitoring costs to protect property  Estray statutes – laws governing lost and found property How do you give up (or lose) property rights?

19 Remedies

20  Maximum liberty: owner can do whatever he/she wants, as long as it doesn’t interfere with another’s property  When it does interfere, externality, or nuisance  Affects small number: private externality, or private bad  Transaction costs low  injunctions preferable  Affects large number: public externality, or public bad  Transaction costs high  damages preferable Remedies (review)

21  Compensatory Damages  intended to “make the victim whole”  compensate for actual harm done  make victim as well off as before  Can be…  Temporary – compensate for harms that have already occurred  Permanent – also cover present value of anticipated future harm Types of damages

22  Temporary damages  Require victim to keep returning to court if harm continues  Create an incentive to reduce harm in the future  Permanent damages  One-time, permanent fix  No incentive to reduce harm as technology makes it easier Temporary versus permanent damages

23  If a nuisance affects a small number of people (private nuisance), an injunction is more efficient  If a nuisance affects a large number of people (public nuisance), damages are more efficient  If damages are easy to measure and innovation occurs rapidly, temporary damages are more efficient  If damages are difficult/costly to measure and innovation occurs slowly, permanent damages are more efficient  What’s done in practice for public nuisances?  temporary damages and injunction against future harm  but… Efficient nuisance remedies

24  Atlantic owned large cement plant near Albany  dirt, smoke, vibration  neighbors sued  plant was found to be a nuisance, court awarded damages  neighbors appealed, requesting an injunction  Court ruled that…  yes, this was a valid nuisance case  and yes, nuisances are generally remedied with injunctions  but harm of closing the plant was so much bigger than level of damage done that court would not issue an injunction  ordered permanent damages, paid “as servitude to the land” Boomer v Atlantic Cement Co (NY Ct of Appeals, 1970)

25  Atlantic owned large cement plant near Albany  dirt, smoke, vibration  neighbors sued  plant was found to be a nuisance, court awarded damages  neighbors appealed, requesting an injunction  Court ruled that…  yes, this was a valid nuisance case  and yes, nuisances are generally remedied with injunctions  but harm of closing the plant was so much bigger than level of damage done that court would not issue an injunction  ordered permanent damages, paid “as servitude to the land” Boomer v Atlantic Cement Co (NY Ct of Appeals, 1970)

26 Limitations and Exceptions to Property Rights

27  Property rights generally protected by injunctive relief, BUT…  Ploof v. Putnam (Sup. Ct. of Vermont, 1908)  Ploof sailing with family on Lake Champlain, storm came up  Tied up to pier on island owned by Putnam  Putnam’s employee cut the boat loose, Ploof sued  Court sided with Ploof: private necessity is an exception to the general rule of trespass  In an emergency, OK to violate someone else’s property rights; still must reimburse them for any damage done Private Necessity

28  Property rights generally protected by injunctive relief, BUT…  Ploof v. Putnam (Sup. Ct. of Vermont, 1908)  Ploof sailing with family on Lake Champlain, storm came up  Tied up to pier on island owned by Putnam  Putnam’s employee cut the boat loose, Ploof sued  Court sided with Ploof: private necessity is an exception to the general rule of trespass  In an emergency, OK to violate someone else’s property rights; still must reimburse them for any damage done Private Necessity

29  Property: “a bundle of rights”  Can you unbundle them?  Separate them, sell some and keep others  Usually, no  Prohibition on perpetuities  I can’t separate the right to own/live on my land from the right to sell it or turn it into a golf course  But in some instances, yes… Unbundling

30  Land ownership consisted of three separable pieces (“estates”)  Surface estate  Support estate  Mineral estate Example of unbundling: Pennsylvania and coal

31  Free unbundling of property rights generally not allowed  Civil law more restrictive than common law  For efficiency…  In general, efficiency favors more complete property rights  People would only choose to unbundle property when that increases its value, so we should allow it?  But unbundling might increase transaction costs  Increases uncertainty about rights  May increase number of parties involved in future transactions Unbundling

32  The government can take your property  “Eminent domain”  And the government can tell you what to do with it  Regulation Two other ways in which property rights are limited

33 Takings

34  One role of government: provide public goods  When public goods are privately provided  undersupply  Defense, roads and infrastructure, public parks, art, science…  To do this, government needs land  (which might already belong to someone else)  In most countries, government has right of eminent domain  Right to seize private property when the owner doesn’t want to sell  This type of seizure also called a taking Takings

35  U.S. Constitution, Fifth Amendment: “…nor shall private property be taken for public use, without just compensation.”  Government can only seize private property for public use  And only with just compensation  Consistently interpreted to mean fair market value – what the owner would likely have been able to sell the property for Takings

36  Why allow takings? Takings

37  Why allow takings?  Why these limitations?  why require compensation? Takings

38  Why allow takings?  Why these limitations?  why require compensation? Takings $3 MM$1 MM $9 MM $10 MM

39  Why allow takings?  Why these limitations?  why require compensation?  why only for public use? Takings

40  Why allow takings?  Why these limitations?  why require compensation?  why only for public use?  The government should only take private property (with compensation) to provide a public good when transaction costs preclude purchasing the necessary property through voluntary negotiations Takings

41  1981: GM was threatening to close Detroit plant  Would cost city 6,000 jobs, millions in tax revenue  City used eminent domain to condemn entire neighborhood  1,000 homeowners and 100 businesses forced to sell  land then used for upgraded plant for GM  city claimed employment and tax revenues were public goods, which justified use of eminent domain  Mich Sup Ct: “Alleviating unemployment and revitalizing the economic base of the community” valid public purposes; “the benefit to a private interest is merely incidental”  Overturned in 2004 ruling (Wayne v Hathcock)  Similar case, Kelo v. City of New London (2005 US Sup Ct) Poletown Neighborhood Council v Detroit

42  1981: GM was threatening to close Detroit plant  Would cost city 6,000 jobs, millions in tax revenue  City used eminent domain to condemn entire neighborhood  1,000 homeowners and 100 businesses forced to sell  land then used for upgraded plant for GM  city claimed employment and tax revenues were public goods, which justified use of eminent domain  Mich Sup Ct: “Alleviating unemployment and revitalizing the economic base of the community” valid public purposes; “the benefit to a private interest is merely incidental”  Overturned in 2004 ruling (Wayne v Hathcock)  Similar case, Kelo v. City of New London (2005 US Sup Ct) Poletown Neighborhood Council v Detroit