Econ 522 Economics of Law Dan Quint Spring 2010 Lecture 8.

Econ 522 Economics of Law Dan Quint Spring 2010 Lecture 8

Logistics This week: Next week: HW1 due Friday, 5 p.m.
First midterm Wednesday in class

Last week… Applications of Property Law… Today… Intellectual property
What it is, what problem it solves, what other problems it creates Types of public ownership, when to privatize a resource Boundary maintenance costs vs. cost of congestion/overuse Fugitive property First possession versus tied ownership rules Proving property rights Today… More on remedies Limitations and exceptions to property rights

Remedies (review) 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 We already saw the principle of maximum liberty: I can do whatever I want with my property as long as that doesn’t interfere with anyone else’s property When the use of my property does interfere with someone else’s use of theirs, we have an externality In property law, harmful externalities are called nuisances. When an externality is imposed on a small number of others, we say it’s a private externality, or in the language of public and private goods, a private bad In these cases, transaction costs should generally be reasonably low, and the problem can be solved through negotiation. (This might be the case with neighbors fighting over a tree that crosses the property line.) In these cases, relief by injunction is generally attractive the court does not need to go through the exercise of calculating damages and the clear enumeration of property rights will hopefully encourage the neighbors to reach an efficient outcome by bargaining. (We saw this with the example of the brewery whose smoke affected only one consumer – he and the brewery could agree to a Pareto-improving transaction to reduce pollution) On the other hand, when an externality is imposed on a large number of people – as with a factory polluting air in an area of dense population – the transaction costs of private negotiation are often prohibitively high This is a public externality, or public bad In these cases, from an economic point of view, damages are ideal Damages cause the factory to internalize the externality – that is, the cost to the neighbors becomes a private cost to the factory But the factory can still choose to accept this cost and continue polluting when this is efficient (With high transaction costs, an injunction would likely force the factory to stop polluting, which may not be efficient.)

Types of damages Compensatory Damages Can be…
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 Compensatory damages is the term for damages intended to “make the victim whole,” that is, to return the victim to being as well off as he or she was before the harm occurred (We’ll come back to other types of damages later on, in contract and tort law) Compensatory damages can be either temporary or permanent Temporary damages compensate for harms that have already occurred. Permanent damages compensate in addition for the present discounted value of harm that is expected to be done in the future By paying temporary damages, a factory compensates the neighbors for whatever pollution has already occurred By paying permanent damages, the factory is effectively pre-paying the neighbors for the right to pollute in the future

Temporary versus permanent damages
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 There are pros and cons to both types of damages Temporary damages require the victim to keep returning to court if the harm continues, and require the court to keep calculating the amount of damages each time, so they impose a high transaction cost However, under temporary damages, reductions in the harm itself lead to reductions in the damages owed, so the factory has an incentive to take steps to reduce pollution, or to pay the neighbors to take steps that reduce the harm on their end if this is more efficient. On the other hand, permanent damages are a one-time, permanent fix, and therefore less costly to implement But once permanent damages have been paid, the factory is not penalized for any additional harm they do (they’ve already paid for it); so there is no incentive to reduce the harm as technology makes this easier In addition, since permanent damages are based on the expected discounted value of future harm, it depends both on future technology and future prices, which cannot be predicted with accuracy So permanent damages suffer from higher error costs, that is, inefficiencies that are introduced when the amount of the compensation is incorrect.

Efficient nuisance remedies
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… So Cooter and Ulen offer the following proscription for appropriate nuisance remedies: if a nuisance affects a small number of people (private nuisance), award an injunction, and count on the parties involved to negotiate an efficient solution 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 (or costly) to measure and innovation occurs slowly, permanent damages are more efficient However, this is not what is typically done in practice With public nuisances, the remedy tends to be temporary damages (for harm already incurred) and an injunction against future harm However, there’s an interesting case that shows the court becoming more receptive to damage remedies for public nuisances, in spite of all the precedent in favor on injunctions.

Boomer v Atlantic Cement Co (NY Ct of Appeals, 1970)
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” However, there’s an interesting case that shows the court becoming more receptive to damage remedies for public nuisances, in spite of all the precedent in favor on injunctions. The case is Boomer v Atlantic Cement Co, decided in 1970 by the NY Court of Appeals Defendant owns large cement plant near Albany; along with cement, produces dirt, smoke and vibration The neighbors sued, the plant was found to be a nuisance They were awarded temporary damages, but denied an injunction against future harms Plaintiffs appealed, requesting an injunction; appeals court ruling was very interesting They agreed that yes, this was a valid nuisance And yes, nuisances are generally remedied with injunctions But in this case, the harm of forcing the plant to close so greatly outweighed the level of the damage being done that they refused to issue an injunction, and instead ordered permanent damages to be paid

Boomer v Atlantic Cement Co (NY Ct of Appeals, 1970)
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” They pointed out that the two sides could settle the issue instead through voluntary negotiations, but that “the imminent threat of closing the plant would build up the pressure on defendant…” They also pointed out that techniques to reduce dirt and vibration from the cement production process would be developed by the industry as a whole, not just by this one plant, and that these were therefore outside the defendant’s control and unlikely to occur within a short time The court had estimated the total of permanent damages to all plaintiffs to be $185,000 And the company had invested $45,000,000 in the plant and it employed 300 people So the court refused to issue the injunction. (Technically, they issued an injunction that would automatically be vacated once permanent damages to the plaintiffs were paid.) They also noted that the damages were paid as “a servitude to the land,” that is, the fact that damages had been paid attached itself to the land, not the individual plaintiffs So if these plaintiffs, having already received permanent damages, sold their property, the new owners could not sue for damages Instead, the ongoing nuisance caused by the cement company would simply be a feature of the land, and would presumably be figured into the price that they could sell it for. Permanent damages typically compensate for “all reasonably anticipated future harms.” Presumably, if Atlantic Cement in the future were to expand greatly, or adopt a much noisier or dustier process of production, these new harms would still be liable for damages; but the established level of harm had already been compensated.

Limitations/Exceptions to Property Rights

One limitation: ways to give up (or lose) property rights
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 We already asked the question, how do you establish property rights over something? Also worth asking is, how do you give up (or lose) property rights over something? One way that this can occur is Adverse Possession Suppose that you own a vacant plot of land next to my house, and decide to build yourself a house there By mistake, you build it so that it intrudes into my land by a couple of feet Now suppose that I don’t notice for a long time 15 years later, I decide to replant my garden, examine the property line, and realize you have trespassed on my property Do I still have the right to force you off my property? Or by being there for long enough, have you established a legal right to that bit of my land? Adverse possession is so named because the trespasser’s possession of the land is adverse to the owner’s own interests In such a case, if you occupy the property for a long enough time (specified by law), you gain legal rights to it; provided the occupation is adverse to the owner’s interests and the owner did not object or take legal action That is, if an owner “sleeps on his rights” and allows you to trespass, he eventually gives up his ownership.

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 Why does such a law make sense? One benefit is that, over time, it clears up any uncertainty about ownership For example, suppose you want to buy a house that was built in 1910 and sold in 1925, again in 1937, and again in 1963 When you research the title, there seems to be some confusion about whether the 1937 sale was legal However, if the current tenant has lived there since 1963 without legal challenge, he has gained legal right to the land; and so you can buy it from him without worry So by making rights unambiguous over time, these laws facilitate trade, making it easier for the property to be sold to whoever values it the most So one defense of adverse possession is that it resolves uncertainty Another defense is that it prevents valuable resources from being left idle for too long, by specifying a way for a more productive user to gain title to the resource. Of course, adverse possession also has a cost – property owners must actively monitor their land against possible trespass Now if you’re renovating your garden close to the property line, I have to keep an eye on you, to make sure you stay on your side of the boundary If you cut into my land a little, I can’t say to myself, “I’m not using that bit of land now, so I’ll let it go, and complain later if I decide I want to use it.” Thus, I incur monitoring costs, which are inefficient So whether adverse possession laws are efficient depends on whether the costs – basically, these monitoring costs – are outweighed by the benefits

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 Estray statutes – laws governing lost and found property One other way I can give up my property rights to something is to lose it Suppose you’re walking down the street and find a diamond ring Is it yours, or do you have to try to find the rightful owner? The relevant legal area is estray statutes. A typical estray rule specifies a procedure for a finder to establish ownership of lost or abandoned property If the property is above a certain value, the finder may have to go to court and document where and how he found the object The court may then place an ad in the newspaper After a certain amount of time, if the owner has not claimed the property, it belongs to the finder A finder who does not go through this process is subject to a fine. Estray rules discourage theft, by eliminating one excuse a thief could give when caught with stolen property (“i found it”) They also increase information spread about lost property, reducing the search costs of owners who lose things To the extent that the original owner is likely to value the object most, this is likely efficient.

Another limitation: determining what happens to your stuff after you die
Owners today control who inherits their property Wasn’t always the case Limitations on who inherits lead to… Circumvention costs One thing owners can typically do with their property is to determine who gets it when they die. This wasn’t always the case. In medieval England, land passed automatically to the owner’s eldest son, and changes to this could only be made under very particular circumstances Feudal and tribal societies typically specified who inherited land, and restricted the sale of land, especially to outsiders Over time, however, the trend in Western countries has been towards more freedom to specify of owners to specify who will inherit their property and what they may do with it. What effect do limitations like this have? Suppose I own some large estate, which the law says I must pass on to my eldest son when I die, but I’d prefer to give it to my daughter One thing I can do: look for ways to circumvent the rules I might be able to sell her the property now, and rent it back from her while I’m still alive There might be other technicalities that allow me to get around the intent of the law But these are likely to be somewhat costly, so I would incur what the book refers to as Circumvention Costs.

Owners today control who inherits their property Wasn’t always the case Limitations on who inherits lead to… Circumvention costs Depletion costs On the other hand, it may be too costly, or impossible, for me to give the property to my daughter; I may have to accept the fact that it will go to my lazy, worthless son In this case, I’m likely to start caring much less about the value of my estate after I am gone, which creates an incentive for me to use the property inefficiently I may choose to overhunt now, not caring whether I wipe out the animals on my land I might cut down trees prematurely, before they mature all the way, to get more use out of the land now (while I’m alive) at the expense of its future value (which I no longer care about) The book refers to the loss due to these decisions as Depletion Costs – inefficiencies I bring on because I stop caring as much about the future value of the property.

Owners today control who inherits their property Wasn’t always the case Limitations on who inherits lead to… Circumvention costs Depletion costs Restrictions I place on how they can use it Impossible  circumvention and depletion costs Allowed  difficult to maintain efficiency in changing circumstances Circumvention costs and depletion costs seem to argue in favor of giving an owner more freedom in determining what happens to his property after he dies. However, there is also a danger when this freedom is made too absolute. Suppose that the estate I own is my family’s ancestral home, and I specify in my will that nobody should ever use that land for purposes other than a residence I die, and several years later, my heirs want to turn the land into a golf course, or sell it to a developer to turn into a mall. Should this be allowed, or should the restrictions in my will be upheld? If my restrictions are routinely set aside by the law, then we return to the old problem – since I don’t have control over what will happen to my estate after I die, I have an incentive to circumvent the law or to deplete the value of the property On the other hand, if the restrictions are typically upheld, it becomes difficult to maintain efficiency as circumstances change, since my heirs may not be able to put the land to its most valuable use (or sell it to an owner who values it more). If I’m wealthy but don’t trust my childrens’ judgment, I may try to create a trust that will prevent them from accessing most of my wealth until they reach a certain age. Similarly, if I don’t trust them to use my estate wisely, I may try to put restrictions on what they can do with it.

Owners today control who inherits their property Wasn’t always the case Limitations on who inherits lead to… Circumvention costs Depletion costs Restrictions I place on how they can use it Impossible  circumvention and depletion costs Allowed  difficult to maintain efficiency in changing circumstances “Restraints on alienation” Common law generally prohibits perpetuities Restrictions limited to “lives-in-being plus 21 years” Earlier, we used the term “inalienability” to define entitlements which you are not allowed by law to get rid of Limitations on the use of property are sometimes called “restraints on alienation,” since among other things they limit an heir’s legal right to dispose of the property English common law typically imposes a time limit on such restrictions, ruling out what is referred to as a perpetuity, a restriction that would last forever Thus, I can legally restrict what happens to my property after I die for a certain length of time, but not forever. The time limit is typically defined as “lives-in-being plus 21 years,” that is, they are binding for the lifetime of my heir plus an additional 21 years. The effect of this time limit is basically to allow me to place restrictions on the next generation, but not the generation after that If I pass my estate on to my daughter, with the restriction that it not be sold or developed into for commercial uses, this limits my daughter But once she dies and passes the estate on to her children, after a certain length of time, they will be free to do what they want with it Thus, this acts as a “generation-skipping rule” – I’m free to do what I want, and the second generation after me is once again free to do what they want, but the generation in between is not. This sort of law makes a lot of sense if you assume that “most” heirs will be prudent and well-behaved, but that every once in a while someone will come along whose judgment can’t be trusted. The law protects my estate from a single bad heir, since whoever passes the property on to them can restrict them; but it does not tie up the property forever in what might eventually be an inefficient way.

Another limitation: Private Necessity
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 We said before that property rights are typically protected by injunctive relief Using another owner’s property without permission is typically considered criminal trespass When transaction costs are low, this leads to bargaining and through bargaining to efficient use of the property. However, these restrictions are not absolute We already noted there are “fair use” exceptions to copyright protection even though a copyright is a form of ownership, there are ways in which I can use others’ property legally, such as for educational purposes or in satire There are also exceptions in general property law The Supreme Court of Vermont decision established one such exception, in the case of Ploof v Putnam, decided in 1908. Ploof was sailing on Lake Champlain with his wife and two children when a storm came up very suddenly and they needed a safe harbor quickly The nearest one was on an island owned by Putnam Ploof tied his boat to a pier on the island to wait out the storm But an employee of Putnam’s worried that the boat would bang against the pier and cause damage, so he untied the boat (with Ploof and his family still aboard) and pushed it away Ploof sued, claiming that the eventual wreckage of his boat and injuries to his family were the fault of Putnam (through his employee) Ploof claimed that the emergency justified his trespassing on the defendant’s property without permission; he asked for damages Putnam answered that property owners have the right to exclude trespassers, and claimed that it was so obvious the case should not even go to trial The Vermont Supreme Court agreed with Ploof, saying that private necessity was an exception to the general rule of trespass.

Another limitation: Private Necessity
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 Thus, in an emergency, one person can use another’s property without permission, and must only compensate the owner for the cost of use So if Ploof’s boat had indeed damaged Putnam’s dock, Ploof would have had to pay to repair the dock, but would not be punished for trespassing. Similarly, a lost hiker is allowed to break into a remote cabin for food and shelter, but must pay for the damage to the cabin and whatever food he took. Other examples where private necessity justifies unauthorized use of another owner’s property breaking into a pharmacy when someone is deathly ill and the owner cannot be found using someone’s valuable vase as a weapon against a murderer. This is also similar to the rule we saw in Demsetz as property rights over land were being established among Native Americans - you could kill an animal for food on someone else’s land if you were starving, but you could not keep its valuable fur. This type of exception to the general rule of property law makes perfect sense, if we see property law as an attempt to encourage individuals to bargain over the most efficient use of property Clearly, in an emergency, there is no time for bargaining Or, transaction costs can be thought of as being prohibitively high So a damages rule is more efficient than a property rule, since it ensures that the property will be put to its most efficient use. (If Ploof had been able to find Putnam and had tried to bargain with him, Putnam would have found himself in a very strong bargaining position, and might have demanded an unreasonable amount of money Ploof might have agreed to pay it, and then tried to get out of it after the fact Once we get to contract law, we’ll discuss, among other things, the legality of contracts signed under situations like this.)

Another limitation: Inalienability
Three ways to protect an entitlement: as property (through injunction) by liability rule (through damages) through inalienability Lots of things that can’t be bought/sold: organs sex heroin Arguments in favor of inalienability… children atomic weapons human rights We mentioned earlier that entitlements can be protected in three ways: as property, by a liability rule, or through inalienability There are lots of things that cannot legally be sold, and most of them strike us as creepy to even think about in those terms: human organs, sex, heroin, children, votes, atomic weapons, and human rights In some cases, you can neither sell the entitlement nor give it away – as with the right to vote. (You can choose not to vote, but you can’t transfer your right to vote to another person.) In most cases, there is not a clear economic argument for the rule, so much as an attempt to rule out something that is seen as disgusting or immoral. The book does mention one argument for outlawing the sale of blood: that it might undermine blood donations. Most (but not all) blood in the U.S. is provided by donations, and its safety is protected by two means: a medical history given by the donor, and a lab test for infections One could imagine that a person has no reason to lie about their history when donating blood; if you were selling blood, you might choose to hide a condition that made you an unfit donor So blood might be more safely supplied by donation rather than purchase But if some places paid for blood, nobody would want to donate for free So outlawing the sale of blood might end up being efficient. In the U.S., the sale of blood is legal, but the sale of organs is not. The supply of transplantable kidneys – both from live donors and from cadavers – falls far short of the demand. There has been lots of discussion about ways to improve the system On the other hand, if people could sell kidneys, might lead to more murders…

Another limitation: Unbundling
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… Earlier in the course, we defined property as “a bundle of rights,” that is, a collection of rights that you have over the use of your property In some instances, an owner may want to unbundle these rights that is, separate them, so that he could sell some of them and hold onto others In most instances, this is not allowed – an owner may be permitted to sell the bundle as a whole, but not in pieces. Last class, we saw one situation where it isn’t permitted I can’t place permanent restrictions on how my heirs will use my property so I can’t separate the right to live on my property from the right to turn it into a golf course that is, I can’t pass on to future generations the right to own and live on the property, but keep for myself the right to determine how it’s used Similarly, the owner of a vacant lot might be able to sell it whole, but zoning restrictions may prevent him from dividing it up into smaller pieces and selling them separately However, in some instances, unbundling is permitted

Pennsylvania and coal Land ownership consisted of three separable pieces (“estates”) Surface estate Support estate Mineral estate A great example of unbundling comes from Pennsylvania Pennsylvania was largely built on coal lots of land has coal under it lots of money was made by mining this coal In Pennsylvania, as of the late 1800s and early 1900s, land ownership consisted of three separable pieces, referred to as “estates” the surface estate – the rights to use the surface of the land (build a house on it, grow corn on it, whatever) the mineral estate – the rights to whatever coal lay underneath the surface and most interestingly, the support estate – the rights to whichever parts of the underground structure are holding up the surface. If I owned the surface and support estates, I could build a house on the land and live there If you owned the mineral estate, you could mine coal from my land So now suppose I build my house, you mine for coal, but the mine weakens the rock under my house and my hosue begins to sink If I own both the surface and support estates, then you owe me damages That is, by owning the support estate, I own the right to my house not falling in On the other hand, if you owned both the mineral and support rights, you could mine the coal however you wanted Since I own the surface, I can still build a house But if the surface fell in as a result of your mining operation, I had no recourse, since I owned the surface but not the right to have it held up In this case, the “support estate” wasn’t tangible property, and had no value on its own But it made it completely clear who had the rights to do what with the property, and the three property estates could be bought and sold separately. There’s an interesting case from the 1920s, Pennsylvania Coal vs Mahon, which is discussed on the textbook website – we’ll come back to that case later today, because it’s interesting for other reasons.

Unbundling Free unbundling of property rights generally not allowed under common or civil law In general, neither the common law nor the civil law allow free unbundling and repackaging of property rights The civil law tradition is the more restrictive of the two In the civil law, the rights which come with property ownership are attached to the property itself, not to the owner so they typically cannot be separated at all. To illustrate unbundling, the book gives an example of two brothers, one of whom inherits a watch that’s a family heirloom The other brother wants to be able to wear the watch at a family Christmas party every year If unbundling of property rights were allowed, the brother could buy the “Christmas rights” to the watch, with the heir retaining all the other rights Then if the heir sold the watch, he could only sell the non-Christmas rights to it, since he did not possess the Christmas rights, and the brother would have a legitimate claim against the new owner to wear the watch on Christmas. The example helps explain why property rights generally can’t be unbundled Unbundling may hamper future trade In this case, it might be very hard for the owner of the 364-day rights to the watch to sell it, since buyers might only be interested in buying a “whole” watch. Of course, if rights could be unbundled, they could presumably be re-bundled But if they were unbundled and individual rights sold to lots of different owners, the transaction costs of rebundling might be overly high.

Unbundling Free unbundling of property rights generally not allowed under common or civil law Efficiency: allow unbundling when it increases the value of the property? But if re-bundling the rights is costly, maybe not Unbundling  uncertainty about rights  harder to trade Efficiency would generally suggest that unbundling should be allowed when it increases the value of the property But if rebundling the rights in the future would be costly, this may argue against unbundling One could also argue that unbundling leads to greater uncertainty In a world without unbundled rights, when I buy an apple, I know exactly what I’m getting In a world with total unbundling, before buying an apple, I would need to verify that the seller owns the specific rights that I want to acquire – say, the eating rights – and not just the right to carry the apple Uncertainty about rights makes trade more difficult Thus, excessive unbundling might increase transaction costs in general. Which would argue against it

Two other limitations on property rights
The government can take your property “Eminent domain” And the government can tell you what you can or can’t do with it Regulation

Takings

Takings 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 Earlier, we discussed the fact that when public goods are privately provided, they tend to be undersupplied It follows, then, that one important role of government is to provide public goods Defense; roads and other infrastructure; parks; to a certain degree, art and science; lots of public goods are, and should be, provided by the government. In order to provide these things, the government sometimes has to use land which would otherwise be private property In some cases, the government can simply negotiate with the owner to buy this land But as we’ve discussed, it’s very hard to negotiate with a large number of people at once if the government needs to buy a large area of adjoining land, which is currently owned by many different people, it may be impossible to negotiate the sale voluntarily. (As we’ve discussed, individual landowners may hold out, hoping to get inflated prices once most of the other land has already been bought up.) In most countries, the government has some right to seize private property even when the owner doesn’t wish to sell This is referred to as the right of eminent domain Not too surprisingly, this type of seizure is also called a taking

Takings 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 In the U.S., takings are limited by the Fifth Amendment to the Constitution, which attaches two conditions: private property may only be taken for public use and only be taken with just compensation “Just compensation” has consistently been interpreted to mean fair market value that is, what the owner would likely be able to sell the property for (This may be less than his subjective value for it, or the price he would voluntarily accept – too bad!)

Takings Why allow takings?
The need for a right to government takings, and the limiting of compensation to fair market value, is fairly clear Calculating someone’s subjective value directly would be impossible And allowing the owner to name his price would be the same as removing the power of eminent domain and simply requiring the government to buy property openly. In situations where many possible sites are available, this might be fine. But in a situation with only a single possible location for a valuable public good, the owner of the property could demand an unreasonable price (not because he valued the property that highly, but because he thought the government would pay it). Similarly, if lots of adjacent bits of land were required (say, to build an airport), some owners might hold out, hoping to get high prices once most of the property had been bought up. The government would then have to either fund the purchase through higher taxes (basically, redistributing wealth from all of society to one person who is already probably relatively well off since he owns property), or fail to provide a valuable public good So public goods would continue to be underprovided, which is the situation we were trying to avoid. So the rationale for allowing takings, and limiting compensation to fair market value, is pretty clear

Takings Why allow takings? Why these limitations?
why require compensation? The two limitations on government takings – that the government can only seize private property for public use, and only with compensation – seem to agree with some notion of fairness. But they also serve another purpose – to discourage the government from abusing this power If the government could seize private property without compensation, this would give it another way (besides taxes) to finance itself Uncompensated takings would function like taxes targeted at specific individuals But we come back to the general principle that the more narrow a tax is, the more distortion it causes, because people will go to greater lengths to avoid paying the tax, which makes it inefficient The more broad a tax is, the less distortion it causes, and therefore the less inefficiency. So the government should be discouraged from using takings as a source of financing, which is ruled out by requiring compensation. (If compensation were not required, this would lead people to take costly actions to make their property less attractive to the government That is, if the government were looking for a suitable place to build a park, people who lived in attractive locations might start cutting down their own trees, or spilling chemicals on their lawn, to make sure that the government didn’t go after their property. Uncompensated takings would also encourage corruption, as owners would be willing to pay large amounts of money to influence the government’s choice of which property to seize If people value their own property more highly than “fair market value,” this type of corruption is still a risk with compensated takings, but on a much smaller scale.)

why require compensation? $10 MM Posner, in “Economic Analysis of Law,” makes the additional point that if compensation were not required, the government might substitute land, which it could get for free, for other inputs, which are cheaper than land in reality, but more expensive to the government He gives an example Suppose the government has two ways to provide the same public good: It can buy a large plot of land, and build a short, wide building Or it can buy a small plot of land, and build a narrow, tall building Suppose The market value of the large lot is $3 million, and the small lot is $1 million The short wide building costs $9 million to build, and the tall narrow building costs $10 million In social costs, the short wide building costs $12 million and the tall narrow one $11 million, so society is better off with the tall narrow one But if the government can seize private land without compensation, than land appears free to the government And if land is free, then the government might choose to seize the larger lot and build the short, wide building. $9 MM $3 MM $1 MM

why require compensation? why only for public use? The restriction of takings to be only for public use similarly discourages the government from abusing this power Suppose I own a home, which has a fair market value of $100,000 But I’ve lived there a long time and grown accustomed to it and value it at twice that much. Along comes a developer who wants to build something else on my land, and values the land at $150,000 Clearly, selling my land to the developer is not efficient, and would not occur on its own But if the government could take private land for any purpose, it could force me to sell for $100,000, then turn around and sell the land to the developer for $150,000, keeping the difference Or it could simply force me to sell to the developer for $100,000, in which case the developer would obviously be willing to go to great lengths (such as paying any sum up to $50,000) to make this happen. The whole notion of Coase was that we should let people negotiate on their own to reach efficiency; by making transactions involuntary Takings go outside this framework, and so should only be used as a solution to a clear problem, such as the provision of private goods.

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 Aside from the possibility of forcing a trade that isn’t efficient, there is another reason overuse of takings is undesirable: it creates uncertainty We said before that when property rights are clearly enumerated and unambiguous, this effectively lowers transaction costs and helps people bargain to efficient outcomes On the other hand, if government takings were very common, this would create a great deal of uncertainty if you’re considering whether to buy new property, you don’t know whether you will get the full benefit of it, or whether it will instead get seized by the government This may make it harder to transfer property to the owner who values it most (We’ll come back to this point.) Given the potential for abuse, and the negative effects caused by uncertainty when takings are overused, Cooter and Ulen suggest the principle that governments should only rely on takings when they cannot be avoided That is, “the government should only take private property (with compensation) to provide a public good when transaction costs preclude purchasing the necessary property.”

Poletown Neighborhood Council v Detroit
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) The “just compensation” restriction on takings is fairly uncontroversial There may sometimes be difficulty in calculating fair market value But there is little conceptual doubt over what it should represent However, the “public use” restriction has come under debate in recent years. The last question on the homework is about one such case, Poletown Neighborhood Council versus City of Detroit In short, in 1981, GM was threatening to close an auto plant in Detroit and move to another state unless it could relocate the plant to an improved site The city of Detroit, which had already lost one auto plant recently, was worried about the loss of 6,000 jobs and millions of dollars in tax revenue The city used eminent domain to condemn an entire neighborhood, Poletown, forcing over 1000 houses and 100 businesses to sell their land, which was used for an upgraded, modern plant for GM The city defended the use of eminent domain, saying that employment for its residents, and tax revenues, were public goods which justified its use. The Michigan Supreme Court ruled for Detroit, saying the taking was legal – that “alleviating unemployment and revitalizing the economic base of the community” were valid public purposes, and that “the benefit to a private interest is merely incidental.” The decision was overturned much later in a 2004 ruling by the Michigan Supreme Court, County of Wayne v Hathcock But a similar case in Connecticut, Kelo v City of New London, was decided by the US Supreme Court in 2005, also in favor of the use of eminent domain.

Poletown Neighborhood Council v Detroit
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) In Kelo, quoting Posner, “the pharmaceutical company Pfizer had decided to build a large research facility next to a 90-acre stretch of downtown and waterfront property in New London. The city hoped that Pfizer’s presence would attract other businesses to the neighborhood. The plaintiffs owned residential properties located on portions of the 90-acre tract that the city’s redevelopment plan earmarked for office space and parking. It might have been impossible to develop those areas for these uses had the areas remained spotted with houses… The city… solved the problem by condemning the houses [seizing them]. It said, “the area [of the redevelopment project] was sufficiently distressed to justify a program of economic rejuvenation.” (Posner criticizes the court’s own logic behind its ruling, but offers what he sees as a better argument: that the more limitations are placed on the private use of seized land, the more the government itself would become a developer, which would be inefficient.) Since it’s a homework problem, I don’t want to say too much more about these cases On the one hand, higher unemployment weakens the local economy, may lead to an increase in crime and other problems that affect everyone, and hence can be seen as public bads On the other hand, as Dana Berliner, an attorney arguing the Kelo case, said, "If jobs and taxes can be a justification for taking someone's home or business, then no property in America is safe. Anyone's home can create more jobs, if it is replaced by a business and any small business can generate greater taxes if replaced by a bigger one." The dissenting opinions in both Poletown and Kelo are similarly dire.

Regulation

Regulation Separate from its takings power, the government has widespread power to regulate (limit) the uses of property. We mentioned earlier that one way to supply clean air (a public good) was to have air quality standards determined and enforced by the government Similarly, most cities have zoning laws, which might prohibit industrial land use in residential areas, in order to avoid noise, pollution, and other nuisances. Of course, a regulation is a limitation on what you can do with your property, so it may change the value you get from your property A U.S. Supreme Court case decided in 1922 established that under certain circumstances, a regulation could diminish the value of your property so much that it would be considered a taking, and would therefore require compensation.

Regulation: Pennsylvania Coal v. Mahon
1800s: PA Coal purchased mineral and support estates, Mahon owned surface 1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.” PA Coal sued government, claiming the regulation was same as seizing their land (without compensation) “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” surface estate support estate mineral estate The case was one that came up earlier today, when we discussed the unbundling of property rights: Pennsylvania Coal Company v Mahon. Recall that land rights in Pennsylvania consisted of three separable pieces: surface, support, and mineral. In the late 1800s, Pennsylvania Coal Company purchased both mineral and support rights to a piece of land, while Mahon owned surface rights. Much later, in 1921, the Pennsylvania legislature passed the Kohler Act, which prohibited “the mining of anthracite coal in such way as to cause the subsidence of, among other things, any structure used as a human habitation.” Pennsylvania Coal Company sued the government, claiming that the new regulation destroyed the value of its property by preventing the mining of the coal, and that the new law was therefore a taking and required compensation. The lower court sided with the government, but the Supreme Court sided with Pennsylvania Coal. Oliver Wendall Holmes wrote the majority opinion: What makes the right to mine coal valuable is that it can be exercised with profit. To make it commercially impracticable to mine certain coal has very nearly the same effect for constitutional purposes as appropriating or destroying it. This we think that we are warranted in assuming that the statute does. … The general rule at least is, that while property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.

1800s: PA Coal purchased mineral and support estates, Mahon owned surface 1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.” PA Coal sued government, claiming the regulation was same as seizing their land (without compensation) “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” surface estate support estate mineral estate Up until then, an action was only considered a taking if the government took physical possession of the property Pennsylvania Coal was the first recognition of a regulatory taking That is, a situation where the government removed the value of property through regulation, which would also require compensation under circumstances Holmes wrote that regulation that “goes too far” constitutes a taking, but never defines what “goes too far” means (SKIP THIS: And from the dissent, by Louis Brandeis: Every restriction upon the use of property imposed in the exercise of the police power deprives the owner of some right theretofore enjoyed, and is, in that sense, an abridgment by the States of rights in property without making compensation. But restriction imposed to protect the public health, safety or morals from dangers threatened is not a taking. The restriction here in question is merely the prohibition of a noxious use. The property so restricted remains in the possession of its owner. The State does not appropriate it or make any use of it. The State merely prevents the owner from making a use which interferes with paramount rights of the public.)

1800s: PA Coal purchased mineral and support estates, Mahon owned surface 1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.” PA Coal sued government, claiming the regulation was same as seizing their land (without compensation) “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” surface estate support estate mineral estate There is an interesting backstory behind the Pennsylvania Coal case. Cooter and Ulen cite a book by William Fischel, Regulatory Takings: Law, Economics, and Politics. Fischel investigated the circumstances leading up to the passage of the Pennsylvania regulation, and found that at that time, even when they owned both the mineral and support rights, coal companies in Pennsylvania tended to take care of the damage they caused. Quoting from the book: The coal companies and the citizens of Scranton were neighbors; some were employers; many were employees; and social contacts among them were, and long had been, frequent. Even if the companies had retained subsurface rights and landowners had waived their right to claims for subsidence damages, as was frequently the case, there was the strong likelihood of hard feelings among surface owners towards the coal companies, and those feelings would interfere with employment and other on-going social relationships. Long before Pennsylvania Coal and the Kohler Act, the very practical necessity of maintaining good public relations led the coal companies to adopt a policy of routinely repairing surface damage caused by their subsurface mining, regardless of the contractual assignment of liability. According to a retired executive of the Pennsylvania Coal Company to whom Fischel spoke, “[I]f the company caused subsidence to any surface structure, it sent a crew up to fix the damage, at company expense. It did not matter to whom the right of support belonged, although it typically belonged to the company.”

1800s: PA Coal purchased mineral and support estates, Mahon owned surface 1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.” PA Coal sued government, claiming the regulation was same as seizing their land (without compensation) “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” surface estate support estate mineral estate Fischel then wondered why the legislature bothered to pass the law, given that its goals were already being met He found that there had been recent developments in mining technology, which the court apparently feared might disrupt the status quo In addition, one local mining company had recently gone bankrupt and had therefore not repaired the damage it had done The Kohler Act was coupled with another bill imposing a tax on coal companies, which would be used to repair the damage already done by the bankrupt firm Part of Pennsylvania Coal’s objection, then, was not even to the regulation itself, but to being forced to pay for another company’s damage when they were already voluntarily paying for their own. (Fischel’s thesis, BTW, is that regulatory takings should only be compensated when they stem from local government, not from state or federal regulations He feels that compensation for regulatory takings should only be required to discourage excessive or inefficient regulation; which he argues is unlikely to occur at the federal or state level, but a legitimate risk at the local level. He also argues that immovability of the property, or inelasticity of its supply, should also be necessary for compensation to be required, since with movable property, the owner could simply relocate to avoid the effect of the regulation. There’s more in the textbook website, if you’re interested.)

Blume and Rubinfeld, “Compensation for Takings: An Economic Analysis”
Support compensation for regulatory takings Shifting burden of regulation from owners of affected property to all taxpayers Equivalent to selling everyone insurance against harmful regulation If such insurance were available, people would buy it But it’s not available, so government should provide it The article by Blume and Rubinfeld, “Compensation for Takings: An Economic Analysis,” gives an interesting argument in favor of requiring compensation for regulatory takings. They point out that compensation is basically just shifting the burden of the regulation’s cost from a narrow base (the owners of the affected property) to a broader base (all the taxpayers). Ordinarily, these are simply zero-sum transfers, and so they wouldn’t matter from an efficiency point of view However, if we allow for the possibility that people are risk-averse, then requiring compensation after the fact is the same as providing an insurance policy against harmful regulation. Blume and Rubinfeld argue that, if insurance against regulatory harm were made available at fair prices, people would probably buy it However, privately-supplied insurance against regulatory harm does not exist; and Blume and Rubinfeld argue it cannot exist, for the usual reasons of market failure in insurance markets: adverse selection and moral hazard If an insurance company offered such insurance, it would have to worry that it would only sell policies to people who had inside information about the likelihood of regulation or that after buying insurance, owners would be less likely to lobby against regulation that would harm them So such insurance, even though it would be beneficial, is not provided by the market.

Support compensation for regulatory takings Shifting burden of regulation from owners of affected property to all taxpayers Equivalent to selling everyone insurance against harmful regulation If such insurance were available, people would buy it But it’s not available, so government should provide it But requiring regulatory takings to be compensated is a way for the government to provide exactly this type of insurance. By compensating owners after the fact when the harm actually occurs, the government would be spreading the cost of the regulation over everyone, rather than forcing it to be borne only by the person directly affected. Looked at from an ex-ante point of view (before the harm occurs), this is identical to selling everyone fair insurance against regulatory harm Of course, the compensation would have to be funded through taxes, and taxes are somewhat distortive; but broad-based taxes are less distortive and harmful than narrow ones, so spreading the cost over everyone causes less distortion (less inefficiency) than having it borne by few Blume and Rubinfeld justify compensation for regulatory takings by focusing on risk aversion, but there is also another way for regulatory uncertainty to be harmful, which we mentioned earlier The possibility of uncompensated regulation leads to uncertainty about the future value of property. This uncertainty may hamper trade, that is, the uncertainty may make it harder to negotiate the sale of property to the owner who values it most, since the possibility of unfavorable regulation may make the two sides uncertain about each others’ threat points during bargaining. Again, by providing insurance against adverse regulation, the government would be reducing the uncertainty over the property’s value, which would encourage it to be traded to the owner who could put it to most valuable use.

Support compensation for regulatory takings Shifting burden of regulation from owners of affected property to all taxpayers Equivalent to selling everyone insurance against harmful regulation If such insurance were available, people would buy it But it’s not available, so government should provide it EXAMPLE. You own a house you valued at H, wealth of W, a concave utility function u, and face a probability p that a new regulation will reduce the value of your house to H’ < H So your expected utility is (1-p) u(H + W) + p u(H’ + W) Now suppose someone offered you insurance against the regulation. You would pay an up-front premium of qa, and receive a payment of a in the event the regulation passed. Would you choose to buy insurance, and how much? If you chose to buy an insurance policy worth a, your expected utility would now be (1-p) u(H + W – qa) + p u(H’ + W – qa + a) Suppose the insurance was actuarily fair – that is, q = p, so the insurance company is just breaking even on average. Then your expected utility, as a function of a, would be (1-p) u(H + W – pa) + p u(H’ + W – pa + a) or (1-p) u(H + W – pa) + p u(H’ + W + (1-p)a) We can find a to maximize expected utility by taking the derivative and setting it to 0: – (1-p) p u’(H + W – pa) + p (1-p) u’(H’ + W + (1-p)a ) = 0 or, dropping p(1-p), u’(H + W – pa) = u’(H’ + W + (1-p)a) If u is concave, u’ is decreasing, so setting these equal requires H + W – pa = H’ + W + (1-p) a  H + W = H’ + W + a, or a = H – H’ So if the insurance comes at a fair price and you were risk-averse, you would choose to buy full insurance – you would buy insurance to cover the full value of the risk (If q > p – if the insurance company was intending to make a profit – you would buy less than full insurance; but if q is not too much bigger than p, you might still choose to buy some insurance, just not insure all the way.)

More on regulation Zoning laws
Distinguish industrial areas from residential areas We mentioned earlier another restriction on property rights – zoning laws These are a specific type of regulation separating industrial property from residential property You could imagine that a single plot of land might be worth more to a factory than to a homeowner, but that the nuisance this would create to the neighboring residences (dust, noise, whatever) would make locating the factory their socially inefficient So a single homeowner selling his land to a factory would impose a negative externality on his neighbors Zoning laws rule out this type of situation Zoning laws also allow a legislature to deliberately plan or alter the way a town is organized For example, as shipping by boat becomes less important to a town’s economy, they might choose to redevelop a large area of waterfront property away from industrial uses and into residences or public space. These transitions might not occur without governmental encouragement, not because they are inefficient, but because nobody would want to be the first to move That is, nobody wants to be the only resident in an industrial space, because it would have a terrible view until all the land was converted, and might be far from supermarkets and other residential amenities By changing the zoning, the town ensures that people expect the area to become largely residential, and therefore people are willing to move in

Distinguish industrial areas from residential areas Nollan v California Coastal Commission (US Sup Ct, 1987) Nollans owned coastal property Asked for permit to expand building, which would diminish view Commission: donate a public walking path, and you get permit Supreme Court: such a deal only legal if there is clear connection – a nexus – between the harm being done and the remedy Finally, I’ll mention a 1987 Supreme Court ruling, Nollan v. California Coastal Commission. The California Coastal Commission is tasked with keeping the California coast looking nice and not allowing it to be spoiled by overdevelopment The Nollans owned some property along the coast, and had a small beachfront bungalow They asked the Commission for a permit to expand the building This would diminish the view of the coast from the road, which the Commission wanted to preserve, so they could have simply said no Instead, however, the Commission made the following offer: donate a public walking path along the beach, and you can have your permit It’s not uncommon for developers to donate land for public use in exchange for permits. However, the Nollans instead chose to sue the Commission. The court, by a vote of 5 to 4, ruled for Nollan. Basically, they said that such a deal was only legal if there was a clear connection – a nexus – between the harm being done (the reduction in the view) and the remedy (the beach path) If the Commission had asked Nollan for something specifically intended to mitigate the harm – a walking path to a point clear of the house to see the original view, for instance – this would have been fine But without such a connection, the walking path was an illegal taking.

Distinguish industrial areas from residential areas Nollan v California Coastal Commission (US Sup Ct, 1987) Nollans owned coastal property Asked for permit to expand building, which would diminish view Commission: donate a public walking path, and you get permit Supreme Court: such a deal only legal if there is clear connection – a nexus – between the harm being done and the remedy The logic here is interesting. It was within the Commission’s power to deny the permit; so all they were doing was offering an outcome that Pareto-dominated that – you get your house, we get our walking path However, allowing this sort of trading – allowing arbitrary “offsets” to counter regulation – would give the Commission an incentive to enact lots of regulations, just to force property owners to give something up to be exempted from the regulation. Of course, there’s nothing wrong with allowing an owner to mitigate the harm he was doing, and thus to satisfy the regulation that way; but the court required a clear connection (again, a nexus) between the harm and the remedy, in order to discourage the abuse of regulatory power. (Cooter and Ulen make the case that by forbidding a Pareto-improving exchange, the court went too far, and could have discouraged abuse in other ways. They suggest the Court could have given the Nollans the choice between remedying the harm (doing something to improve the view) or creating this unrelated benefit to offset the harm; this would still discourage abuse of regulatory power, but leave both sides better off.)

Property law: the big-picture question
What are benefits and costs of… having property rights at all? expanding property rights to cover more things? introducing an exception/limitation to property rights? When will benefits outweigh the costs? To sum up our approach to property law, nearly all the analysis we’ve done has boiled down to two related questions What are the benefits, and what are the costs, of… Having a system of property rights in place at all? Expanding those rights to cover more goods, or more rights? And introducing an exception or a limitation to these rights? And in each case, under what conditions are the benefits likely to outweigh the costs? And with that, I’ll draw a big horizontal line through the page, and say… End of material on first midterm Up next: contract law HW1 due Friday, 5 p.m.

Econ 522 Economics of Law Dan Quint Spring 2010 Lecture 8.

Similar presentations

Presentation on theme: "Econ 522 Economics of Law Dan Quint Spring 2010 Lecture 8."— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

Econ 522 Economics of Law Dan Quint Spring 2010 Lecture 8.

Similar presentations

Presentation on theme: "Econ 522 Economics of Law Dan Quint Spring 2010 Lecture 8."— Presentation transcript:

Similar presentations

About project

Feedback