Econ 522 – Lecture 8 (February 12 2009)
Tuesday, we discussed
 Three types of public ownership
 Ways in which property rights are established, verified, and lost
 Limitations on property rights
o laws against perpetuities (the inability to permanently restrict your heirs)
o rights to use others’ property in an emergency
o inalienability (the inability to sell something)
Today, we’ll wrap up property law with
 A couple more ways in which property rights are limited
o Unbundling
o Eminent domain/takings
o Regulation
 And a return to remedies when property rights are violated
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One more example of limitations to property rights: Unbundling
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
o 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.
A great example of unbundling comes from Pennsylvania
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Pennsylvania was largely built on coal
o lots of land has coal under it
o lots of money was made by mining this coal
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In Pennsylvania, as of the late 1800s and early 1900s, land ownership consisted of
three separable pieces, referred to as “estates”
o the surface estate – the rights to use the surface of the land (build a house
on it, grow corn on it, whatever)
o the mineral estate – the rights to whatever coal lay underneath the surface
o and most interestingly, the support estate – the rights to whichever parts
of the underground structure are holding up the surface.
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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, but if my
house began to sink, it was your fault and you owed me damages
That is, by owning the support estate, I had the right to my house not falling in.
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On the other hand, if you owned both the mineral and support rights, you could
mine the coal however you wanted
If I owned the surface, I could 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
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.
(I don’t think the support estate had any value on its own.)
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.
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Land in Pennsylvania is one example where an unbundling of rights was allowed
 But there are also many instances when unbundling is not permitted
 On Tuesday, we saw one situation where it isn’t permitted
o I can’t place permanent restrictions on how my heirs will use my
property
o so I can’t separate the right to live on my property from the right to turn it
into a golf course
o 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
o 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
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.
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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.
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The example helps explain why property rights generally can’t be unbundled
o Unbundling creates uncertainty that may hamper future trade
o 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.
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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.
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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
o In a world without unbundled rights, when I buy an apple, I know exactly
what I’m getting
o 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
o Thus, excessive unbundling might increase transaction costs in general.
o Which would argue against it
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Next, on to remedies for Violations of Property Rights
(This is partly a review of the Calabresi and Melamed material we saw earlier)
The book made the case earlier that the common law roughly approximates a legal
system 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.
o (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
o the court does not need to go through the exercise of calculating damages
o and the clear enumeration of property rights will hopefully encourage the
neighbors to reach an efficient outcome by bargaining.
o (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
o Damages cause the factory to internalize the externality – that is, the
cost to the neighbors becomes a private cost to the factory
o But the factory can still choose to accept this cost and continue polluting
when this is efficient
o (With high transaction costs, an injunction would likely force the factory
to stop polluting, which may not be efficient.)
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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
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(We’ll come back to other types of damages later on, in contract and tort law)
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Compensatory damages can be either temporary or permanent
o Temporary damages compensate for harms that have already occurred.
o Permanent damages compensate in addition for the present discounted
value of harm that is expected to be done in the future
o By paying temporary damages, a factory compensates the neighbors for
whatever pollution has already occurred
o By paying permanent damages, the factory is effectively pre-paying the
neighbors for the right to pollute in the future
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.
So Cooter and Ulen offer the following proscription for appropriate nuisance remedies:
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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
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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.
The case is Boomer v Atlantic Cement Co, decided in 1970 by the NY Court of
Appeals
 Defendant owns a large cement plant near Albany, which, along with cement,
produces dirt, smoke and vibration
 The neighbors sued, the plant was found to be a nuisance, and they were awarded
temporary damages, but denied an injunction against future harms
 Plaintiffs appealed, requesting an injunction.
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The 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
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.
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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.
Next, Takings.
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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
o 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.
o (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
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This is referred to as the right of eminent domain
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Not too surprisingly, this type of seizure is also called a taking
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In the U.S., takings are limited by the Fifth Amendment to the Constitution,
which attaches two conditions:
o private property may only be taken for public use
o and only be taken with just compensation
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“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!)
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.
o In situations where many possible sites are available, this might be fine.
o 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.
o 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
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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
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If the government could seize private property without compensation, this would
give it another way (besides taxes) to finance itself
o Uncompensated takings would function like taxes targeted at specific
individuals
o 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
o The more broad a tax is, the less distortion it causes, and therefore the less
inefficiency.
o 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.)
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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
o He gives an example
o Suppose the government has a choice of putting up a tall but narrow
building on a small lot, and a short but wide building on a large lot
o The market value of the small lot is $1 million, and of the large lot $3
million
o The tall narrow building costs $10 million to build and the short wide one
$9 million
o 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
o But if land is free to the government, it might seize the larger lot and build
the short, wide building.
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The restriction of takings to be only for public use similarly discourages the
government from abusing this power
o Suppose I own a home, which has a fair market value of $100,000
o But I’ve lived there a long time and grown accustomed to it and value it at
twice that much.
o Along comes a developer who wants to build something else on my land,
and values the land at $150,000
o Clearly, selling my land to the developer is not efficient, and would not
occur on its own
o 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
o 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.
o The whole notion of Coase was that we should let people negotiate on
their own to reach efficiency; by making transactions involuntary
o 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.
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Aside from the possibility of forcing a trade that isn’t efficient, there is another
reason overuse of takings is undesirable: it creates uncertainty
o We said before that when property rights are clearly enumerated and
unambiguous, this effectively lowers transaction costs and helps people
bargain to efficient outcomes
o 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
o This may make it harder to transfer property to the owner who values it
most
o (We’ll come back to this point.)
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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, in their words, “the government should only take private property
with compensation to provide a public good when transaction costs preclude
purchasing the necessary property.”
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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.
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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.
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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.”
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(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.)
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Since it’s a homework problem, I don’t want to say too much more about these
cases
o 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
o 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."
o The dissenting opinions in both Poletown and Kelo are similarly dire.
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.
The case was one that came up earlier in the week, 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:
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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.
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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.)
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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.”
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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.)
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The article by Blume and Rubinfeld, “Compensation for Takings: An Economic
Analysis,” gives an interesting argument in favor of requiring compensation for
regulatory takings.
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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
Since it’s not available, he argues, the government should supply it, by
compensating regulatory takings
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),
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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.)
So Blume and Rubinfeld point out that, if you faced the uncertain prospect of regulation
that would affect the value of your property, and if you were offered actuarily-fair
insurance against that risk, you would probably choose to 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.
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
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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.
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
o 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.
o These transitions might not occur without governmental encouragement,
not because they are inefficient, but because nobody would want to be the
first to move
o 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
o By changing the zoning, the town ensures that people expect the area to
become largely residential, and therefore people are willing to move in
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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.
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.)
And that’s it for property law.
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(We ran out of time, but here’s) A very short recap of everything we’ve done on
property law...
We began with the question: why do we need property rights in the first place?
(without property rights that are well-defined and enforced, people waste resources
stealing from each other, or overuse common resources, which is inefficient)
Coase – without transaction costs, initial allocation of property rights doesn’t matter, only
that they’re well-defined and tradable, as private bargaining will lead to efficiency.
What are transaction costs?
Two different normative views of the legal system: legal system should aim to minimize
transaction costs (“lubricate” private exchange, a la the normative Coase), since if we
make them low enough, efficiency follows; or, legal system should aim to allocate
property efficiently (the normative Hobbes) so that less is lost when private exchange
fails
What things can be privately owned?
 Public vs private goods. General principle: private goods should be privately
owned, public goods should be publicly owned/provided/regulated
 We expect private ownership to begin when costs of boundary maintenance are
smaller than losses due to overuse of common resources
o Demsetz: fur trade made furs more valuable and caused overhunting, so
loss due to overuse went up, leading Native Americans to develop private
land rights
o Another neat theory is mentioned in the Friedman book: “we owe
civilization to the dogs:” when dogs were domesticated, they could be
trained to recognize their owner’s land and guard it, and so private
ownership of farmland became feasible because the cost of boundary
maintenance went down
 Property rights over information – patents (to create incentive to innovate),
copyrights (to encourage the supply of a public good)
 Different types of public ownership (common access vs regulation vs unanimous
consent)
What can (or can’t) an owner do with their property?
 General principle: maximum liberty
 Nuisances, public and private nuisances
 Rules against perpetuities – an owner can’t restrict heirs indefinitely (but can for
one generation)
 Emergency exception to rules against trespass
 Inalienability – there are some entitlements that you can’t sell (or even give away)
 Can’t always unbundle property rights (but can in some instances, for example
with land in Pennsylvania, and with conservation easements in some locations)
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How are property rights established?
 Fugitive property – paradigms of first possession and tied ownership
o first possession tends to be simpler to implement, but causes resources to
be wasted in trying to gain possession
o example of this: Friedman on Homestead Act, saying that the resources
wasted in starting to farm before it was efficient basically wasted much of
the value of the land (p. 120 in Law’s Order)
 First possession versus tied ownership is one example of the general tradeoff
between simple, “bright line” rules versus more complex rules that might be more
costly to implement but create better incentives – Pierson vs Post, whaling
 Verifying legal ownership (property deeds and car titles), acquiring title
 Losing property rights – adverse possession, estray rules
 Government’s rights to claim private property – eminent domain/takings,
limitations (public use, just compensation); regulatory takings, abuse of takings
What remedies are available when property rights are violated?
 injunctions vs damages – injunctions simpler (cheaper) to implement, create
bright-line property rights to encourage bargaining; damages more efficient when
transaction costs are high (bargaining unlikely to succeed)
 temporary versus permanent damages – temporary damages more efficient when
damages are easy to calculate and technology is changing; permanent damages
are more efficient when damages are hard to calculate and technology is stable
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