How do legal institutions interact with economic outcomes? I think it’s fair to say that legal institutions often don’t register on economists’ radars, mainly because life is simpler when you assume the law is exogenously determined by factors beyond your control.
While such assumptions are valid for many types of economic analysis, legal institutions are not exogenously determined factors, at least in the long-run. By engaging with legal institutions, economists may be able to identify ways they could be improved. Of course reforms of legal institutions are slow to implement, but they do occasionally happen. Recent amendments to the RMA being a case in point. By engaging with legal institutions, economists can improve our analyses and help to identify possible opportunities for reform = Win-win.
The high-level question I want to answer in this post is whether these powers help or hinder urban development. My interest in these matters was prompted by the Productivity Commission’s recommendation for Auckland to establish an Urban Development Authority (UDA) with powers of compulsory purchase. That is, the UDA should have the power to expropriate privately-held property for the purposes of urban development. I think it’s fair to say the idea of an UDA with compulsory powers of purchase has attracted interest from across the political spectrum, including the Government (source).
In this post I consider why government’s need powers of compulsory purchase and, second, how should such powers be exercised. This post does not present conclusions or recommendations, mainly because I haven’t formed many yet. Instead, it seeks to identify some relevant economic and legal literature as a means of stimulating discussion.
I welcome your comments: Do you think Auckland needs an UDA and, if so, then should the UDA have powers of compulsory purchase? If yes, then what are the potential risks and how would you mitigate them? I’d also be keen to hear about possible alternatives. Enjoy.
Reference: The post that follows draws on an academic paper I am writing about government powers of compulsory purchase. In the interests of avoiding academic self-plagiarism, I should mention that the paper was written first, while this post was written second.
The historical development of most cities has been significantly influenced by government interventions. The Eixample of Barcelona, the boulevards of Paris, and the highways of New York are all noteworthy examples of government interventions that have left large and permanent marks on the affected cities.
The powers of compulsory purchase governments use to appropriate private property in order to undertake these interventions is a perennially controversial topic. One U.S. presidential candidate, for example, recently described powers of compulsory purchase as: “… absolute necessity for a country, for our country. Without it, you wouldn’t have roads, you wouldn’t have hospitals, you wouldn’t have anything.” (Team Fix, 2016). In contrast to this effusive support, Justice O’Connor’s dissenting opinion in Kelo v. City of New London argued that contemporary legal interpretations of the scope of the powers mean “Any property may now be taken for the benefit of another private party … beneficiaries are likely to be those citizens with disproportionate influence and power …” (O’Connor, 2005).
Given these divergent views, there would seem to be value in developing a clear understanding of the economic evidence on which the powers are based, certainly before we expand the number of government institutions that have recourse to these powers. In particular, I think there is a need to understand why governments need powers of compulsory purchase and how they should be exercised. The standard economic justification for the powers is that — in their absence — information asymmetries gives market power to landowners, leading to hold-out problems. This is where landowners refuse to sell so as to capture surplus associated with the government’s investment. By annulling landowners’ market power, compulsory purchase avoids hold-out problems and enables efficient levels of government investment. It’s important to note that private actors seeking to assemble property don’t face the same issues, mainly because they can negotiate anonymously to buy properties via third-parties.
Exercising powers of compulsory purchase is not without economic costs. Perhaps the most notable costs arise from involuntary transfers of property, which may result in welfare losses for affected landowners. To counter this issue, most jurisdictions require governments to demonstrate that the proposed intervention is in the public interest, and to pay adequate compensation to affected landowners. These legal requirements give rise to two additional economic questions: How should we define “adequate compensation” and “public interest”?
Neither definition is as straightforward as it first appears. Most jurisdictions define adequate compensation using market prices. Some scholars argue the value of property to its current owners, however, includes idiosyncratic attributes, such as sentimental attachment, which are not reflected in market prices (Nadler and Diamond, 2008). Other scholars argue that these idiosyncratic attributes are already accounted for in market prices, while noting that the landowner’s loss of autonomy is not (Lee, 2013).
Definitions of public use are similarly complex. In the U.S. the definition of public use has even been broadened to include wider economic impacts arising from private activities. Under this definition, governments have been allowed to use powers of compulsory purchase to appropriate private property, which is then transferred to private third-parties. The aforementioned opinion by Justice O’Connor in Kelo v. City of New London was prompted by precisely such a situation. Even where the resulting asset is publicly-owned, there are many situations where public access is restricted, for example by user-charges and/or regulations, which are on the surface not readily distinguished from private ownership. From an initial survey, the economics literature doesn’t seem to have a good answer to the question of how one defines “public use”.
Finally, the processes involved in determining adequate compensation and demonstrating public interest may generate non-trivial transaction costs. Imagine, for example, the resource cost of the recent Unitary Plan hearings, where many highly-skilled, well-paid people were paid to sit in a room for months if not years. Is it possible that the transaction costs involved in a particular legal process outweigh its benefits? I think so. At the very least, there seems to be a need to understand potential interactions between legal processes and transaction costs. It may, for example, be more efficient to offer more compensation early in the process, so as avoid transaction costs downstream.
Answers to such questions are not a trivial academic exercise. Evidence also suggests that protection of property rights affects the incentives facing governments and citizens alike, and impacts on long-run economic development (Acemoglu and Robinson, 2005). Powers of compulsory purchase may also have implications for social justice, with some studies finding that land owned by low-income households is more likely to be taken (Carpenter and Ross, 2009). Recent experiences in Auckland, whereby wealthy neighbourhoods successfully opposed the proposed Eastern Motorway across Hobson Bay, provide some indication of why such patterns may emerge. In the U.S., scepticism over the use of powers of compulsory purchase has given rise to significant opposition from across the political spectrum.
Initially simple questions are, upon closer inspection, revealed to be anything but. Understanding why governments need powers of compulsory inspection, and how these powers should be exercised, can contribute to more informed policies on Urban Development Authorities.
Of course, this doesn’t mean that I’m opposed to an UDA having powers of compulsory purchase. Personally, I’ve always been attracted to the notion of a “New Zealand Place-Making Authority” (NZPA) to counter-balance the NZTA’s movement focus on movement. I think the potential benefits could be significant. Nonetheless, the powers such an institution should have is an open-question.
Gnawing in the back of my mind is the fact that powers of compulsory purchase have in the past been used to pursue questionable outcomes. The highways of New York promulgated by Robert Moses, for example, were justified under the auspices of slum clearances. One of the great urban thinkers of our time, namely Jane Jacobs, was spurred into action by a government body wielding powers of compulsory purchase. Would ignoring the risk such things happen again be indicative of the “fatal conceit”?
Acemoglu, D. and Johnson, S. (2005). Unbundling Institutions Daron Acemoglu and Simon Johnson. Journal of Political Economy, 113(5):949–995.
Carpenter, D. M. and Ross, J. K. (2009). Testing O’Connor and Thomas: Does the Use of Eminent Domain Target Poor and Minority Communities? Urban Studies, 46(11):2447– 2461.
Nadler, J. and Diamond, S. S. (2008). Eminent Domain and the Psychology of Property Rights: Proposed Use, Subjective Attachment, and Taker Identity. Journal of Empirical Legal Studies, 5(4):713–749.
O’Connor, J. (2005). KELO V. NEW LONDON (04-108) 545 U.S. 469 (2005).
Team Fix (2016). Transcript of the New Hampshire GOP debate, annotated.
Blume, L., Rubinfeld, D., and Shapiro, P. (1984). The Taking of Land: When Should Compensation be Paid? The Quarterly Journal of Economics, 99(1):71–92.
Burrows, P. (1991). Compensation for Compulsory Acquisition. Land Economics, 67(1):49– 63.
Kelly, D. B. (2006). The Public Use Requirement in Eminent Domain Law: A Rationale Based on Secret Purchases and Private Influence. Cornell Law Review, 92:1–66.
Miceli, T. J. and Sirmans, C. (2007). The holdout problem, urban sprawl, and eminent domain. Journal of Housing Economics, 16(3- 4):309–319.
Strange, W. C. (1995). Information, Holdouts, and Land Assembly. Journal of Urban Economics, 38:317–332.