University of Minnesota Law School Scholarship Repository Minnesota Law Review 2018 Positive and Negative Externalities in Real Estate Development Richard A. Epstein Follow this and additional works at: https://scholarship.law.umn.edu/mlr Part of the Law Commons Recommended Citation Epstein, Richard A., "Positive and Negative Externalities in Real Estate Development" (2018). Minnesota Law Review. 109. https://scholarship.law.umn.edu/mlr/109 This Article is brought to you for free and open access by the University of Minnesota Law School. It has been accepted for inclusion in Minnesota Law Review collection by an authorized administrator of the Scholarship Repository. For more information, please contact [email protected]. Article Positive and Negative Externalities in Real Estate Development Richard A. Epstein† INTRODUCTION Externalities of all sorts and descriptions are a fixed feature of all real estate development in advanced societies, for much of the value of owning and using land derives from the simple fact that everyone has neighbors.1 But having neighbors is a two- edged sword, as they are welcomed on some occasions and scorned on others. To deal with inevitable appearance of neigh- bors, legal systems have developed a wide range of land-use con- trol devices that have worked their way into the fabric of modern law.2 Thus modern legal systems contain techniques to regulate the use of land, such as private restrictive covenants and ease- ments on the one side and elaborate local zoning codes and re- gional growth-control regimes on the other. These same legal systems often develop devices from rent control to affordable housing regimes to regulate the price at which real estate can be sold or rented.3 The use of these various devices has long been a source of intellectual disagreement and institutional conflict. What is needed in many cases is a single mode of analysis that tries to † Laurence A. Tisch Professor of Law, New York University School of Law; Peter and Kirsten Bedford Senior Fellow, The Hoover Institution; James Parker Hall Distinguished Service Professor Emeritus and Senior Lecturer, University of Chicago. I would like to thank Philip Cooper, University of Chi- cago Law School, Class of 2017, and Bijan Aboutarabi and John Tienken, Uni- versity of Chicago, Class of 2018, for their usual excellent and thorough research assistance. Copyright © 2018 by Richard A. Epstein. 1. Stephen Malpezzi, Affordable Housing: Supply Side Innovation?, RUT- GERS CTR. FOR REAL EST.: BLOG•RE (Mar. 8, 2018), http://rutgersrealestate .com/blog-re/affordable-housing-supply-side-innovation. 2. See generally id. (listing a wide range of land-use control devices that are used in the modern law). 3. Id. 1493 1494 MINNESOTA LAW REVIEW [102:1493 figure out which of these systems should be welcomed for the improvements that they generate and which should be con- demned for the discord they sow. In order to achieve that goal, it is necessary to identify which real estate innovations from behind a veil of ignorance generate overall social improvements and which tend to result in redis- tributive struggles that tend to undermine both political stabil- ity and economic growth. In order to achieve that end, it is nec- essary to take a systematic look at the various devices that are used to identify and control both the negative and positive exter- nalities in real estate markets. This Article take up that challenge by examining the exist- ence and control of negative and positive externalities in real es- tate markets from a comparative perspective, with special em- phasis on English and American law. These externalities are present everywhere but assume their greatest importance in re- gions with high population densities,4 where high land values make it essential to allow multiple claimants to create overlap- ping interests in the same parcel of real estate.5 But how should these common interests be coordinated? One approach is top down, where centralized state authorities make the allocative decisions. The alternative approach is decentralized. The state simply sets and enforces boundaries between strangers, and then it lets multiple parties decide privately whether to pool or to separate their activities. The first approach is marked by no- ble ambition and backed by claims of dispassionate expertise. Yet the results are usually disappointing. It is much easier for governments to keep people apart than to bring them together. As a rule, voluntary arrangements tend to work better than zon- ing laws or other compulsory land-use arrangements. In order to explain and defend this thesis, I shall proceed as follows. Part I examines the various meanings of the term exter- nality as it is used in law and economics. Part II then launches a conceptual attack on the externality problem by examining the idealized conditions in which it cannot exist—namely those in which all persons obtain their full bundle of rights and obliga- tions from a single owner, so that they wholly consent to the full 4. See generally JOHN P. BLAIR, LOCAL ECONOMIC DEVELOPMENT: ANALY- SIS AND PRACTICE 30 (1995) (stating the “externality problem increases rapidly as urban density increases”). 5. See, e.g., GOH Yihan, Tort Law in the Face of Land Scarcity in Singa- pore, 26 ARIZ. J. INT’L & COMP. L. 335, 340 (2009) (discussing the effects of high population densities and land value on legal property rights in Singapore). 2018] REAL ESTATE EXTERNALITIES 1495 package of benefits and burdens they receive. In these settings, any controls over both positive and negative externalities follow identical paths, given that the owner has every incentive to max- imize total revenues from his project, which necessarily requires the minimization of future negative externalities and allowing, but not requiring, the creation of future positive ones. Part III then explores the differing treatments of positive and negative externalities when neighboring landowners do not acquire prop- erty from a single owner. It explains why it is both easier and more critical to control negative externalities than to create pos- itive ones. It also rejects the provocative proposal of Professor Ariel Porat to recognize a private-restitution remedy for unre- quested benefits.6 Part IV then illustrates the perils of moving from the decentralized private law models generated by the sin- gle ownership paradigm to various forms of public intervention in land-use settings, such as zoning laws and affordable-housing mandates. The contrast is clear. The private models do not allow for redistributive objectives to weaken productive decisions. The public models, which operate over a far greater scope, neces- sarily use coercive power to enforce both land-use regulations and transfer payments. These interventions are far more vulner- able to political influences, especially when their exercise is not hedged in by a requirement to compensate parties who have suf- fered disproportionate losses of their property rights. I. EXTERNALITIES, BROAD AND NARROW In its broadest formulation, an externality covers any im- pact that one party’s activities have on the welfare of another party.7 In a normal situation we measure externalities by their effects on other human beings. But often those individuals or- ganize themselves into groups, be they commercial arrange- ments or social organizations. It is therefore often sensible to short-circuit the analysis of each person’s individual position by treating the legal entity as a stand-in for the individual members whose fortunes have been altered by the activities of another person. The relevant impacts can be positive or negative, and 6. See infra note 83 and accompanying text. 7. THEORY AND MEASUREMENT OF ECONOMIC EXTERNALITIES 1 (Steven A. Y. Lin ed., 1976) (“Generally, effects on persons not directly privy to the decision leading to an activity are termed externalities . .”). 1496 MINNESOTA LAW REVIEW [102:1493 refer not just to real estate transactions, but to all human af- fairs.8 Under that definition, all actions by all persons and firms, however innocuous, necessarily generate both sorts of externali- ties, often to different people. Taken seriously, this definition im- plies that private markets will inevitably fail because they can- not, in Professor Harold Demsetz’s famous phrase, “internalize the externalit[ies]”9 of human action. Government regulation, which generates its own positive and negative externalities, can never be categorically ruled out.10 Thus the system of state con- trol snowballs, under the same broad definition, creating mas- sive externalities, positive or negative, of its own.11 Clearly something is amiss in this grand formulation that uses a definition of externality that, whatever its intuitive ap- peal, is too broad for legal or policy work. Any serious examina- tion of the externality problem thus starts by narrowing the class of externalities for which legal intervention is justified, that is, to what traditional lawyers called cognizable or actionable harms. The folly, moreover, of any broad definition is that it treats any refusal to deal in a competitive market as a negative externality, which would mean that any action that leaves any- one else worse off may count as an actionable harm that justifies government intervention.12 On this expansive view of the world, A cannot marry B because of the disappointment of C, a rival suitor. But if the situation were reversed, C’s successful court- ship could be blocked by B. Under this definition, there are al- ways overlapping and crippling externalities. Disappointed suit- ors in competitive markets can always complain of losing one sale to a rival at which all sales are suspect. The correct view, therefore, declines to provide compensation for all competitive losses. 8. See Externality, INVESTOPEDIA, http://www.investopedia.com/terms/e/ externality.asp (last visited Apr. 26, 2018) (“An externality is a consequence of an economic activity experienced by unrelated third parties; it can be either positive or negative.”).