Cities, property, and positive externalities.

• Author: Parchomovsky, Gideon
• Position: Introduction through I. Externalities and the Law, p. 211-236

ABSTRACT

Cities are the locales of numerous interactions that generate externalities--both negative and positive. Although the common law provides a vast array of mechanisms for limiting negative externalities, there is a striking absence of provisions for stimulating the production of positive ones. As a consequence, activities whose social benefits are greater than their private costs are not undertaken, with a resulting efficiency loss.

In this Article, we demonstrate how cities can develop commercial districts that allow for the capture of positive externalities by following the example of suburban malls. In malls, anchor stores provide positive externalities--additional customers--to neighboring stores. Anchors capture these externalities through the subsidized rents they pay to mall owners, who in turn charge higher rents to the smaller businesses who benefit from the additional traffic. This private law mechanism provides a strong reason for large stores to locate in suburban malls--where they can recoup some or all of the spillover benefits they provide--as opposed to urban centers, where they are unable to recover the benefits they provide to neighboring stores.

Businesses in cities may generate similar positive externalities, but the law offers virtually no mechanisms by which they can recover any of the value of the benefits they provide. We argue that cities should use pubic law to create planned commercial districts, analogous to suburban malls, which would allow for the capture of positive externalities among commercial establishments. We also discuss how cities can use the legal powers at their disposal to achieve this goal. We submit that the reconfiguration of downtown areas will not only result in the production of new positive externalities but will also reduce the negative externalities associated with urban sprawl.

TABLE OF CONTENTS INTRODUCTION I. EXTERNALITIES AND THE LAW A. Of Negative and Positive Externalities B. Theoretical Justifications and Their Limitations II. OF CITIES, SHOPPING MALLS, AND EXTERNALITIES A. The Economics of Cities B. The Economics of Shopping Malls III. TOWARD A NEW APPROACH TO URBAN DEVELOPING A. Asset Configuration B. Arriving at the Right Combination 1. Self-Development 2. Auctioning Off the Project IV. THE UNDERAPPRECIATED WELFARE EFFECTS OF OUR PROPOSAL CONCLUSION INTRODUCTION

Viewed from an economic perspective, cities are all about positive (1) and negative externalities. (2) Cities that minimize the scope and magnitude of negative externalities and are able to produce positive externalities will have an inherent edge over localities that fail at these twin tasks. (3) From a legal standpoint, therefore, successful urban planning requires cities to adopt legal policies that minimize harmful third-party effects--that is, negative externalities, and encourage uses with salutary spillovers--that is, positive externalities. Both types of externalities are of great significance to the economic performance of cities. Yet, the two types have been treated very differently by scholars and lawmakers. (4)

With a few notable exceptions, property and land use laws are largely concerned with the problem of negative externalities--acts that impose unaccounted-for costs on others. Ownership structures, as well as the laws of nuisance, servitudes, and zoning, are commonly understood as means for internalizing negative externalities, (5) which have also been a focal point in property and tort theory.

All the while, however, scholars have paid scant attention to the mirror-image phenomenon of positive externalities--acts that confer unaccounted-for benefits on others. Property theorists have long recognized the existence of positive externalities, but the literature has largely ignored them. (6) Even worse, in the few cases in which urban planners have touted positive spillovers from various development projects such as sports stadiums, these promised benefits have typically failed to materialize. (7)

In this Article, we propose a legal policy that would enable cities to better manage positive externalities, increasing their odds of success. One aspect of urban life that is rife with positive externalities is commerce. (8) Not all businesses are created equal, however. Famous brand name stores and large commercial establishments create a plethora of positive externalities for their smaller neighbors. (9) To illustrate, consider the effect of a downtown Apple store on neighboring business. Many of the customers attracted by the Apple store are likely to purchase a coffee at a neighboring cafe or a meal at a nearby restaurant. Some may even use this opportunity to shop for clothes or furniture. Importantly, there is no reciprocity in the relationship: most smaller businesses simply do not have the gravitational pull to attract masses of customers independently, and thus do not bestow a similar benefit on brand name stores. (10) The positive effect of larger businesses on smaller ones can best be seen when an anchor business shuts down or relocates to another area. Closings or relocations of anchor stores are often the kiss of death to many small businesses and may portend the economic decline of entire downtown areas. (11) The opposite is also true: the arrival of an anchor store may revive a commercial district, and a critical mass of branded stores can do much to secure the viability of a downtown area. (12)

Cities' failure to take account of the positive externalities generated by anchor stores may have played an important part in the much-lamented hollowing-out of central city business districts and the flight by retail commerce, and its customers, to the suburbs. (13) Because--as we demonstrate below--large retail stores are able to capture the positive spillovers they generate when they locate in malls, but not when they locate in central cities, suburban malls have a built-in competitive advantage over urban centers when it comes to attracting such enterprises. (14)

Cities can attract branded stores in many ways. One obvious way is to subsidize them. We believe, however, that the subsidy solution is misguided. Subsidies impose a cost on the public and raise the specter of political corruption. (15) Instead, we suggest that local planners should adopt policies that can unlock the value inherent in positive externalities by attracting businesses and establishments that create positive spillovers for neighboring businesses, and by allowing the former to internalize those benefits. (16)

To get a handle on how to achieve this result, it is useful to think about the problem from the perspective of a single owner. In his seminal article, Toward a Theory of Property Rights, Harold Demsetz demonstrated that it is possible to internalize the externalities resulting from the usage of land by consolidating all the rights in the hands of a single owner. (17) Adopting the Demsetzian perspective, we imagine a world in which a single entity owns all commercial properties and ask how she would manage the properties to take account of the spillover benefits that large stores create for smaller ones. In fact, this problem is less hypothetical than it may appear at first glance: owners of private shopping malls encounter this problem on a regular basis and have come up with an effective solution: differential rents. (18)

Most people know that a key to the success of many shopping malls is the inclusion of one or more major anchor stores that have an independent ability to draw clientele. (19) What is less well known is that such anchors pay a highly reduced rent relative to other stores. (20) Empirical studies establish that anchor stores average 14 percent of the rent per square foot charged to smaller retailers, and in some cases pay no rent at all. (21) The lower rent reflects the beneficial effect such stores generate for neighboring smaller retailers via the additional customers that the anchor stores bring to their smaller cotenants. (22) The differential rent collected by mall owners is effectively an internalization mechanism that takes account of the relative contributions of store owners to each other's business. Indeed, one of the important functions of mall management is to...