Private takings

• Published date: 01 June 2017
• DOI: http://doi.org/10.1111/jpet.12235
• Author: Ed Nosal,Alessandro Marchesiani
• Date: 01 June 2017

Received: 23 February2016 Accepted: 3 July 2016

DOI: 10.1111/jpet.12235

ARTICLE

Private takings

Alessandro Marchesiani1Ed Nosal2

1Universityof Liverpool

2FederalReserve Bank of Chicago

AlessandroMarchesiani, University of Liverpool,

Liverpool,UK (marchesiani@gmail.com).

EdNosal, Federal Reserve Bank of Chicago, 231 S

LaSalleSt, Chicago, IL (ed.nosal@gmail.com).

Wewish to thank Aleks Berentsen, Ricardo Cav-

alcanti,Guillaume Rocheteau, Perry Shapiro,

andan anonymous referee for helpful comments

andsuggestions. The views expressed here do

notnecessarily represent those of the Federal

ReserveBank of Chicago or the Board of Gover-

norsof the Federal Reserve System.

This paper examines the implications associated with a recent

Supreme Court ruling, Kelo v. City of New London (2005). Kelo can be

interpreted as supporting eminent domain as a means of transfer-

ring property rights from one set of private agents—landowners—to

another private agent—a developer. Under voluntary exchange,

where the developer sequentially acquires property rights from

landowners via bargaining, a holdout problem arises. Eminent

domain gives all of the bargaining power to the developer and, as

a result, eliminates the holdout problem. This is the benefit of Kelo.

However,landowners lose all their bargaining power and, as a result,

their property investments become more inefficient. This is the

cost of Kelo. A policy of eminent domain increases social welfare

compared to voluntary sequential exchange only when the holdout

problem is severe, and this occurs only if the developer has very

little bargaining power. We propose an alternative government

policy that eliminates the holdout problem but does not affect the

bargaining power of the various parties. This alternative policy

strictly dominates a policy of eminent domain, which implies that

eminent domain is an inefficient way to transfer property rights

between private agents.

1INTRODUCTION

A recent Supreme Court decision, Kelo v. City of New London (2005), reaffirmed that the public-use criterion from the

takings clause of the Fifth Amendment of the U.S. Constitution1can be fulfilled even when a government takesprop-

erty from one private agent and gives it to another. Although the Court has long rejected a literal interpretation of

public use,2the Kelo decision generated a fair amount of controversyboth among the judiciary and the public. Perhaps

it is because the public purpose3of the taking that underlies Kelo is less transparent than previous important Court

rulings.

1“[N]orshall private property be taken for public use, without just compensation.”

2InFallbrook Irrigation Dist. v. Bradley (1896) and Clark v.Nash (1905), the Court ruled in favor of a taking that only benefitted a small set of private landowners.

Ashort summary of relevant cases regarding the definition of public use, some of which we refer to, can be found in Rolnick and Davies (2006).

3InMt. Vernon-Woodberry Cotton Duck Co. v. Alabama Interstate PowerCo. (1916), the Court only required that a taking serve a public purpose.

Journal of Public Economic Theory 2017; 19: 639–657 wileyonlinelibrary.com/journal/jpet c

2017 Wiley Periodicals,Inc. 639

640 MARCHESIANI AND NOSAL

In the landmark case of Berman v. Parker(1954), the owners of a non blighted department store had their property

taken as part of a large-scale redevelopment plan to rid parts of Washington D.C. from blight and slums. The rede-

velopment plan, provided by the District of Columbia RedevelopmentAct, included the condemnation of nonblighted

buildings. The Court unanimously ruled that private property can be takenfor public purpose as long as owners receive

just compensation. Furthermore, it ruled that it is up to lawmakers—not courts—to decide what is in the public’s best

interest.4In Berman v. Parker,the public purpose of the taking is easy to visualize: It turns something that is ugly and

dangerous into something that is beautiful and safe.

In another important case, Hawaii Housing Authority v.Midkiff (1984), the Hawaiian legislature proposed to regulate

an oligopoly in the housing market by taking away the property rights from a few large landowners, with compensa-

tion, and distributing them to many new owners. As in Berman v. Parker, the Court deferred to the legislature as to

whether the public purpose was being served, and unanimously ruled in favor of the legislature’s actions. Giventhat

governments havemade a practice of regulating industries that exhibit market power for many years, it is plausible to

envision that the taking served a public purpose.

Qualitatively speaking, the basic facts of Kelo are not so different from the above cases. The city of New London

formulated an economic development plan that would benefit the city and its residents by providing growth oppor-

tunities and increased tax revenues. As in Berman v. Parkerand Midkiff, the city’s plan required the taking of private

property that would ultimately be owned by other private parties. The Court ruled in favor of the city of New London.

However,unlike Berman v. Parker and Midkiff, the Court rendered a split 5–4 decision. And there was a vigorous public

debate regarding the appropriateness of the decision. Much of the debate focused on whether taking property for pri-

vate economic development serves a public purpose. Even though the Court deferred to the legislature regarding the

public purpose in Midkiff, it did not absolve itself from interfering when the public purpose was at question: “Apurely

private taking could not withstand the scrutiny of the public use requirement; it would serve no legitimate purpose of

governmentand would thus be void. ... The court’s cases have repeatedly stated that “one person’s property may not be

takenfor the benefit of another private person without a justifying public purpose, even though compensation be paid”

(Midkiff at 245 and 241, respectively). Evidently, in the minds of a great number of people, the case that private eco-

nomic development serves a public purpose was not made in Kelo. In response to the Kelo decision, 43 states changed

their eminent domain laws that placed limitations and/or restrictions on municipalities’ use of eminent domain when

the stated public purpose was economic development.

From an economic perspective, some sort of market failure or friction must exist if a government taking is to be

part of the solution for a redevelopment project. For example, marketsolutions to redevelop blighted areas may fail

because of a free-rider externality;see, e.g., Grossman and Hart (1980) and O’Flaherty (1994). In a blighted area, prop-

ertyowners may be reluctant to sell their properties to developers at “low” prices—even though these prices are appro-

priate for the properties in their current state—because they anticipate the value of their properties will increase as

the area is redeveloped.Because of this, the market will deliver redevelopment projects that are too small from a social

perspective. A government taking, along with just compensation, can internalize this externality,and result in socially

preferable outcomes. The Berman v.Parker decision can be rationalized along these lines.

It would be difficult, however, to justify the Kelo decision by appealing to a free-rider argument. Forstarters, the

proposed redevelopment area in New London was not blighted or run-down. Given this, how would Suzette Kelo’s

property value be affected if the redevelopment project proceeded without the sale of her property? Being close to

a new shopping area would be beneficial, since it would be convenient for running errands, dining, and so on. But the

new shopping area and a major research facility would bring about increased traffic and congestion, which would be

costly.Since it is not at all obvious which effect would dominate, it would not be unreasonable to assume that property

values would be unaffected by the redevelopment. That is, there are no external benefits associated with the taking.

One can interpret the dissenting opinion of Justice Day O’Connor being consistent with such a view: “Anyproperty

may now be takenfor the benefit of another private party ... the beneficiaries are likely to be those citizens with dispro-

portionate influence and power in the political process, including large corporations and development firms” and the

4“[W]henthe legislature has spoken, the public interest has been declared in terms well-nigh conclusive” (Berman at 32).