Sunday, July 10, 2005

Private property is a cornerstone of capitalism. The protection of property rights is essential to our free enterprise system’s efficient operation. When that protection is weakened, negative economic consequences invariably follow.

In the well-publicized case of Kelo v. New London, the Supreme Court in a 5-4 decision ruled a local government can take private property for private economic development when it believes the taking will benefit the public.

The court upheld the city’s seizure of privately owned properties and the real estate’s transfer to private developers to build a hotel, offices and conference center.

The expected public benefits, according to the city government, were increased tax revenues and jobs, though the proposed development’s financial success was uncertain.

What are the likely economic consequences of the Kelo decision, whose publicity has educated if not shocked the nation? In covering the Kelo case, the media have brought to light similar court decisions in past decades.

In such cases, the owners of the property taken are inevitably shortchanged. Fair compensation can only occur when a willing buyer and a willing seller, be it the owner of a home or business, voluntarily agree upon a price.

A fair market price can’t be determined when property owners don’t want to sell, as in Kelo. In a property seizure, the government, which has a biased self-interest, or its agent, decides the price, usually based on the estimated value of comparable properties (which are often not comparable).

The government’s condemnation price may not take into account the property’s expected future value — that is, the expected increase in value because of the development, which the property taking itself makes possible. If the development raises surrounding property values, the neighbors whose properties were not taken by the government will benefit, but the former owner of the seized property may not.

In a voluntary market transaction, the seller would ordinarily take into account in determining his price (if any) not only current comparable sales, but also a possible subjective value (e.g., sentimental attachment) and the likely future appreciation due to development or other improved use. Government pricing limited to comparability estimates would be unfairly lower, to the property owner’s detriment.

Consider what can happen when commercial properties are taken. Small businesses must close their doors and their properties are transferred to other, usually larger, businesses with more political clout. Small businesses often depend on local customers. Forced relocation will likely cost them sales.

Accumulated good will is lost. Failure is more probable, threatening a loss of jobs, output and tax revenue. Trees perforce transplanted to poorer soil bear less fruit or die.

The big businesses that move in may not fully make up for the losses to the community due to driving out the former small businesses. To the extent the new businesses are government-subsidized, they have less to lose than if they risked their own capital, and thus less incentive to succeed.

Unlike the displace small business, a big business headquartered out of state often will not reinvest its profits locally.

Resources become misallocated in another way. When property acquisition becomes political, those who covet another’s property will divert funds from economically productive uses to lobbyists and lawyers to influence local governments. Consequently, investment and growth suffer.

Alerted to the risk of confiscation, entrepreneurs hoping to start a business must weigh the possible costs of having their property taken by the government down the road. The increased uncertainty and risk are likely to deter investment or shorten investment planning horizons with resulting economic loss to both the community and the government. To compensate for greater risk, entrepreneurs will require higher returns, possible only if they are able to charge higher prices.

Business improvements become riskier. Farmers must think twice before expanding or buying new tractors or building new barns. Store owners may have to reconsider renovating or building an extension. Small business loans could prove more elusive or expensive. Homeowners may forgo improvements. All told, capital formation will likely be depressed.

Property is put to its best use by whoever values it most highly, i.e., whoever pays the highest price in a free-market transaction. Taking private property from one owner and transferring it to another private party violates that basic tenet of economics. It is likely to reduce investment, productivity, economic growth and the tax base. The cumulative economic costs over time may well exceed the intended public benefit, turning the stated purpose of property takings on its head.

In the defendant’s and amicus curiae briefs supporting private property rights in the Kelo case, the writings of my old graduate school economics teacher, Ludwig von Mises, were cited, as were those of his students Nobel laureate Friedrich A. Hayek and Murray N. Rothbard.

In 1962, Rothbard wrote on the misuses of eminent domain: It “greatly distorts the structure of production. Instead of being determined by voluntary exchange, self-ownership, and efficient satisfaction of consumer wants, prices and the allocation of productive resources are now determined by brute force and government favor.”

People who didn’t know their property was at risk now do. Their heightened awareness because of the publicity about the Kelo decision can only accentuate the likely economic fallout.

Congress needs to act. The states also need to increase their protections to reduce risks to their own economies. Those states offering the best protection may find homeowners and businesses migrating to them, to the economic detriment of states that offer less protection.

Alfred Tella is former Georgetown University research professor of economics

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