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III. A Transaction Cost Of Theory Of Land-Use Planning And Development Control (10)

Just as for generic planning, Pigouvian welfare economics has justified government intervention in what would otherwise be unregulated land and property markets. An alternative account draws on social choice theory. Institutional and transaction cost economics provide more parsimonious explanations, while TCT offers the added merit of applicability in institutional design.

Three traits give TCT its institutional design potential. One is its unit of analysis: the transaction, which is ubiquitous, concrete, and well defined. The second is its concept of remediableness, demanding comparison between feasible alternatives. The third is its main hypothesis: discriminating alignment, which prescribes testing the fit between transaction characteristics and alternative forms of governance. The most appropriate form (or mix) of governance is the one that minimizes all concerned parties' transaction costs.

Institutional economics and transaction cost theory (TCT) offer two ways to explain why public land use planning and development control exist and why they are so popular. These approaches represent different levels of analysis in a three-level schema of society. The micro-level, dealing with the individual, is outside TCT's concern. TCT focuses on the meso-level: forms of governance and their relative costs. The macro-level is the institutional environment, the domain of mainstream institutional economics.

Public land use planning and development control can be defined as "government delineation and/or restrictions of rights over land within certain spatial confines" (Lai, 1994: 77). In this sense, then, they are a significant part of the institutional environment of the land development process and the land and property markets. Public planning assigns and restricts land development rights, and development control intervenes in the processes of land development, construction, occupancy and use to enable and constrain transactions in accordance with prescribed rules.

Institutional economics modifies classical economic theory by introducing transaction costs, suggesting that these make the effective operation of markets impossible without some third-party enforcement of contractual commitments. Though voluntary institutions can be deployed (such as arbitration), these will ultimately also be confronted with the problem of enforcing compliance. A state administered institutional framework of third-party enforcement, therefore, is essential even for efficient impersonal exchange in the classic economic market, and the clear delineation of property rights is a critical precondition for markets to work at all.

Rights over land is a powerful case in point: the assignment of and control over land uses will generally reduce transaction costs (as discussed in more detail later) and can create or enlarge markets. But recognizing planning and development control as part of the market's institutional environment still leaves the question open: "Why public?" Is it not possible to substitute voluntary compliance and enforcement for parts or all of the regulatory institutions of governmental intervention in the land development process? This is a valid question, which gets different answers depending on the level of analysis.

A meta-level approach gives this question a negative answer, asserting that assigning property rights in land (which is what land use planning and its implementation through regulation and development control do) is a sovereign task. Sovereign tasks involve commands (laws, regulations, rules) that can only be issued and enforced by the state.

When it defines land use planning and development control as sovereign tasks, making them part of the market's institutional environment, institutional economics joins mainstream planning theory in acknowledging public planning as essentially a political activity. This combines with the quasi-judicial aspects of development control to confirm the public nature of land use planning and regulation.

The TCT approach, however, sees the question: Why public?" as open, to meso-level examination of the discriminating alignment between transaction attributes and alternative forms of governance. This section continues with a review of the land development process, analyzing the relevant transactions in the production and transformation of the built environment.


Land development and the real-estate market

A model of the basic relevant transactions and their parties follows. It is important to note that this model does not include planning and development control, or any other form of statutory or voluntary governance: they are contingent, not necessary parts of the process. This description of the land development process is at a level of abstraction that fits any society with the general characteristics of a market economy (11).

But this also means that for practical application in institutional analysis or design, this model needs adaptation to the particular context concerned. These modifications will include the particular forms of governance and the actual institutional framework of current land development and the property market there, which of course vary widely from place to place (12). The generic model includes the following transactions and parties:


Land purchase

Acquisition or assembly of undeveloped (open or agricultural) land. The parties are the seller (the original landowner) and the buyer: a speculator, developer/builder, or an individual, household, firm or agency buying the land for its own use. In some countries government is one of the parties, in the primary developer's role.

In this transaction the land value is critical in setting the price. The fact that neighborhood effects, apart from locational and physical site attributes, are what determine land value, is a major source of uncertainty. One way buyers reduce this uncertainty is by assembling large tracts to enhance their control over their relevant environment.

This uncertainty involves information impactedness, too: information asymmetries between the buyer and the seller. The seller wants to advertise his property's development potential, so as to maximize the price. A common way of reducing the risk of seller misrepresentation is the purchase option, which makes the eventual land price contingent on (at least partial) realization of the land's development potential.

The buyer is often more sophisticated than the seller: after all, this is land speculators' and developers' business. But they are not about to share their inside information, educated knowledge, or experienced intuition with the seller. Consequently, this transaction is subject to opportunism. Misrepresentation, suggesting a lower land value than its real development potential, is of course the speculator's stock-in-trade: the concealed value difference is his speculative profit.

Manipulation is also common: e.g. secret land assembly. Buying parcels through straw men allows the purchaser to internalize the value increment of large-scale development without sharing any of it with the sellers. Developers with political influence have insider knowledge of government intentions, or the ability to affect public actions: the location of public amenities, the timing and routing of infrastructure, and designated land uses and intensities for adjacent sites or the wider surroundings. The offered price is unlikely to reflect this value increment, unless the seller's local influence and links make her an active partner. Then, both parties share the value created by their political actions.

Referring to political manipulation seems to imply public planning and zoning, but these are unnecessary. Even a minimal government, providing only basic public services, would, through its responsibility for funding and siting public amenities, and locating and constructing infrastructure and capital projects, be vulnerable to special interests with the same consequences.

Clearly, then, primary land acquisition and assembly has many idiosyncratic attributes. It represents a major investment, which may remain locked in for years before it can be realized. Even for the speculator, profitable short-term resale is a risky proposition. This transaction, even though it is a unique one-time exchange, combines significant information-impactedness, long duration, and very high uncertainty.


Financing

Procuring capital to finance land acquisition and development. The primary land purchase is often more complex than a simple sale. The buyer may be a composite entity, combining a development partner with the source of some or all of the financing. If financing is not through equity participation, it may be by borrowing, but in both cases financial institutions become active participants in the land development process.

Financing has the same problem as land acquisition: information impactedness related to the property's true land value. A financial institution as equity partner becomes subject to the same hazards as the developer. If capital is raised through borrowing, the lender is also vulnerable to manipulation. Both the amount of the loan, and the lender's security are based on the value of the asset: its development potential. In a form of moral hazard not uncommon in land development, the developer can raise his leverage by exaggerating his scheme's profitability, and (increasing the whole venture's riskiness) reduce his own exposure.

Sophisticated lenders are well aware of this hazard and invest considerable resources in acquiring precontract information. Nevertheless, though their uncertainty can be mitigated by such market supports and voluntary transaction costs, financing institutions undoubtedly have an interest in governance that can reduce uncertainty about interdependencies and future neighborhood effects, and provide authoritative information to minimize their transaction costs in precontract discovery.


Land preparation and development

To prepare his land for building, the developer has to engage professional consultants (planners, architects and engineers) and contractors. If these are simple market transactions, procuring these services is unrelated to the property's value, so it is not subject to the hazards described above.

However, often the interactions between developer, consultants, and contractors are more durable and less predictable. Interaction on one project can last years, and uncertainty about the area's development potential may involve the developer and her consultants in a joint exploration of possibilities. Contingent fee contracts are a market adaptation to this uncertainty. Their interdependence gives consultants and contractors a mutual interest with the developer in reducing the uncertainties of the land market and in governance that can provide reliable information on prospective neighborhood effects.

Often, joint involvement in land development generates repeated contracts between the same parties. This becomes a classic case of asset specificity, with transaction specific investments of expertise and resources. With the trust engendered in ongoing relationships, these links are often handled informally. But dependency risks opportunism. Consequently, vertical integration may ensue, with large land development corporations internalizing consultant and contractor services.


Land disposition

In this transaction, the developing agent (developer, builder, public corporation or agency, or local government) sells or leases developed areas or building sites to their next owner or user: a developer-builder completing site development and construction of structures for sale, or a speculative builder, or households and firms intending to build for their own use. In all these cases land disposition is subject to many of the hazards of land acquisition, except that completion of site development has reduced uncertainty.

Widespread cases of misrepresentation and fraud (like the famous Florida swamp subdivisions) illustrate the fact that development and subdivision do not eliminate the risks. Their completion does significantly enhance certainty about the area's future, raising the value of developed sites by more than the direct costs of land preparation and infrastructure. But neighborhood effects remain uncertain, and the developer's investment can represent his confidence either in his ability to predict or control them, or in the buyer's gullibility.

Both parties have a mutual interest in reducing the unpredictability of neighborhood effects. Authoritative confirmation of her assertions on the future of the surrounding area enhances the price the developer can obtain. At the same time it reduces the buyer's risk of discovering that he has overpaid when surprised by neighborhood effects, or when finding that anticipated development in the area does not materialize.


Construction

Procurement of professional and contractor services. This stage is very like land preparation and development. Though uncertainties are fewer because the property is further down the development track, they are not entirely absent. If they are totally independent, the consultants and the building contractor are not affected by the developer's uncertainties, except when he reneges on his contractual obligations to pay them. This can happen when expected demand does not materialize, e.g. after office construction booms leave developers with unlet space.

On the other hand, the landowner, professionals and contractors may be linked in long-term relationships. This holds increasingly true as the scale of development grows: in large-scale residential tracts, industrial parks or mixed developments. These relationships are sometimes institutionalized in various forms of vertical integration or equity participation, but in any case they create a mutual interest among all the parties in reducing uncertainties about neighborhood effects.

Authoritative information about a property's development potential and its surroundings is also important to some of the consultants -- planners, engineers and architects -- because it makes their jobs much easier. Indeed, in cases of high uncertainty (e.g. large-scale development on greenfield sites) their task would be impossible without it.


Property transfer

Change of ownership of land and improvements, leading to change in occupancy, changes in kind or intensity of use, additional construction or reconstruction, adaptive reuse, or clearance and redevelopment. Here, the price is still largely based on the property's value, but more of that value is based on the actual property and its neighborhood, and less on its future development potential.

The mix between these depends on neighborhood effects, and the kind of transaction. At one extreme, with maximal stability and certainty, is simple transfer of ownership, stimulated by mobility or particular changes in circumstances.

This kind of transaction makes up the bulk of most property markets. Though it is also information-impacted and has high asset-specificity (13), it is less subject to the hazards discussed above. Nevertheless, here too there is a common interest in making immunity to unforeseen neighborhood effects a self-fulfilling prophecy. This is usually effected through local government zoning, and some control over design, construction and use.

At the other extreme are property transfers premised on instability and change, initiating radical transformation of the proximate built environment. The sale of built-up land for large-scale redevelopment is much more like primary land acquisition, than the sale of a single-family home. The difference -- the existence of buildings and infrastructure -- is only relevant if those have any intrinsic value, and to the extent that the project involves clearance and reconstruction, they do not.

Here the land's development potential is again critical, and its vulnerability to interdependence and neighborhood effects is high. Like primary land acquisition, the transfer of built-up land for clearance and redevelopment has high asset-specificity, long duration, and high uncertainty. Consequently, the authoritative information that public planning can supply, on designated land use for the property, and prospective use types and intensities in the area, is at a premium.

Between these two poles are other kinds of property transfers: sales for internal alterations enabling more intensive use, or adding construction, or conversion of structures for adaptive reuse. The latter is often responding to neighborhood effects: transitional areas experiencing locational or functional obsolescence. Much as for redevelopment projects, interdependence uncertainties are high, and areawide planning can mitigate them. Public intervention is one response, but other possible governance options are discussed below.

Analysis of this generic land development process and property market reveals transaction characteristics that are incompatible with a perfect market. These transactions demand market modification in some hybrid form of governance that will minimize their costs and reduce their hazards. Some form of land use planning and development control can do this. Discriminating alignment asks: What is the most appropriate form of governance to address the transaction characteristics and hazards that have been described?


Forms of governance

A repertoire of alternative forms of governance and their transaction-related characteristics is shown in Table 1 below. These are the various ways in which land use planning and development control may be delivered.

TABLE 1: Forms of Governance in Land Development and the Property Market

Form of Governance: Third Party Governance (administrative support)
 Bilateral Governance (market support)
Agent: Public/
Government
Private
(delegated)
 Public/
Government
Mixed
(Public/Private)
Private
(Firms, corportations, households)
Task:

Planning


Statutory
public planning
(government
agencies,
bureaus)


Professional
consultant
firms


 Public
developer-
planner
(government/
public agencies)

Indicative planning:
(Public planner and/
or delegated consultants)
Infrastructure, public
facilities/open space,
indicative designation
of private land uses/
intensities



Public-
Private
Partnership


Developer-
initiated
planning

Informal
planning


Development
Control

Regulatory:
(government/
public agency)
Zoning, building
regulations, other
(environmental,
hazard, special
area designation,
etc.)


Contract zoning:
Plan as a condition of
contract of lease or
sale between public
landowner and
developer

Contractual:
CCRs between
developer/
planning agent
and subsequent
propertyowners


The question of "make" (in-house provision of professional planning services by a government agency) or "buy" would be addressed on a case specific basis. "Buy" can include privatizing forward planning activities through procurement from consultants, and monitored delegation of governmental regulatory and enforcement activities such as plan review and building inspection to private service providers.

Planning in bilateral governance involves deliberate intervention in the land development process. This can be done directly by government and its agencies, or through public-private partnerships, which have become popular development instruments over the last two decades. It is of course also extensively done in the market itself, by large-scale landowner-developers.

Indicative planning is a form of bilateral governance where government does not intervene directly but provides indirect market support. Indicative plans show public investments (infrastructure, strategic facilities and public amenities) and indicate desired patterns of area development. An indicative plan needs private investors' confidence in government's commitment to implement its own decisions, and in the quality of its data. Its success also depends on how it incorporates market-led development that would occur in any case. To the degree that it is normative, prescribing development contrary to expected trends, an indicative plan must be supported by a political community of interests or be supplemented by other implementation tools.

The bilateral governance alternative to regulation is contractual development control, which takes two forms. When the state is the landowner, contract zoning ensures implementation that conforms to public plans. Examples include Hong Kong's long-term leasing of Crown land, The Netherlands' municipally acquired and prepared developments, and Israel's management of public lands.

On large privately owned tracts, developer-sponsored planning can link with voluntary development control in the form of contractual covenants and restrictions (CCRs). Though these are popular in North America, they are rarer in Europe, and are almost unknown elsewhere. Evaluations of their success are mixed and raise many contextual considerations, which are undoubtedly relevant to their transferability.


Discussion

This institutional analysis of the land development and real-estate sector illustrates the fallacy of juxtaposing planning and the market. It is only in third-party governance that we find land use planning outside and complementary to the market. Here planning and regulatory development control are conceived of and delivered as sovereign tasks, becoming part of the land and property markets' institutional environment as institutional economics prescribe.

But our analysis reveals alternative forms of governance. In bilateral governance various forms of planning and development control exist as administrative and market supports in the market. Non-statutory planning ranges from public agencies planning in developer roles, through public indicative planning and public-private partnerships, to developer-sponsored planning of new communities and large-scale tracts. Development control that is in and by the market includes contract zoning and contractual covenants. None of this fits the simplistic dichotomy of planning and markets.

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