5. Bad Economics, Good Law: The Concept of Externality

The latter is rarely of concern even though it is common. Details of the economic definition of externality will be reviewed later in the chapter.

Middlebury College v. Central Power Corp. of Vermont, 143 A. 384, 390 (Sup. Ct., Vt. 1928), citing Holmes (1899).

In a contested will, the court looked to effectuate the textratrix’s intention. “The criterion designated by Mr. Justice Holmes as ‘the externality of the law’ simply reflects that we must ask what the words used in the instrument would mean ‘in the mouth of a normal speaker of English using them in the circumstances in which they were used...’ (Holmes 1899, p. 417)” Hemphill v. Mississippi State Highway Comm., 145 So.2d 455, 459 (Sup. Ct., Miss. 1962). The same court used the word in that context a few years later in Yates v. State, 189 So.2d 917 (Sup. Ct., Miss. 1966), stating, at 921, “The infeasibility of getting into the mind of a person to determine what he thought or believed is a sound reason for the principle of externality that requires judgments be based on something more than subjective statements of what one believes or thinks.”

For specific references to network externalities see U.S. v. Microsoft Corp., 147 F.3d 935, (D.C. Cir. 1998); California Dental Assn. v. F.T.C., 224 F.3d 942 (9th Cir. 2000); U.S. v. Microsoft Corp., 253 F.3d 34 (D.C. Cir., 2001); Freeman v. San Diego Association of Realtors, 321 F.3d 1133 (9th Cir. 2003) where Judge Kozinski noted, at 1153 fn. 28, that those who worry about the anti-competitive consequences of network externalities have made it the market “defect du jour;” Broadcom Corp. v. Qualcomm, Inc., 501 F.3d 297 (3rd Cir. 2007); Novell, Inc. v. Microsoft Corp., 505 F.3d (4th Cir. 2007); Sprint Nextel Corp. v. AT&T, Inc., 821 F.Supp.2d 308 (2011).

Matter of Sinclair, 870 F.2d 1340 (7th Cir. 1989) and In re Walsh, 260 B.R. 142 (Bkrtcy. D. Minn. 2001).

Center for Fair Public Policy v. Maricopa County, Ariz., 336 F.3d 1153, 1162 (9th Cir. 2003). Other courts have ruled similarly, holding that regulation of “adult” business, such as strip clubs, is a permissible activity for the state as it protects parties from external effects created by the presence of such businesses; see Entertainment Productions, Inc. v. Shelby County, Tenn., 588 F.3d 372 (6th Cir., 2009).

Superior Oil Co. v. Western Slope Gas Co., 604 F.2d 1281 (Ct. App. Colo. 1979); Court Street Steak House, Inc. v. County of Tazewell, 643 N.E.2d 781 (Sup. Ct. Ill. 1994); Smelkinson Sysco v. Harrell, 875 A.2d 188 (Ct. Spec. App. Mary. 2003); Willard Packaging Company, Inc. v. Javier, 899 A.2d 940 (Ct. Spec. App. Mary. 2006).

For example, People v. Pate, 310 N.W.2d 883 (Ct. App., Mich. 1981); Zettlemoyer v. Fulcomer, 923 F.2d 284 (dissent) (3rd Cir. 1991); U.S. v. Meyers, 906 F.Supp. 1494 (D. Wyo. 1995); U.S. v. Bin Laden, 132 F.Supp.2d 168 (S.D. N.Y. 2001); People v. Huston, 802 N.W.2d 261 (Mich. S.Ct., 2011).

Id. at 1018.

Id. at 1032.

Alliance for Clean Coal v. Miller, 44 F.3d 591 (7th Cir. 1995); U.S. v. Marine Shale Processors, 81 F.3d 1329 (5th Cir. 1996); LaFleur v. Whitman, 300 F.3d 256 (2nd Cir. 2002); Glustrom v. Colorado Public Utilities Comn., 280 P.3d 662 (Colo. S.Ct., 2012); American Coatings Assn., Inc. v. South Coast Air Quality Dist., 278 P.3d 838 (Calif. S.Ct., 2012).

Carpenter v. Double R Cattle Co., 669 P.2d 643, 653 (Ct. App. Idaho 1983). “Externalities distort the price signals essential to the proper functioning of the market.” The court cited Coase (1960), and argued that intervention was required because there are “impediments to changes of property” that might otherwise solve problems such as the one illustrated in this case.

Philadelphia Electric Co. v. Hercules, Inc., 762 F.2d 303 (3rd. Cir. 1985); the court cited, at 314, an article with the word externalities in the title. Cottle v. Superior Court, 3 Cal.App.4th 1367 (Ct. App., 2 Dist., Cal. 1992); the court briefly discussed the divergence of private costs and social costs, citing an article on externality at 1402. In neither case did brief discussion of externality appear to have any effect on the outcome.

Lincoln v. Republic Ecology Corp., 765 F.Supp. 633 (C.D. Cal. 1991); Transportation Leasing Co. v. State of California, 861 F.Supp. 931 (C.D. Cal. 1993); Louisiana Pacific Corp. v. Beazer Materials & Services, Inc., 842 F.Supp. 1243 (E.D. Cal. 1994); Westfarm Associates LP. v. Washington Suburban Sanitary Comm., 66 F.3d 669 (4th Cir. 1995); Acushnet Co. v. Coaters, Inc., 948 F.Supp. 128 (D. Mass. 1996).

Aetna Casualty & Surety Co. v. Dow Chemical Co., 28 F.Supp.2d 448 (E.D. Mich. 1998); PSI Energy, Inc. v. U.S., 59 Fed.Cl. 590 (Fed. Cl. 2004).

McGowan v. Mississippi State Oil & Gas Bd., 604 So.2d 312 (Sup. Ct., Miss. 1992); In re Water Use Permit Applications, 9 P.3d 409 (Sup. Ct. Haw. 2000); U.S. v. Wayne County, Mich., 369 F.3d 508 (6th Cir. 2004).

Public Utility Commissions have different names in different states; the term is generic here.

Brae Corp. v. U.S., 740 F.2d 1023, 1057 (D.C. Cir. 1984); Colorado Office of Consumer Counsel v. Public Utilities Comn., 786 P.2d 1086 (Sup. Ct. Colo. 1990); CF&I Steel, L.P. v. Public Utilities Comm., 949 P.2d 577 (Sup. Ct. Colo. 1997); GTE Southwest Inc. v. Public Utility Comm., 10 S.W.3d 7 (Ct. App. Tex. 1999); New York State Electric & Gas Corp. v. Public Service Comm., 753 N.Y.S.2d 332 (Sup. Ct. N.Y. 2002); Commonwealth Edison Co. v. Illinois Commerce Comn., 937 N.E.2d 685 (Ill. App., 2nd Dist., 2011); People ex rel. Madigan v. Illinois Commerce Comn., 958 N.E.2d 405 (Ill. App., 1st Dist., 2011).

Engineering Dynamics, Inc. v. Structural Software, Inc., 26 F.3d 1335 (5th Cir. 1994). See also Autoskill, Inc. v. National Educational Support Systems Inc., 793 F.Supp. 1557 (D. N.M. 1992); Kepner-Tregoe, Inc. v. Leadership Software, Inc., 12 F.3d 527 (5th Cir. 1994); Mitel, Inc. v. Iqtel, Inc., 124 F.3d 1366 (10th Cir. 1997); Torah Soft Ltd. v. Drosnin, 136 F.Supp.2d 276 (S.D. N.Y. 2001). The Mitel case was cited, in the same externality context, in Dun & Bradstreet Software Services, Inc. v. Grace Consulting, Inc., 307 F.3d 197 (10th Cir. 2002).

Computer Associates International, Inc. v. Altai, Inc., 982 F.2d 693 (2nd Cir. 1992). Similarly, another court referred to a network externality caused by too much demand on computer user bases; Free FreeHand Corp. v. Adobe Systems Inc., 852 F.Supp.2d 1171 (N.D. Cal. 2012).

Apple Computer, Inc. v. Microsoft Corp., 799 F.Supp. 1006 (N.D. Cal. 1992). Another case mentioned network externality in referring to a publication with the term in the title; DocMagic, Inc. v. Ellie Mae, Inc., 745 F.Supp.2d 1119 (N.D. Cal. 2010).

DeArmond v. Sommer, 348 N.E.2d 378 (Ct. App. Ohio 1975); Dickerson v. U.S. Steel Corp., 472 F.Supp. 1304 (D.C. Pa. 1978); Martin v. Sullivan, 932 F.2d 1273 (9th Cir. 1991); Westinghouse Hanford Co. v. Hanford Atomic Metal Trades Council, 940 F.2d 513 (9th Cir. 1991); Martin Marietta Corp. v. Lorenz, 823 P.2d 100 (Sup. Ct. Colo. 1992); Davis v. Portline Transportes Maritime Intl., 16 F.3d 532 (3rd Cir. 1994); Northern California Drywall Contractors Assn. v. Dist. Council of Painters No. 8, 879 F.Supp. 96 (N.D. Cal. 1995); Carollo v. Cement and Concrete Workers Dist. Council Pension Plan, 964 F.Supp. 677 (E.D. N.Y. 1997); Collette v. St. Luke’s Roosevelt Hospital, 132 F.Supp.2d 256 (S.D. N.Y. 2001); Melvin v. US Local 13 Pension Plan, 202 F.Supp.2d 564 (W.D. N.Y. 2002); City of Long Beach v. Dept. of Industrial Relations, 1 Cal.Rptr.3d 837 (Ct. App. 2 Dist., Cal. 2003); Keenan v. Director for Benefits Review Board, 392 F.3d 1041 (9th Cir. 2004); Committee of Concerned Midwest Flight Attendants for Fair and Equitable Seniority Integration v. International Broth. of Teamsters Airline Div., 662 F.3d 954 (7th Cir. 2011).

Id. at 1551, citing Epstein (1987).

Joseph M. Still Burn Centers, Inc. v. AmFed Nat. Ins. Co., 702 F.Supp.2d 1371 (S.D., Ga. 2010). Similarly, in another worker’s compensation case the court noted that payment from another source was an externality (a benefit to the worker); In re Wadsworth’s Case, 935 NE.2d 333 (Mass. App. Ct. 2010).

Creed v. California Coastal Zone Conservation Comm., 118 Cal.Rptr. 315, 321 (Ct. App., 4th Dist., Cal., 1974), citing Sato (1972).

Melillo v. City of New Haven, 732 A.2d 133 (Sup. Ct. Conn. 1999), the court rejected that a takings occurred due to airport noise, which the plaintiff claimed to be externalities; District Intown Properties LP v. Dist. Columbia, 198 F.3d 874 (D.C. Cir. 1999), the concurring opinion asserted that historic preservation laws resulted in positive externalities by protecting old buildings that some people enjoy; R&Y, Inc. v. Municipality of Anchorage, 34 P.3d 289 (Sup. Ct. Alaska 2001), holding that a construction setback requirement was not a taking. Such land-use restrictions impose externalities no worse than the traffic suffered from increased commercial activity; it is non-actionable.

International-Stanley Corp. v. Dept. of Revenue, 352 N.E.2d 272 (Ct. App. Ill. 1976); Nunes Turfgrass, Inc. v. County of Kern, 111 Cal.App.3d 855 (Ct. App. Cal. 1980); Michigan Assn. of Counties v. Dept. of Management and Budget, 345 N.W.2d 584 (Sup. Ct. Mich. 1984); Chevron U.S.A., Inc. v. City of Perth Amboy, 10 N.J.Tax 114 (Tax Ct. N.J. 1988); Lampy Ready Mix, Inc. v. County of Otter Tail, 1991 WL 44882 at 4 (Tax Ct. Minn. 1991); Vermont Soc. of Assn. Executives v. Milne, 779 A.2d 20 (Sup. Ct. Vt. 2001).

IHC Health Plans, Inc. v. Commissioner of Internal Revenue, 325 F.3d 1188 (10th Cir. 2003), referring to the “positive externalities” generated by certain public goods; PSI Energy, Inc. v. U.S., 59 Fed.Cl. 590 (Fed. Cl. 2004), referring to the “positive externality” received by free riders who get public benefits without paying for the benefits.

In one case the court euphemistically called the taxes a “compensation charge” or “user fee” where property owners were assessed a fee when they demolished a residential building. The fee could be avoided if the property owner constructed “affordable” housing. The fee was to compensate other city residents for the impact of the demolition. Kathrein v. City of Evanston, Ill., 636 F.3d 906 (7th Cir 2011); then cited in Empress Casino Joliet Corp. v. Balmoral Racing Club, Inc., 651 F.3d 722 (7th Cir. 2011). In this case the court was not ruling on the constitutionality of the taxes but on the right to contest the taxes. In Rincon Band of Luiseno Mission Indians of Rincon Reservation v. Schwarzenegger, 602 F.3d 1019 (9th Cir. 2010), the court struck down a state tax on gambling on an Indian reservation but noted that in general gambling taxes may be imposed to help offset the negative externalities caused by gambling.

Holmdel Builders Assn. v. Township of Holmdel, 583 A.2d 277 (Sup. Ct. N.J. 1990), referring to “unfettered non-residential development” that has caused externalities; Burlington Northern Santa Fe Railroad Co. v. The Assiniboine and Sioux Tribes of the Fort Peck Reservation, 323 F.3d 767 (9th Cir. 2003), referring to “nonmember activities that produce externalities for tribes but do not rise to the level [required for legal action or for compensation to be required]” as the tribes wanted to be paid for costs suffered by trains crossing the reservation; Carter v. Carolina Tobacco Co., 873 N.E.2d 611 (Ct. App. Ind. 2007), regarding externalities asserted to exist, by a consultant to states’ attorney generals for the Master Settlement Agreement on tobacco, if any tobacco sellers could avoid being part of the settlement.

Id. at 437. Posner (1992) is cited in support.

Monroe v. Sarasota County School Bd., 746 So.2d 530 (Ct. App., 2 Dist., Fla. 1999). This language was quoted later in Virgilio v. Ryland Group, Inc., 695 F.Supp.2d 1276 (M.D. Fla., 2010). The court rejected a claim by homeowners that it was negligent for a developer not to reveal to them that the location of their homes had once been a bombing range used by the military.

Id. at 75. The court cited the Miles Labs case, supra n. 107 for the proposition that “the costs or externalities are thrust upon victims or upon society,” at 1471.

LaFleur v. Shoney’s, Inc., 83 S.W.3d 474 (Sup. Ct. Ky. 2002); Travelers Casualty and Surety Co. v. United States Filter Corp., 870 N.E.2d 529 (Ct. App. Ind. 2007); Bonewitz v. Parker, 912 N.E.2d 378 (Ind. App. 2009); Whitehouse v. Target Corp., 279 F.R.D. 285 (D. N.J. 2012); Robbins v. Physicians for Women’s Health, LLC, 38 S.3d 142 (Conn. App. 2012).

Many zoning cases involve a constitutional law claim but there are enough of these to list them as a separate category.

Basiardanes v. City of Galveston, 514 F.Supp. 975 (S.D. Tex. 1981); George Washington Univ. v. Dist. of Columbia Bd. of Zoning, 429 A.2d 1342 (Ct. App. D.C. 1981); City of Los Angeles v. State of California, 138 Cal.App.3d 526 (Ct. App. Cal. 1982); American Aggregates Corp. v. Highland Township, 390 N.W.2d 192 (Ct. App. Mich. 1986); City of Mandan v. Mi-Jon News, Inc., 381 N.W.2d 540 (Sup. Ct. N.D. 1986); Giger v. City of Omaha, 442 N.W.2d 182 (Sup. Ct. Neb. 1989); Howard v. City of Garland, 917 F.2d 898 (5th Cir. 1990); France Stone Co. v. Charter Township of Monroe, 802 F.Supp. 90 (E.D. Mich. 1992); Dvorak v. City of Bloomington, 702 N.E.2d 1121 (Ct. App. Ind. 1998); Louhal Properties, Inc. v. Strada, 751 N.Y.S.2d 810 (Sup. Ct. N.Y. 2002); Scenic Arizona v. City of Phoenix Bd. of Adjustment, 268 P.3d 370 (Ariz. App. 2011); Green v. Douglas County, 263 P.3d 355 (Or. App. 2011).

The Washington state high court held that zoning rules could not prevent a homeless encampment supported by a church as that would violate freedom of religion, City of Woodinville v. Northshore United Church of Christ, 211 P.3d 406 (Wash. Sup. Ct. 2009); a lower court later followed this decision and recognized the externality argument, but upheld the challenge to a homeless encampment as void on procedural grounds. Mercer Island Citizens for Fair Process v. Tent City 4, 232 P.3d 1163 (Wash.App. 2010).

Ben’s Bar, Inc. v. Village of Somerset, 316 F.3d 702 (7th Cir. 2003); George Washington Univ. v. Dist. of Columbia, 318 F.3d 203 (D.C. Cir. 2003); Greenville County v. Kenwood Enterprises, Inc., 577 S.E.2d 428 (Sup.Ct. S.C. 2003); R.V.S., LLC v. City of Rockford, 361 F.3d 402 (7th Cir. 2004); Andy’s Restaurant & Lounge, Inc. v. City of Gary, 466 F.3d 550 (7th Cir. 2006); Ballen v. City of Redmond, 466 F.3d 736 (9th Cir. 2006); City of Chicago v. Pooh Bah Enterprises, Inc., 865 N.E.2d 133 (Sup. Ct. Ill. 2006); State v. Stummer, 171 P.3d 1229 (Ct. App. Ariz. 2007); Martin Marietta Materials, Inc. v. Board of Zoning Adjustment of Cass County, 246 S.W.3d 9 (Ct. App. Mo. 2007); City of Joliet, Ill. V. New West, L.P., 562 F.3d 830 (7th Cir. 2009).

State of Texas v. Sec. of Interior, 580 F.Supp. 1197 (D.C. Tex. 1984), referring to outside information; Peters Township School Dist. v. Hartford Accident and Indemnity Co., 643 F.Supp. 518 (W.D. Pa. 1986), regarding events beyond insurance coverage; In re 523 East Fifth Street Housing Preservation Development Fund Corp., 79 B.R. 568 (S.D. N.Y. 1987), concerning outside events; Wint v. Yeutter, 902 F.2d 76 (D.C. Cir. 1990), referring to things that damage crops; Northern California Drywall Contractors Assn. v. Dist. Council of Painters No. 8, 879 F.Supp. 96 (N.D. Cal. 1995); concerning language outside an arbitration agreement; Demers v. Snyder, 659 A.2d 495 (Super. Ct. N.J. 1995), referring to outside information that could taint jury deliberations; Federal Trade Comm. v. QT. Inc., 448 F.Supp.2d 908 (N.D. Ill. 2006), referring to external factors that affect pain relief studies.

Smith v. City of Riverside, 34 Cal.App.3d 529 (Ct. App. Cal. 1973), referring to events that spill over from one city to another; In the Matter of the Valuation Proceedings under Sections 303(c) and 306 of the Regional Rail Reorganization Act of 1973, 445 F.Supp. 994 (Sp. Ct. R.R.R.A. 1977), noting the need to consider externalities and social values in rail reorganization; South East Lake View Neighbors v. Dept. Housing and Urban Develop, 685 F.2d 1027 (7th Cir. 1082), referring to bad effects of investment decisions that are non-actionable by third parties; Kastenbaum v. Michigan State Univ., 327 N.W.2d 783 (Sup. Ct. Mich. 1982), regarding positive benefits from the spread of information; International Union, UPGWA v. Dept. of State Police, 373 N.W.2d 713 (Sup. Ct. Mich. 1985), concerning positive benefits from the spread of valuable information; Martin v. Sullivan, 912 F.2d 1186 (9th Cir. 1990), referring to the bad consequences of a reduction in SSI benefits; Vieux Carre Property Owners, Residents and Associates, Inc. v. Brown, 948 F.2d 1436 (5th Cir. 1991), noting damage to historic properties from bad construction; Yang v. Reno, 852 F.Supp. 316 (M.D. Pa. 1994), referring to added costs of further review of deportation orders; F.D.I.C. v. Perry Bros., Inc., 854 F.Supp. 1248 (E.D. Tex. 1994), referring to financial setbacks suffered by debtors from setoffs; Escalera v. New York Housing Authority, 924 F.Supp. 1323 (S.D. N.Y. 1996), regarding drug dealing in housing projects; Martens v. Smith Barney, Inc., 182 F.R.D. 243 (S.D. N.Y. 1998), noting the social benefits from Title VII; Gardner v. Allstate Indemnity Co., 147 F.Supp.2d 1257 (M.D. Ala. 2001), referring to reducing bad effects from harmful acts; Brooks v. Pre-Paid Legal Services, Inc., 153 F.Supp.2d 1299 (M.D. Ala 2001), regarding bad effects from forum shopping; Fair Share Housing Center, Inc. v. Township of Cherry Hill, 802 A.2d 512 (Sup. Ct. N.J. 2002), noting costs imposed on some property developers; Territory of the United States Virgin Islands v. Goldman, Sachs & Co., 937 A.2d 760 (Ch. Del. 2007), concerning costs of financial abuses; Assurance Co. of America v. Lucas Waterproofing Company, Inc., explaining that a party may act strategically in litigation to shift legal costs to another party; Penn Mont Securities v. Frucher, 534 F.Supp.2d 538 (E.D. Pa., 2008), making a similar point about improper fee shifting in litigation; 581 F.Supp.2d 1201 (S.D. Fla. 2008); Department of Children and Family Services v. Chapman, 9 So.3d 676 (Fla. App., 2nd Dist., 2009), noting that external costs of certain activities may be borne by the taxpayers; Rock River Communications, Inc. v. Universal Music Group, 276 F.R.D. 633 (C.D. Cal. 2011), explaining that fee shifting in litigation from one party to another is an externality suffered by the party who is forced to bear an unexpected cost.

This does not imply that the judges who made use of externality to bolster their position were intentionally making clever use of economics they knew to be weak; economists talk so much about externality as if it is a scientific concept that one could easily assume it provides solid theoretical justification for a desired legal outcome.

“[E]verything can be said to affect everything else, so we ignore many things and focus on technological externalities.” (Hirshleifer 1980, p. 532).

The person wearing the ugly shirt probably thinks it is just dandy.