Once again we are having an acrimonious debate about land-use planning and development. Our planning system is designed, of course, to create acrimonious debate as we have a ‘winner takes all, loser loses all’ outcome.

Just take, for example, the possibility that my neighbour would like to build a house in his back garden. He has an incentive to build the biggest possible house and I have an incentive to oppose all development. We both have an incentive to take positions that are antagonistic to each other unless, out of simple neighbourliness, we try to accommodate what we believe to be the desires of the other party. A bureaucrat will then come along and settle the dispute in one direction or another.

The fact is that at some price I would be happy with my neighbour’s development and, at some price, he would prefer not to undertake the development. Furthermore, the price at which I would accept his development would go up the bigger the development was and the value to the neighbour is only likely to go up with the size of the development at a decreasing rate (because every extra square foot of house will have a decreasing marginal utility and every extra square foot of garden lost will have an increasing marginal utility). There will be a price – paid by the developer to the neighbour – at which some development is acceptable to both parties. If there is not, then development should not take place in any case.

There are problems to be overcome. As with any bilateral monopoly there will be a range of outcomes acceptable to both parties and negotiation will be necessary. There will be transactions costs. There will also be the problem of defining the initial property rights – should my neighbour compensate me for the development or should I pay him not to develop?

As we move to a larger scale, some of these problems are alleviated. For example, if a developer wants to build 100 houses, he might be able to build these near five different villages and we no longer have a bi-lateral monopoly problem. Furthermore, the price mechanism means that the preferences of the different sets of villagers would be taken into account. If Village One wanted £1m compensation and Village Two wanted £2m compensation for the building of the 100 houses, the developer would weigh this up against the value of the houses in the different villages (which would reflect the value put on the houses in the two different locations by potential purchasers). You would get development where the benefits outweighed the costs to the greatest degree and all parties would be happy. Not only that, efficient ways of mitigating the effect of the development would also be encouraged – a community might want less compensation if all the houses were brick and flint, had large gardens and were surrounded by an apple orchard for example. These sorts of negotiations could be undertaken at parish level in much of Britain. Not every villager would be happy with the outcome, but that is better than the current system where nobody is happy if development takes place.

In other words – if left broadly in its current form – our planning system needs to include compensation mechanisms to ensure that the value put on new development is taken into account; that environmental amenities are enhanced; that we can have planning ‘by agreement’ and not by bureaucratic resolution of conflicts; and so that people’s reasonable claims to established property rights can be taken into account.

In the government’s proposals for reforming the planning system, there are three compensation mechanisms. The first is that the developer has to provide all the infrastructure and compensate local communities for the impact on their infrastructure. That is okay as far as it goes but only addresses part of the problem. Section 106 ‘agreements’ remain but these are basically used to enrich local councils and finance projects that are not really necessary rather than involve real money finding its way to the people. And local councils will be able to keep the council tax and business rates from new development – again nice for the bureaucrats but no substitute for real money going to real people. None of these mechanisms are effective. They do not lead local communities and developers to actually uncover preferences for development relative to the value of environmental amenities and so on.

The answer to this problem was proposed in The Land Use Planning System by John Corkindale in 2004. It requires direct payments to the people affected by development decisions and a proper delineation of property rights – as summarised above. The main argument against this approach is the transactions costs it would involve. There may be transactions costs but the potential gains are huge. Furthermore, Corkindale shows (rightly in my view) that the transactions costs are likely to be less than people fear. After all, both sides to any planning negotiation will have an incentive to ensure that there is an outcome that suits both sides. Currently, both sides to a planning dispute have an incentive only to ensure that they benefit the most and the other side gets nothing.