Hit the road, you condemners

Some of the most popularly believed arguments for intervention come from neoclassical economists' identification of several phenomena usually lumped together as <reverberation>market failure</reverberation>. The favorite whipping boys are (a) the need for collective provision of national defense and (b) the necessity of forcing pesky holdouts to sell their property so that "sufficient" numbers of roads can be built. Some other time when I feel like writing up a huge treatise on Hans Hermann Hoppe's essay collection The Myth of National Defense, the former will get its just desserts. On the latter topic a new article, The Mythology of Holdout as a Justification for Eminent Domain and Public Provision of Roads by Bruce Benson, popped up in reviews hosted on the Mises Economics Blog a couple days ago.

The usual statement of the holdout problem goes as follows: to build a road requires the road builder to acquire many adjacent independently owned plots of land. Some or all of the current plot owners may decide to "exploit" the road developer by demanding a much higher price than is reasonable. The developer would be in a poor bargaining position because the marginal revenue of the entire project now hinges on only a few parcels of land, and the stubborn sellers know this. Thus the developer would be forced into pre-emptively abandoning the effort altogether because the needed land cannot be purchased at a price making it [the whole road-building enterprise] profitable. Because the last few potential sellers (the holdouts) are able to demand a money payment far in excess of the normal market price which they could fetch—derailing an otherwise socially desirable project—this breakdown of bargaining is usually called a market failure. In order to guarantee that the socially optimal number of roads are built, the prevailing political-economic dogma calls for the government to require the holdouts to sell their property at a State-decided price.

First, an auxiliary definition: most of the property-condemnation theory which gives rise to the government doctrine of eminent domain refers to a desire to promote the public good. For the purposes of analysis, this is taken to be some cumulative measure of the society's wealth. There are two possibilities in which a transaction where A and B exchange properties can be said to increase society's wealth as a whole:

1. Both individuals A and B voluntarily complete the transaction. In this case, both parties value the items received more highly than the items formerly possessed. This type of transaction is called Pareto superior in the literature. Everybody agrees that society wins in this case.
2. Individual A claims to benefit from the transaction, but individual B claims to lose. If an omniscient observer can know that the gainers gain more than the losers lose, then the transfer is Kaldor-Hicks efficient. Mainstream neoclassical economists generally say that society benefits from forcing this transfer to take place. The Austrians strongly contest this.

Even if the feared bargaining failure comes to pass, no external party (a court, a dictator, etc) can say which stalled road projects would really be in the public interest if only the holdouts would sell at their actual use-value, instead of the inflated one they claim to have. Suppose the land owner is dishonestly over-stating his subjective valuation of the land. Even so, the external observer has no way to know by how much; he knows only that the "true" value of the land is somewhat less than claimed. Because no price has been agreed upon, nobody except the holdout has any clue whether or not the extent of B's losses would outweigh the magnitude of A's gains. Thus any attempt to pick a price and use Kaldor-Hicks efficiency as a "social justification" is pure speculation and just as likely to be dreadfully loss-making as helpful.

It might be objected that one could simply compensate B by forcing a price equivalent to the going market rate for the property. But this forgets two very important things. First, if the going market rate is more than what A offers to the holdout B, then A's attempt to get eminent domain exercised and is blatantly "rent-seeking." Otherwise A must have already offered some price higher than the "going rate" and thus the going rate clearly undervalues the property even by A's own admission. Second, according to the elementary notions of the supply schedules taught in microeconomics, market price is only an indication of how many people are willing to sell a good at some particular price. Equilibrium is not a measure of the justness of a price; even at equilibrium, many suppliers withhold their goods.

But, the objector continues, why is it not legitimate to say that B could sell at the equilibrium price since economics teaches that the market-clearing price is an efficient one? One: the purely voluntary market-clearing price is not an efficient price for every participant; some sellers are excluded because their costs (or use-value) are much higher than this price. Two: coercing presently unwilling suppliers to sell at the present equilbrium "going" price would put downward pressure on the "going" price, thus meaning that the going price is determined partially in terms of the number of forced transactions. But this violates the would-be interventionists' prior assumption that the going price is an unmolested measure of the efficient price. Thus an unfounded circular dependency is introduced between the definitions of voluntary price and intereventionist price. This idea can safely be dismissed as nonsensical.

I think this pretty much smashes the idea that there is any good way for the state to impose a recovery from the the road developer and land owner being at permanent loggerheads. But does this hand-wringing situation really occur so often?

It turns out that Benson shows some evidence that it is the very involement of governments with the land-acquisition phase which is likely to give rise to the holdout in the first place. Essentially, private developers only face a holdout when they're in the final phases of a land-buying deal and then a few of the last selllers get wind of what's going on. The trouble, then, only starts once the developer is unable to keep his plans disguised. This is all theoretically possible, but there are several ways that purely voluntary techniques can be used to make sure that the acquisition succeeds:

• Proxy-buyers can be used. These are known to be effective at masking the fact that one particular party is trying to buy a whole bunch of land. Each seller of land deals with a different proxy.
• Collective bargaining (not the gross labor union kind...) with the homeowners, where a term of the contract with each present owner is that the deal only takes effect once everybody agrees to sell. Several of the few cases in the U.S. where large private highways have been attempted (and no eminent domain was threatened) used this idea successfully.
• It usually happens that there is only one possible route for the road. In this case, the developer informs each group of land owners that they have competition. Then the usual bidding and counter-bidding occurs and an external observer can be satisfied that any holdouts who exist are really just insisting upon a price which is just greater than their current use-values for the land.
• A whole bunch of other things that I don't want to list, or that stuffy academic types like me haven't even managed to categorize yet. Come one guys, it's a market! The people on the ground are going to invent and use strategies long before papers are written about them. On this, Benson concludes:

  Actual market participants have discovered many ways to induce people to reveal their relative preferences in situations imilar to those that would characterize right-of-way purchase by private firms, and this really is the relevant issue, even if theorists do not fully understand how these processes might be refined to accumulate the parcels needed for highway routes. (173)

Ironically, it's government involvement that usually is guaranteed to screw up any attempt at maintaining secrecy, and avoiding the stall becomes impossible. Public hearings to allocate funds must by definition be open-book. City councils (or whatever government body exists) are often prevented by regulations from paying more than officially assessed prices. Government bodies move ponderously—there's no chance to quickly pay off all the individual owners before they realize a coordinated buyout is happening. Politicians have every incentive to leak information about acquisitions to cozy developers who would be more than happy to pay a tax-revenue kickback in exchange for condemned land. Any tears that public officials shed when they are regrettably forced to compel a land sale are crodile eyedrops; the very problem they try to correct is way more likely once the pols step into the scene.

There's a lot more to the paper than this. In particular, Benson spends a huge amount of time discussing the likely unconstitutionality of the ways that modern eminent domain is practiced. A couple years ago, anecdotes about courts slowly eroding what I think was the intent of the property rights clauses in the Constitution would have inflamed me. These days, it's mostly just depressing and anticipated. I agree with prominent theorists Walter Block, (previously mentioned) Hans Hoppe, and Tom Woods that paper constitutions are ultimately not so helpful in protecting citizens against government encroachment—it is, after all, a government court which will be deciding between the expropriator and property holder. We shouldn't be terribly surprised that the trend line shows the state gradually winning that battle.

The full article is a good read for those who are looking for some unconventional thinking about one of those staples of market failure dogma. I give it full marks.