Can we ever change the status quo and know that we've not done harm?
I had an interesting Twitter exchange with David Seymour and Jim Rose the other night. I'd characterised Epsom as a millstone for any aspiring liberal party in New Zealand. Epsom voters, or at least enough of them, strongly oppose that any of their neighbours be allowed to build anything anywhere: no subdivision, no townhouses, no apartments. Seymour's maiden speech, which I otherwise generally liked, included this bit:
I totally support building more suburbs. But you cannot build more Epsom where an essential part of it is location: close to amenities and downtown. The only way of having more Epsom is building more in Epsom.Our communities are leafy and our schools prestigious. If people want more Epsom the answer should be to create more Epsom. More good schools, more good suburbs.But the opposition would cram more people into smaller denser dwellings, changing the character of our communities and putting intolerable pressure on burgeoning school zones.
Maybe some parts of Labour or the Greens would support approaches that would force densification by banning development on the outskirts of town, but simply allowing property owners to decide how to use their land isn't cramming more people in, or at least not beyond that which those residents would voluntarily choose. A neighbour down the road putting up a townhouse does not force you to cram more people into your house. And neither does an apartment two blocks over. And while there can be pressure then on local schools, the better response is to expand the schools. It's not like Epsom voters own or pay for the schools: schools are covered out of everybody's income taxes and GST, not just current Zone residents' taxes.
In the later Twitter chats, David re-emphasised that neighbours do have a property right in each other's land use, and that Coase could solve.
@EricCrampton both do, question of extent.I agree with David that, because our consenting processes give many many people veto rights over others' developments, or at least the right to impose hassle and cost on anybody wishing to develop, there are de facto property rights in others' land use. That's one reason that it's important to find ways of paying off the losers to encourage that change can happen. But I'm very pessimistic that Coasean solutions can obtain where the starting point is that just about anyone can deem themselves to be an affected party and object to a change in land use.
— David Seymour (@dbseymour) October 22, 2014
Coase makes the important point that externalities are two-sided and that the efficient solution can obtain where parties can negotiate: whether I have the right to subdivide, or my neighbour has the right to block me, we'll get to the efficient solution either way so long as property rights are clear and we can bargain reasonably. If my subdivision annoys my neighbour more than it benefits me, then either he'll block my subdivision attempt if he has the right to do so, or he'll pay me to not subdivide if he doesn't.
These Coasean solutions are limited by the extent of transaction costs. When transactions costs are high, the allocation of default rights matters. Suppose that my subdivision is worth $1000 to me and annoys each of 10 neighbours by $150. If my neighbours cannot easily get together to pay me to not subdivide, then I subdivide if I have the right to subdivide, and I don't if they have the right to block me. Default rights then matter. Conversely, if my subdivision is worth $2000 to me and annoys each of my 10 neighbours by $150, they will block me, if they have the right to, unless I find some way of transferring at least $150 to each of them.
In the higher transaction cost case, we aim to set the property rights such that the nuisance is avoided at lowest cost. Is it simpler for affected neighbours to get together and negotiate a package to pay someone not to develop, or for the would-be developer to find all of the potentially affected neighbours and negotiate a package deal with them to let him develop?
If the number of affected neighbours is fixed rather than variable, then the solution on either side very likely involves option contracts or dominant assurance contracts. Consider the case listed above, where the development is worth $1000 to the developer and aggregate nuisance is $1500. In that case, if the developer has the right to develop, one affected neighbour could write the following contract:
I agree to pay $130 into a common pool to pay the guy down the road to put a covenant on his house against further subdivision, but only if each of the 10 affected neighbours, including me, signs onto the deal. If we don't all sign on, then the deal doesn't go ahead.That's called an assurance contract. And if we worry about free-riding, we can use a dominant assurance contract: the most aggrieved neighbour (say a guy who experiences costs of $200 instead of $150) agrees to pay each of the others $5 to sign the assurance contract. Everybody signs, then they buy the covenant restriction on the neighbour, and the inefficient development is stopped.
Flip is around now to have an efficient development but veto rights being held by the 10 neighbours. I would use an option contract in that case: go around to each of the 10 neighbours and offer them the following contract:
I will pay you $5, right now, if you promise not veto my subdivision. If I do subdivide, I will pay you an additional $160. If I do not wind up subdividing, you get to keep the $5 for having signed on.Each neighbour is paid more than the cost of the development to him and gets a $5 signing bonus. Hooray! We get the efficient solution. There are transaction-cost reducing contractual forms.
Unfortunately, the mess is more intractable than that. We do not have a fixed pool of potential veto players. Any number of heritage advocacy groups could emerge to object, for instance, and they don't even have to be based in the local community. The emergence of veto players is then endogenous to the expected returns from objecting. In other words, if you expect that somebody might pay you off for not blocking, then you might just get people getting into the blocking business. We can also imagine endogenous entry into the subdividing business: if I just saw my neighbours pool together a pile of money to block the guy down the road from subdividing, I might start making noises about wanting to subdivide in order to extract similar payments, even if I had no interest in subdividing.
In that case, and if we follow a Coasean logic, we set the rights to minimise this kind of entry. Part of the solution is limiting the number of persons with legal standing to object, but that begs the question when the matter at hand is who should have the property rights. It is cheap and easy to object to things: entry into the objecting business is simple. Making credible threats of subdividing or putting up an apartment building are harder. You need to get a whole pile of planning documents together, get architectural plans for the new buildings, start the building consent process. It's far more expensive to get into the building-as-rent-extraction business than to get into the blocking-as-rent-extraction business. And so the default rights should lie with the property owner.
We also have the very serious problem, where entry is endogenous, of potential over-extraction. The assurance contract set-up, and especially the dominant assurance contract set-up, avoided that by getting ex ante agreement among the affected parties on the scale of the request. If you shift to individual one-by-one negotiated payments to each of the veto players, because more veto players can emerge endogenously, you risk that the sum of the extraction requests exceeds the value of the development project, even if the real costs of the project are less than the benefits: each party over-plays his hand and sinks the bargain.
I consequently argue that the Coasean logic points pretty strongly towards a right to develop rather than a right to block. I however agree with David that the status quo is otherwise. And so we then come to the status of the status quo.
When I argue against Canadian dairy subsidies, I suggest that we need to pay off the losers to make it happen. This isn't because I have inordinate sympathy for Canadian dairy farmers who have effectively stolen from Canadian children for decades: the value of their dairy permits is really the capitalised value of annual theft. It is because I recognise that you can't manage it unless you pay off the losers.
James Buchanan made a similar point in his classic The Status of the Status Quo.
Buchanan says the only norm is agreement; we can't use an efficiency norm. And the only way of getting agreement is to compensate the losers, turning Kaldor-Hicks moves into Pareto moves. In Buchanan's framework, the positive economist begins by identifying things that look inefficient, then moves into thinking about compensation frameworks that allow change to happen.
While economists may well look to compensation regimes for buying out Canadian dairy farmers, or owners of taxicab medallions, it would be rather perverse for economists, or classical liberal non-economists, to spend a lot of time decrying any attempt to liberalise agriculture, or taxicabs, or housing, because of the implicit assault on de facto property rights. If the justice system failed to prosecute theft under $1000 because of the transactions costs, then a technology change made it efficient to prosecute theft in the $500-$1000 range, we would not spend a lot of time bemoaning the de facto right that thieves held in theft under $1000. If thieves were sufficiently politically powerful that we had to pay them off to make the change, we could recommend that, but we'd hardly spend all the lead-up time working to strengthen the thieves' bargaining position in the later political negotiations.
Buchanan takes a principled epistemic position here:
The Pareto construction may, of course, be translated directly into the Wicksellian approach (Wicksell, 1896) already outlined by making agreement the only test for determining whether or not any proposed change is Pareto superior. There may be normative properties of the set of compensations that might be required to secure agreement on proposed efficiency-enhancing shifts in constraints – normative properties that the observing political economist might, in some personalized way, abhor.
Straightforward "taking," as opposed to compensation aimed to secure agreement, may seem preferred, and especially if the positions in the status quo seem to be "ill-gotten." Nonetheless, a too-early or too-eager intrusion of external and independent value norms into the discussion will serve only to reduce the usefulness of the whole Wicksell–Pareto construction, which, as noted, remains value free save for the minimal normative weight assigned to the individualistic presupposition.In this kind of case, we'd have no change to anything in Epsom unless we have the agreement of everybody in Epsom and every other potential veto player. But I caution that there would be zero case for any other change in this kind of world either: there will always be parties so intractable that you cannot compensate them for allowing the existence of partnership schools, mining on land they don't own but care about, or subdivision on land they wrongly believe to be critical for agriculture. There are no Pareto improving moves where we allow psychic costs to count; heck, some would object just for lulz. We need Buchanan and Stubblebine's framework instead, where we count actual willingness to pay rather than imagined harm.
But while that seems that it would allow for no change to anything anywhere, he de-privileges the status quo where the status quo policy emerged not from unanimous consent but rather from the operation of a majority coalition: the majority giveth the regulatory rent, the majority taketh away.
Return again to the rent-control example. If the initial legislation establishing rent control is considered to have been an unwarranted ‘‘taking’’ of potential value from acknowledged owners of property, the maximal compensation that might be offered to beneficiaries may be much below that required to secure agreement.
For any of several reasons, there seems to be a strong likelihood that the parties on the separate sides of any potential agreement will differ, and perhaps substantially, in their relative evaluations of the control claim. The current recipient of the housing subsidy may treat the claim as if protected by an operative property rule, whereas the prospective beneficiaries of abolition may reckon optimistically on electoral success, in part because they do not accept the claims to be legitimate. Both sides of the prospective debate about legislative action to remove existing controls may find it advantageous to invest resources in rent seeking – the occupant, to protect the value of her claim, and the prospective beneficiary of removal, to secure the promised return. The political economy of conflict replaces the political economy of consensus.And what of the case in which abolition of height and density restrictions in Epsom would increase the value of land in Epsom, but reduce the cost of dwellings (each on a smaller footprint), and so enrich the current owners and benefit new residents? While it's frustrating, I still think we have to pay them off at the margin: they perceive themselves as aggrieved, and they're powerful enough to block things.
David is doing exactly what he needs to be doing as Epsom MP: enhancing the bargaining position of his voters in the later negotiations, so that when their illegitimate restrictions on others' land use are removed, a bunch of very wealthy people will be compensated with even more money for a policy move that will very likely make them wealthier even absent the compensation. But it's voters like these, in Epsom, that make me despair for the existence of a liberal party based there. Hard to say where would be better though; if it were based in the Coromandel, maybe it would care most of all about Coromandel people's right to block mining on other people's land even if there are zero real effects on them, because of the character of the Coromandel, and because they have a starting right that allows them to block.
The lefties have one part very right when they suggest that RMA reform should start in Epsom: why should the status quo be especially privileged in privileged places? I can't see how anybody can credibly stand on a platform of "Development for thee, but not for me". The better starting point is individual property rights, default presumptions of a right to build or to develop, and restrictions placed where there is evidence of real and substantial negative externalities. It's liberal, and it's right, and it's what moves the country forward: not just on housing, but on development more broadly.