The Real Life 'Up' House - A Storybook Holdout

The other night a few of my friends and I decided we wanted to stay in and have a movie night. The debate over what to watch was hotly contested, but we finally settled on Up, the heartwarming Pixar movie about a grouchy old man (Carl) who goes on an adventure with a young boy (Russell). Part of the exposition of the movie is Carl's stubborn refusal to sell his old home to the developers building skyscrapers around him. This is a great example of a holdout; a developer who wants to build something on Carl's block, even having bought up the surrounding property, still needs to negotiate with him individually. The sentimental value that Carl places on his home is far more than market value, making him a difficult holdout to deal with and giving him inordinate power. The key difference between Carl's example and a true perfect holdout, however, is that ownership of the houses on the block is not truly shared. The developers can build around Carl's home on all of the adjacent properties they own, making his holdout more of a hindrance than a total barrier.

I was curious about the inspiration behind this story, and a quick Google search showed me that Up is loosely based on the story of Edith Macefield, a Seattle woman who allowed a shopping center to be built up around her house rather than sell it. She's far from the only real world example; there's a small leatherworks shop in my hometown that is in a similar position. Again, while these may not be perfect examples of holdouts due to home ownership on a block being an imperfect example of shared property, they are some of the clearest and simplest real world demonstrations we have. The power a single stubborn property owner can have over the development of a larger block of land closely resembles the power a single owner can have over shared property, which is the textbook definition of the holdout problem.

Gonzales v Raich through the Economic Lens of Markets Externalities

    This past Tuesday I was sitting in my Comm Law class, listing to Professor Sherri Moore lecture on the Commerce Clause and its many applications. The Commerce Clause gave Congress the power to regulate interstate commerce to prevent states from establishing laws that may disrupt the free flow of goods. There have been numerous commerce clause-related cases appealed to the courts. One case in particular, Gonzales v Raich, relates to our discussions on markets and externalities. The 2005 case involves Gonzales, a citizen of California, who had been growing medical marijuana in his backyard. The 1970 Controlled Substances Act made the use of marijuana, along with many other drugs, illegal on the federal level. Gonzales was arrested for his possession and potential use of marijuana. Gonzales went on to appeal his case under the 1996 California Compassion Act, which made the use of medical marijuana legal in California. The court ruled that the commerce clause gave jurisdiction to the federal law, specifically because the local cultivation of marijuana affected the state market for medical marijuana, thus altering market prices. Gonzales was found guilty.

            The court’s ruling on Gonzales was based on Wickard v. Filburn, a 1942 case involving the quantity of wheat allowed. The Agricultural Act of 1938 restricted the quantity of wheat individual farms were allowed to grow in hopes of manipulating market prices. Wickard, a small farmer in Ohio, sold only the allowed quantity, yet grew more for his own personal use. Although intrastate and not exceeding the quantity of wheat allowed to be sold, the courts found Wickard guilty. Their ruling was as follows: although insignificant when only one farmers, dozens and thousands of farmers growing excess wheat for personal use affects market prices for wheat. Thus, the intrastate wheat market was affected, and the commerce clause stands. Wickard was found guilty.   

            Professor Moore added another justification for Gonzales’ inditement, a justification that directly relates to our Public Choice class and discussion of externalities. Moore commented on “the possibility of overflow smells” from the marijuana, which would inadvertently influence and intoxicate the neighbors. Assuming his neighbors did not want to “get high”, the “spillover” of Gonzales’ marijuana smoke is a negative externality, much like the smelly hog farms of Michigan. 

 

Unemployment Benefits and Negative Externalities

During covid, the government increased federal unemployment benefits to help those who lost jobs due to the pandemic or those who worked in service industries that may not have felt comfortable going back to work because of the virus. However, since the end of lockdowns and the restart of the economy this has been creating a negative production externality for many consumers. For example, the other week my friend locked her keys in her car and we called AAA to help us out. AAA is a company that provides 24/7 roadside assistance and advertises themselves on their prompt service. However, they have had issues with staffing because of these unemployment benefits and many former employees are more content with their current benefits than their previous salaries. Due to this, we had to wait 5 hours in the middle of the night, the night before the first day of classes, for a tow truck that never came. And apparently this has been an issue for AAA since the end of June, as this article shows.

We experienced a negative production externality because of the external cost of the unemployment benefits that has not yet been addressed by AAA. And while the federal unemployment benefits are coming to an end soon, employees may not necessarily return to their previous jobs, since many enjoyed the changes to their work environments that they experienced during covid. To address this issue, AAA should pay attention to the external cost and either charge consumers more in order to reduce the amount of people using their service or pay their employees a higher percentage of their revenues to entice them to come back and better serve their remaining customers.

Ideology & the Hold Out Problem in the Senate

     As October approaches, the Biden administration is pushing hard for the president’s long-awaited infrastructure bill. With the narrowest possible majority in the Senate, Democrats can only pass the high-spending measure using the budget reconciliation process - a loophole allowed once per year to circumvent the filibuster. Still, in order to take advantage of this opportunity, every single democratic senator and Vice President Harris will have to vote in favor of the bill. As time to whip the votes necessary to pass the infrastructure bill wanes, centrist Democrats like Sen. Joe Manchin of West Virginia can take advantage of the holdout problem described in Grueber chapter 5. 

    Rather than property rights, these 50 democratic senators all share voting rights. As the “last one” to exercise his right to vote - since Manchin’s conservative tendencies mean his vote along the party line is not guaranteed - Manchin is in a position to hold the other Democrats hostage, negotiating bill provisions that uniquely benefit his political interests and/or his constituency. Earlier today, in fact, he decided to capitalize on this position by publicly declaring that the party needed to take a “strategic pause” on the bill the administration is so eager to pass. Majority Leader Schumer will give Manchin much more in negotiations to secure his vote now that he is essentially the only thing blocking this important political victory. 

    This example of the holdout problem is slightly different from those that plague Coasian negotiations. For one thing, though Manchin’s strategy may crumple the collective action of the Senate Democrats, it will not have any negative effect on Senate Republicans, who uniformly oppose the bill. This intragroup effect of the holdout problem is different than intergroup scenarios we studied, where an opposing group’s actions were blocked by the original group’s failure to act collectively. Additionally, unlike a more classical example of the holdout problem, Manchin is one of the only Senate Democrats willing to use the holdout strategy. The political consequences of not supporting such an important party vote could cost more liberal Democrats reelection, meaning there is not much competition to be “the last one.” 

Competitive Governance Puts The 'Choice' In Public Choice

Milton Friedman in the second chapter of Capitalism and Freedom takes for granted the government's monopoly in the role of ‘rulemaker and umpire.’ This assumption is reasonable in the context of his book, as he wants to stress shared values with those who may disagree with him, but it merits closer inspection today as the idea and implementation of competitive governance spreads around the world.

Businesses are forced to fulfill consumer preferences by competition; if they fail to provide what buyers want, they can take their money elsewhere. The absence of competition uncontroversially leads to higher prices and lower quality of goods and services. Governments use the high costs of switching governments and the high cost of starting a new government as barriers to competition. These barriers are undesirable for the same reasons as in the market. They lead to lower quality public goods and higher taxes. There are several technological and institutional strategies that we could implement in order to lower barriers and increase competition in the provision of public goods like rule-making and arbitration.

Barriers to switching governments include the costs of moving, crossing borders, job search, and cultural change. These costs can be decreased by transportation technology, federalism, and remote work. In 1850 the fastest route from New York to San Francisco was a 50 day boat journey through the Isthmus of Panama that cost several thousand dollars and put you at high risk to die of cholera on the way. Moving long distances is now much cheaper, faster, and safer than it was and there is room to improve with advances in supersonic air travel, high-speed rail, and self-driving cars. Federalism can decrease the costs of switching governments by putting many governments close together and uniting them under a free trade and open borders zone. Moving from Texas to Florida is a lot easier than moving from Cuba to Florida and Albemarle County to Fairfax County is easier still. The more autonomy that local governments have, the easier it will be to choose preferred bundles of public goods. Finally, remote work makes moving less costly by making location less important. One no longer needs to search for a new job when moving to a new place. These present and future technologies and institutions are ladders over the barriers to switching governments.

Starting new governments has traditionally required conquest or revolution, but new institutional forms such as special economic jurisdictions and decentralized autonomous organizations allow for much lower entry costs into the market for government services. Special economic zones are already allowing for more competitive governance in China, India, and Honduras, and they are spreading quickly to many more nations. Decentralized autonomous organizations (DAOs) are a way for people to securely organize social groups and governance around an agreed upon set of rules. These preference aggregation algorithms can act as venture capital firms, hedge funds, and even provide public goods. New technology and institutions have made Friedman’s assumption of a monopoly over the creation of rules, arbitration, and public goods provision unnecessary.

A Different Perspective on a Classic Negative Consumption Externality

I am sure that everyone is familiar with the classic externality example in which a house party's loud music reduces the wellbeing of a neighbor, who may be trying to sleep.  This would be an example of a negative consumption externality.  Surely if you walk down Rugby Road on a Thursday-Saturday night, you will hear fraternities playing loud EDM music, too.  While this may be disturbing to some, I am on the other end of the spectrum.  I enjoy hearing the loud late night music, so for me, it is a positive consumption externality.  I benefit from the fraternities' consumption, but I do not pay for the benefit.  When I hear the late night music, I am reminded (fondly) that UVA is a work-hard play-hard school, and that I fit in with the school's culture and made a good decision when choosing my college.  Furthermore, I am a deep sleeper, so the loud music is not costly in any way as it relates to my sleep.

But what about those that do not like the music?  After some online reading, it seems that often a noise complaint can lead to a party's music being shut down and, in some cases, the host being fined.  I am somewhat conflicted on this matter because I can see both sides.  I think in this example, though, we see one of the major problems with The Coase Theorem.  The transaction costs and negotiating problems that would arise between party-goers and neighbors are far too great.  However, when a house party is fined by a local authority for loud music I have doubts that those who are harmed (the neighbors) are the ones who receive the compensation.