The Answer Is Transaction Costs

The Devil Went Down to Grievance: Tuh, Taxes, and HOAs

• Michael Munger • Season 1 • Episode 15

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Are HOAs an argument for anarchy, or an example of it?
Ex post recontracting as a form a of aggression, when the enforcer of contracts is also a party to the contract.
And of course the TWEJ

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You can follow Mike Munger on Twitter at @mungowitz 


Transaction Costs and Institutional Role

Speaker 1

This is Mike Munger of Duke University , the knower of important things Homeowners , associations or clubs are they like states ? What would Buchanan and Tullock say about that ? And who is Tuh ? And why would we worry about him ? Also , twedge and this week's letter Straight out of Creedmoor . This is Tidy C .

Speaker 1

I thought they'd talk about a system where there were no transaction costs . It's an imaginary system . There always are transaction costs . When it is costly to transact , institutions matter and it is costly to transact . Last week's letter asked I have a disability under control now on a drug trial Doing great .

Speaker 1

I found myself quickly unable to perform routine home care and maintenance , so I traded my toolkit for a checkbook . When I moved to a condominium , my neighbors would complain about our HOA fees . I thought I'd won the lottery . Look , I give you $200 a month and you mow the lawn , shovel the walks , fix the roof , paint the garage , pay my water and trash bill and I get a swimming pool . Shared resources helps , but it occurs to me that a big part of this bargain is transaction costs . Just one contract for 500 lawn sections , one contract for 500 sidewalk segments , going super macro , would you extend this as an argument against anarchy ? One could individually contract for all these services that has high transaction costs , or subscribe to a big Randy Barnett style super HOA that would have fewer transaction costs , but it might start to resemble a government as it grows to cover more services . My HOA is a bargain , but it's not utopia . They tell me how many plants I get to have on my patio .

Speaker 1

Yes , the stoplight that you talked about in an earlier episode in Desert Town is the heavy hand of the state . But as Desert Town aficionados have accepted the intrusion of the stoplight over negotiating every intersection , I suggest that the bundling of sometimes inferior services provided by government might , like the stoplight , end up being preferable To superior services that required research and procurement . I'm a menarchist somewhere twix , nozick and Russ Roberts , with many anarchist friends . Anyway , that's what I was wondering . All the best , jk . This is a really interesting point . I always want to start by asking this utopia thing of which you speak when can I find it ? But in fact , that is actually exactly JK's point . He's rather deftly making the case for anarchy , and he knows it , but he's also raising an important question At what point does a private club take on the bad aspects of the state , which is exactly what we're trying to avoid .

Speaker 1

Isn't that really a problem of ex-post-recontracting , a standard category of transaction costs ? The economies of scale in having public goods provided in a club setting , because that's what HOAs are , they're excludable and locally non-rival those economies of scale are enormous . They come with some inconveniences , but if you'd wanted to have a standalone house and mow your own lawn , mine your own sidewalks and have plants on your patio , that was available . If you chose a neighborhood with an HOA as a package , that must have been better . You had two different , non-utopian choices and you chose , in this case , sensibly , the one with the HOA . Now , if utopia had been an option , you would have picked it . Why is utopia not an option ? Well , the answer is transaction costs . It's actually an example of T-Bow sorting . There weren't enough different HOAs to compete along all the dimensions that you might want , so you have to pick bundles and compare them to other neighborhoods with no HOA .

Speaker 1

But there is a larger question , and that's really JK's point , which is a smart point to make . Look , the usual argument for the baseline state is that markets cannot provide security because it's a public good , non-excludable and non-rival , as was discussed earlier . That means that the state can tax your wealth because you wouldn't have that wealth if it weren't for the state protecting it . Your wealth is created in partnership with society and with the government , particularly the police , courts , military . All of those things make the protection and enjoyment of that wealth possible . Now the flaw in that argument is that providing security is actually not all that expensive . We could all pay a sum for the service , like tickets to the opera . Now maybe it costs 10 times as much to protect 10 times as much wealth . That's not how it works . We want the rich to pay a higher proportion of their wealth . Does that make sense ? Many social contract theorists say yes , since wealth was formed in partnership with society , the rules of the contract require the wealthy much more because they benefited more from the partnership .

Speaker 1

Let's pursue that line of reasoning as if a contract were in fact . What's going on ? Imagine that I'm building a new house and I want a toilet . I contact a plumber , we negotiate a contract , I choose a toilet installed in a particular way as part of the contract and we agree on a price . Now , any voluntary agreement on price logically implies a disagreement about value . Let me say that again . I've said it before , but it's important Now . Any voluntary agreement on price logically implies a disagreement about value .

Speaker 1

If I'm willing to pay the plumber $1,500 for the parts , equipment and labor to have the water lines , sewage line and toilet installed , I must value it more than $1,500 . Actually , I'd probably value it a lot more , maybe $10,000 . A house without a toilet is not very good . By contrast , the plumber is a very efficient work . She can obtain the parts and equipment for $300 , which means she makes $1,200 for the six hours of labor that are required to install those parts in the toilet . That's $200 per hour , which is decent pay . I'm benefiting $8,500 because I value the toilet at $10,000 , but I only have to pay $1,500 . Well , that's the nice thing about markets . The plumber would have liked to charge more . I would have liked it if the plumber had charged less , but there's a competitive market for expert plumbing services . If I had tried to offer less or if she had tried to charge more than a different contract would have taken place . Anyway , the plumber does the work , the toilet works and looks good . I pay her the $1,500 and we're all happy .

Speaker 1

But the next day the plumber knocks on my door . She says hey , bud , that's how plumbers talk . Hey , bud , hey bud . I was thinking your house is worth much more with a toilet than without . I created a lot of value for you by doing my job . After thinking about it , I decided that you should pay me more , since the toilet is so useful . Well , this is an attempt at ex-post-recontracting . The plumber could have tried it with the job half done and one of the pipes spewing water all over the floor . Pay me another $500 or I walk . Well , I point out that in a competitive marketplace , the price of a service is generally based on how much it costs to produce , not how valuable the service is , and a reputation for doing the job for the agreed price is an important part of the solution to the asymmetric information problem that the plumber faces to get future jobs . So , no , I'm not paying more , and if the plumber doesn't stop bugging me , I'm going to change my positive review on Craig's List . The plumber's angry , but she goes away .

Speaker 1

My house is now nearing completion and I realize that having security protection will , like the toilet , make the house much more valuable . Being able to live in the house without fear of being attacked or robbed is something I'm perfectly willing to pay for . How much should this service cost ? Well , if it were private security . It would be pretty expensive , but security services are a public good , meaning that providing security for the entire neighborhood is relatively cheap on a per household basis . Just like JK's point , we have one contract for security for 500 houses . It's not much more expensive to have security for 501 or 520 houses .

Speaker 1

So I contract with a local security firm , tuz Security . The motto of Tuz Security is our bite is worse than our bark . Now it turns out that Tuz is a big , dumb , strong dog . But Tuz doesn't need to be smart , because security , like plumbing , is actually not that complicated . It takes some experience and it pays well because you have to do it right , but once you learn the craft it's not that difficult . Tuz signs a contract . He commits to bite anyone who breaks the law , takes property or threatens violent . I pay the first monthly installment for security services and everything's going great . My house is worth quite a bit more because now I have a toilet and security services .

Speaker 1

One day , though , I come home and there's Tuh sitting on my couch , drinking my best scotch and watching English Premier League soccer on the Peacock Network on my big-screen TV . This is upsetting because I don't actually subscribe to the Peacock Network . Taa must have added it to my cable package . I yell Taa , taa , bad , dog , bad , get off my couch . And how dare you add channels to my cable package using my credit card ? I don't want that . Taa doesn't move , but he looks at me . Then I notice that he's cleaning my Kalashnikov , my AK-47 . Apparently he's pried open my gun cabinet .

Speaker 1

Things get quiet . Then Taa says look , I was thinking , your house is worth much more with security than without , so I created a lot of value for you by doing my job . After thinking about it , I decided that you should pay me more , since protecting your wealth is so useful to you . I try to be patient . Taa , after all is not very bright . The plumber had tried to make this same argument . The fact that the contracted service provides me with a lot of value doesn't mean that I owe more for security than it costs to provide in a competitive market . And since security is actually a public good , it's cheaper than private goods such as a toilet , as long as it's also being provided to many other people at the same time . So no , I'm not going to pay Taa anymore , just like I'm not going to pay the plumber anymore , even though Taa is right that I value his service more than I paid for it . As Don Draper said , that's what the money is for . And again , I demand that Taa get his dirty dog butt off the couch . That's private property .

Speaker 1

This time , taa has reassembled the AK-47 . He's good with stuff like that , though , again , like plumbing , it's really not all that complicated . Anyone could do it with some training . I hear him chamber around in the Kalashnikov Ka-chunk . I say Taa , what are you doing ? Taa says in a quiet but firm voice .

Speaker 1

Well , like I said , I've been thinking the social contract is different from private contracts . I have the gun , so I make the law . The law says you have to pay more and you have to keep paying as long as you have any wealth left . I'm not providing protection . I'm deciding how much wealth is beneficial for the society to allow you to keep . I speak for the society because I am security . Now I'm mad . There's no social contract here . Taa is just making that up .

Transaction Costs and Public Choice

Speaker 1

I didn't consent to this change in status from a private contract to a social contract . This is just expost recontracting . In fact , if I pay Taa to enforce contracts , I expect him to enforce this contract , even though Taa is also a party to that contract . It had never occurred to me that this was a problem . Taa can enforce the contract with the plumber because he's outside that contract . Who's going to enforce the contract with Taa ? There are special transaction costs when the enforcer is also a party to the contract . So while I'm thinking these deep thoughts , taa's getting mad . He starts to growl and he comes closer to me and I yell Taa stay , no , no , taa stay , stay , taa stay , taa stay , stay , dang . Taa has become the state . So here's the problem . Any decision rule has transaction costs .

Speaker 1

Buchanan and Tulloch pointed out that there's actually two costs in decision the costs of excluding someone from having a voice in the decision and the decision costs themselves the negotiations of reaching an outcome . Unanimity imposes minimal exclusion costs . The undesirable solutions where someone is forced to do something against their will are reduced , but the decision costs of reaching unanimous agreement are really high . Now , in some ways , this is a problem for bilateral contracts also . Notice that my contract with the plumber was unanimous also , but there were only two of us . If we're talking about a unanimous agreement among 500 people or 5 million people , reaching unanimous consent is much harder and we have hold-up problems and other kinds of transactions costs .

Speaker 1

Well , the story of TA illustrates a new transaction cost problem , one that highlights public choice , something we haven't talked much about on TIDC . The plumber might engage in ex-post-recontracting , but it's not catastrophic because you could enlist the aid of the enforcement agency against the plumber . But what if it is the enforcement agency itself that's engaging in ex-post-recontracting ? Tuck can come back at any time and demand that you pay even more , and if you appeal to the enforcement agency to enforce the contract you agreed to , you're just asking Tuck to enforce that contract against itself . Hoas are a kind of middle ground . If you bought a house in that neighborhood , you consented to those rules . But then what if they changed the rules ? The rules were that they could change the rules by majority vote , and you consented to that rule by buying the house . But is that the same thing Overall ? Do HOAs increase or reduce the value of homes , or do they increase or decrease the variance of the value of homes in the neighborhood over time ? Well , we'll talk about those questions again in a future TIDC . Whoa , that means it's time for the twedge .

Speaker 1

This week we have three short ones on the public perception of economists and of economics . First , some people say that economic forecasters assume everything except responsibility . Second , economists are people who are too smart for their own good and not nearly smart enough for anyone else's good . Finally , on the first day , god created the sun . In response , the devil created sunburn . On the second day , god created sex . The devil laughed and created marriage . On the third day , god created rich , delicious food and the devil gleefully created heartburn and obesity . God kept on creating , but the devil hung right with him tit for tat . That was day 39 . Answering each creation with its evil consequence . Finally , on the 238th day , god created an economist . The devil was stumped at first , but then he invented the union grievance , because God was poaching on the devil's turf .

Speaker 1

The first letter we got was actually a correction from the twedge from last week . Mj writes if the economist for the Bureau of Labor Statistics can count but can't differentiate between a dog and a sheep , then he should have overcounted the sheep by one . So unless he knew that there was at least one dog in the group , because all shepherds have a dog , but didn't know enough to know which one was a dog and which one was a sheep , mj , end of letter . Well , that's absolutely right . If the economist could really count , he would have miscounted the number of sheep , adding one because he counted the dog . That's fine so far , but then why did the shepherd agree that the number of sheep was correct ? It should have been one over , but the shepherd agreed with the count . Well , it's okay that the twedges are not funny that comes with the territory but in this case there was a logical problem . My mistake , and thanks , mj

Salad Bar Pricing and Issues

Speaker 1

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Speaker 1

Now on to the letter that we'll take up next week . It's from KR . Kr writes that how do salad bars work ? All of the items cost different amounts to the producer , but they charge a single by the ounce price , retail , to the customer . Why do they do that and what are the issues in deciding what price to charge ? It seems like if you charge a high price you'll get adverse selection , with people only taking the expensive items and then mixing them later with the cheap items . Kr end of letter . Well , thanks for listening . We'll work on that puzzle . Have another hilarious twedge and more next week on Tidy Sea .