617
Fractured Markets and Legal Institutions
Herbert Hovenkamp
I. INTRODUCTION ............................................................................. 618
II. THE COSTS OF RESOURCE MOVEMENT ......................................... 621
A. RELATIVE DEADWEIGHT LOSS .................................................. 624
B. THE CHOICE OF AN INITIAL POSITION AND THE VALUE OF
PLANNING ............................................................................... 625
III. COASEAN MARKETS ....................................................................... 627
A. IDENTIFYING THE EFFICIENT OUTCOME .................................... 627
B. MICROMARKETS: FUNCTIONALITY AND FRACTURE .................... 629
C. THE COUNTEREXAMPLE OF AUTOMOBILE ACCIDENTS ............... 631
D. KEEPING CONTRACT AND BEHAVIORAL EXPECTATIONS WITHIN
APPROPRIATE BOUNDS ............................................................. 634
IV. COASEAN MARKETS WITH MANY PLAYERS ..................................... 636
A. THE PUBLIC GOODS CHARACTER OF MANY-PLAYER COASEAN
MARKETS ................................................................................ 639
B. EXCESSIVE CYCLING OR EXCESSIVE STABILITY? .......................... 643
C. FRACTURED MARKETS AND THE OPTIMAL SOURCE OF
REGULATION ........................................................................... 645
D. EX ANTE AND EX POST DECISION MAKING: EFFICIENCY AND THE
LONG RUN .............................................................................. 646
V. MANAGING FRACTURE THROUGH DEFAULT RULES ...................... 648
A. DEFAULT RULES FOR DIFFERENT LEGAL INSTITUTIONS .............. 651
1. The Selection of a Default Rule ................................... 651
2. Choosing Between Default and Absolute Rules .......... 654
3. Minimum Coalition to Reverse a Default .................... 655
B. DEFAULT RULES IN TRADITIONAL MARKETS: COMMERCIAL VS.
NONCOMMERCIAL ................................................................... 656
C. DEFAULT RULES FOR COASEAN MARKETS ................................. 657
Ben V. & Dorothy Willie Professor, University of Iowa.
618 IOWA LAW REVIEW [Vol. 100:617
VI. “STACKING” LEGAL INSTITUTIONS TO MINIMIZE FRACTURE: “ONE
WAY” DEFAULTS ............................................................................ 658
VII. CONCLUSION: THE DESIGN OF MARKETS ...................................... 660
I. INTRODUCTION
How should the legal system address conflicts that occur in very small
environments? The conflicts come in many kinds, including a nuisance
dispute between neighbors, an impending collision between two moving
vehicles, a joint decision between spouses about whether or on what terms to
continue their marriage, or a disagreement between managers and
shareholders within a firm.
The literature often refers to these small environments as “markets.”
Considering them in that way, however, averts our attention from larger
environments that should be included in the inquiry but that often do not
function well as private markets. The term “institutions” is better, because it
encompasses environments in which people have both market (exchange-
based) and non-market interactions. Further, institutions are human
creations, while environments need not be.
One way to think of the problem is as “market fracture,” or the cost of
breaking the arenas in which people interact into excessively small pieces.
Focusing on the larger rather than the smaller arena can enable an increase
in social wealth or welfare but may also require greater state oversight. In the
process it may also require us to abandon the language of markets or
constrain its use, particularly in situations where instability (cycling) or
behavioral issues are prominent. In these settings the “market” is often little
more than an unhelpful metaphor.
People’s options often narrow as their commitment to a course of action
becomes deeper or more specific. One good example is marriage. While the
market for getting married is large and competitive, depending on the size of
the community, the market for divorce is a bilateral monopoly: you can get a
divorce only from the one you are with. This partly explains why most divorces
are more costly than most weddings. But if we assumed that the divorce rate
is excessive and something should be done about it, the fix might require state
intervention in the marriage market. That is, it may be preferable to fix this
problem earlier rather than later.
Alternatively, employers and prospective employees may bargain over
jobs in a competitive market. Post-hiring promotion or termination issues are
negotiated in a much smaller institution, however, which may also be a
bilateral monopoly in some cases.
Similarly, when a farmer in early spring makes a decision about what to
plant, the “market” she faces includes the full range of products she is capable
2015] FRACTURED MARKETS AND LEGAL INSTITUTIONS 619
of growing on her land and with her existing equipment. Once she has
planted beans, however, the market she faces is typically reduced to that
product, although it may be salable over a large geographic range. After the
beans have been delivered to a particular store, the market for them may
consist only of the subset of people who shop there. Each further stage in the
process fractures the market further and leaves people with a smaller range
of choices, provided that the costs of reversing the decision are greater than
the payoffs from switching.
To the extent reversal is costly, making a decision earlier saves more
resources than making it later. Indeed, the prospective farmer faces her
largest range of choices before she has settled on farming as a career at all. At
that time even her purchase of land and equipment is one of many options.
In addition, the decisions to enter farming, to grow beans in a particular year,
or to sell them to a particular store may have been mistakes. If so, they are
corrected more cheaply earlier rather than later.
In The Problem of Social Cost, Ronald Coase identified the costs of
bargaining as the main impediment to the free and efficient flow of
resources.1 As a result, Coase argued throughout his career that transaction
costs make a legal system important to social ordering.2 Coase wrote about
several common law disputes among neighbors whose economic activities
conflicted with one another. One of them was Sturges v. Bridgman, a 19th-
century British nuisance case between the two occupants of a duplex building
sharing a party wall.3 Octavius Sturges was a London pediatrician who
specialized in childrens’ respiratory diseases, such as pneumonia. Frederick
Horatio Bridgman was a confectioner to Queen Victoria, whose process for
making sweets required him to use a mechanical mortar and pestle to
pulverize substances such as chocol ate.4 The nuisance dispute arose when
Sturges complained that Bridgman’s machine, with its repetitive pounding,
made it impossible for Sturges to use his stethoscope to diagnose patients.
Coase argued that if high transaction costs did not interfere, private
bargaining would provide a solution to the problem of conflicting uses, which
he characterized as “efficient.” By that he meant that the right to continue
would be given to the person who valued it most.5 For example, if the
pediatrician valued the right to relative silence at £100, while the confectioner
valued the right to conduct his business at £60, the efficient solution would
preserve the pediatrician’s £100 value over the confectioner’s £60 value. If no
1. R.H. Coase, The Problem of Social Cost, 3 J.L. & ECON. 1, 15 (1960).
2. See, e.g., R.H. Coase, Professor, Univ. Chi. Law Sch., The Institutional Structure of
Production, Prize Lecture for the Alfred Nobel Memorial Prize in Econ omic Sciences (Dec. 9,
1991), in 82 AM. ECON. REV. 713 (1992).
3. See generally Sturges v. Bridgman, LR 11 Ch.D. 852 (1879).
4. For more on the players and the facts in Sturges v. Bridgman, see generally A.W. Brian
Simpson, Coase v. Pigou Reexamined, 25 J. LEGAL STUD. 53, 54–58 (1996).
5. Coase, supra note 1, at 16.