The mythology of holdout as a justification for eminent domain and public provision of roads.

• Author: Benson, Bruce L.

One of the alleged justifications for government provision of roads is that the power of eminent domain is necessary in order to overcome holdout problems and obtain right-of-way properties (Goldstein 1987). (1) After all, this argument continues, only the state has such power, so the private sector would be unable to supply the efficient amount of roads. (2) In this article, I examine this market-failure justification for public roads from three different perspectives and demonstrate that it is not valid. (3) The first and perhaps the most obvious point regarding the eminent-domain justification for government provision of roads is that even if this power is required to obtain a fight-of-way, the government does not have to site, construct, finance, or operate (that is, maintain and police) the road. I briefly summarize some of substantial historical and modern evidence that members of the private sector are able and, indeed, willing to site, construct, finance, and operate roads if they are allowed to do so. The implication is that even if eminent domain is required in order to obtain a right-of-way, that right-of-way can be turned over to the private sector, which can then build and operate the road.

I turn next to a direct examination of the alleged market-imperfection justification for the use of eminent domain to obtain right-of-way properties: transactions costs owing to the "holdout" problem that is assumed to prevent private-sector acquisitions of multiple contiguous land parcels for a roadway (Fischel 1995, 68-70). I demonstrate that the holdout problem is not nearly as severe as it is assumed to be when private entities make the purchase. Although government entities may face a significant holdout problem, the magnitude of any market failure that might occur with a private road system is much less significant than this holdout justification for public roads assumes. Finally, I explain that the use of eminent domain is undesirable for a number of government-failure reasons. Therefore, even if a potential market failure limits private road providers' ability to obtain right-of-way properties, the "need" for eminent domain does not justify public provision of roads. Eminent domain is not even justified for the private provision of roads because the probability of market failure is low in the absence of this power and because the substantial degree of government failure that accompanies the power appears to overwhelm any benefit from overcoming the holdout problem.

Must the State Own, Build, or Operate Roads?

Putting aside for a moment the issue of eminent domain, let us consider whether the state must own, build, or operate roads. (4) Numerous examples of privately provided roads from highways to local roads in the United States and other countries, both at the present time and in the past, indicate that it evidently need not. In addition to the chapters in the forthcoming Roth volume on Sweden's extensive private road system, recent privately built and run highways in the United States, the many privately built and maintained local roads, the history of privately built roads in Great Britain and in the United States, and the privatization of road management, Beito (2002) and Newman (1980) discuss the history and recent past of privately provided roads in St. Louis. Shearing and Stenning (1987) detail the massive role of private security and the resulting order in Disney World, a huge complex with hundreds of miles of private roads and highways (also see Foldvary 1994). Furthermore, many developing countries are franchising roads to private firms that construct the roads and then operate them, charging tolls to earn the costs of construction and operation, and to cover franchising fees paid to the government (Pereyra 2002). Indeed, providing such roads is so attractive, in part because of their impact on real-estate values, that it is becoming increasingly common for governments to auction franchises (Engel, Fischer, and Galetovic 2002). Roth also documents several private road projects in developing and developed countries, such as two recent private highways in Great Britain (the Dartford River Crossing Ltd.'s toll bridge crossing the Thames and Midland Expressway Ltd.'s M6-Toll Road, a twenty-seven mile expressway to relieve congestion in one of England's busiest urban areas) (forthcoming and 1996, 180-97). The United States also has begun to develop and even encourage private highway projects. The Intermodal Surface Transportation Efficiency Act (ISTEA) of 1991 attempts to stimulate privately provided toll roads, bridges, and tunnels in the United States (as long as they are not part of the interstate highway system) by making them eligible for a 50 percent grant from the Highway Trust Fund, and in an effort to take advantage of these available funds a number of states have passed their own legislation to allow private provision of roads (private providers of roads have been reluctant to accept such funding, however, choosing to seek private financing instead because of the added costs and delays that arise when the federal government becomes involved).

Private entities can and do finance, build, and operate roads, and they would do so much more often if they could retain profits. Thus, even if eminent domain is necessary in order to obtain right-of-way properties (and for many of the roads, especially local roads, it is clearly not necessary), the state can purchase and then transfer the land to private entities. Are eminent-domain powers necessary, however, to obtain property for a major road's right-of-way?

Do Holdouts Justify Eminent Domain?

Resources, such as land for a right-of way, can be acquired through compulsory sale, but for efficiency's sake voluntary exchange is clearly more desirable if it is possible. To see why, suppose one person, individual A, wants to obtain possession of a tract of land that is currently legally controlled by another person, individual B. There are two ways for A to obtain the property: through bargaining in an effort to achieve a mutually advantageous exchange or through coercion if A has the power to force a transfer or the ability to call on someone (for example, the legislature) who has such power. The bargaining option is considered here; the alternative is discussed later. Suppose that A values the land at $500,000, and B values it at $300,000. A and B are then likely to find mutually advantageous terms to make the exchange. At a price of $420,000, for example, both can conclude the exchange pleased by the deal they brokered. A fundamental if common fact is that voluntary exchange takes place only when both parties expect to be better off as a consequence. Voluntary exchanges occur because both parties trade something they value less for something they value more. Therefore, if a successful voluntary exchange takes place, the traded good will be allocated to a higher valued use. (5) Of course, some readers may not find normatively attractive the goal of allocating things to their highest-valued use according to individuals' subjective value. Note, however, that voluntary exchange makes both parties to the exchange better off: voluntary exchange increases wealth (subjective well-being) in what economists refer to as a Pareto optimal way. Pareto optimality denotes a condition in which all actions that make someone better off without making anyone else worse off have been taken. In general, voluntary exchange achieves this outcome. (6) Pareto optimality is not the end of welfare analysis, but it is an important component that virtually everyone finds desirable.

Holdout Problems and Involuntary Transfers

Because exchange is not costless, some mutually beneficial exchanges never take place. In theory, then, a substitute for bargaining, such as regulation or compulsory sale through eminent domain, may increase social welfare. In this context, Calabresi and Melamed (1972) point out that an entitlement (the right to use an asset or resource) can be "protected" (that is, supported by the legal system) in three different ways: by a "property rule," by a "liability rule," or by "inalienability." An entitlement is protected by a property rule to the extent that someone who wishes to remove the entitlement from its holder must obtain the current entitlement holder's permission before the transfer (for example, in a voluntary exchange). When an entitlement can be taken without prior permission by someone who pays objectively determined compensation after the fact, the entitlement is protected by a liability rule. The government's power of eminent domain exemplifies a liability rule. (7) Of course, after the entitlement has been taken, the previous holder has an incentive to claim that a high price would have been required to induce him to sell, and the taker has incentive to claim the opposite, so a court will often have to determine liability based on evidence other than the statements of the parties involved.

In an efficiency perspective, entitlements should be protected by a property rule when bargaining is possible because only the parties directly involved know their subjective values, which are likely to be revealed only through voluntary bargaining. It is often claimed, however, as Posner (1977, 10-12, 51) and Kraus (2000, 788) explain, that when transactions costs are so high that bargaining is not likely to occur, a liability rule is preferred (see also Barnes and Stout 1992, 56; Fischel 1995, 67-70). Both Kraus (2000, 788-90) and Posner (1977, 39-44) emphasize, however, that this argument has significant problems (see also, for example, Polinsky 1980, 1111; Krier and Schwab 1995, 45). One reason for questioning this widely held conclusion is the often implicit assumption that whereas transactions costs are high for private parties, information costs are low for judges or juries who must determine compensation (Polinsky 1980). As Kraus notes...