Economics is all about the choices humans make and in the aggregate human societies (micro economics and macro economics).  Negotiating can be thought of as a specific case of micro economics closely linked to the core concepts of marginal utility and marginal value.  Therefore, Reinvent Trenton is taking this opportunity to explain basic concepts in negotiation and the role of eminent domain in them.

Eminent domain should be an issue in our 2010 elections as it is front and center in the city’s train station redevelopment plan.  Furthermore it has been used or threatened over the years in many Trenton development projects.  Do we as Trentonians want our new crop of political leaders to wield this weapon?

There are two types of negotiations: successful ones and unsuccessful ones.

A successful negotiation is where a deal is struck.  A deal can only be struck when both parties feel they have profited from it.

We’ll use the example of a developer wanting to buy a property from a homeowner.  The development is large($100,000,000) and will cost the developer $200,000 to change the plan if he can’t buy the house.  The homeowner wants $60,000 but fears it will only be worth $50,000 if he doesn’t sell because there will be a big office building next door.

There is a key concept at play here called BATNA.

• BATNA stands for Best Alternative To a Negotiated Agreement.
• Each party has an implicit BATNA and has it in the back of their mind.
• The BATNA has a certain value to the party.

With no eminent domain on the table the homeowners has the power.

For instance, in the case of a homeowner, not coming to a deal might mean they have to stay in their home.  However, the future value of their home might be diminished in the case where a developer is building around them.  So, although the homeowner might like to sell for $60,000, in the back of their mind, not coming to an agreement is unsatisfying because their properties value will be diminished.  The BATNA would therefore be the perceived value of the property after development has happened around them plus the intrinsic value of not having to move or pay transaction costs let’s say $50,000.

In the same deal, the developer has a very different situation.  He might be happy to buy for $60,000, but if he can’t make the deal bad things will happen.  His “alternative” to striking the deal is to redesign the project or maybe relocate it.  This could be expensive so it’s conceivable that the BATNA could be very high, perhaps $200,000 for a large project.

If the above negotiation is unsuccessful, everybody loses.  The homeowner’s property is de-valued AND the developer gets a big hit in costs.

In this situation you might say the homeowner has all the power, and you’d be right.  Conceptually the developer would pay up to $200,000 for the home in order to avoid change costs.  The savvy homeowner knows this, so he likely won’t settle for just $60,000 and will try to stick it to the developer.  The property is simply worth more to the developer than to the homeowner.

Conceivably they could come to a satisfying deal at very close to $200,000.   The developer can’t economically reject the deal and the homeowner would be crazy not to milk it for everything its worth.

Enter eminent domain.  Eminent domain is the power of government to condemn and force the sale of a property.

City’s and lets be clear about who the “city” is in this case.  Politicians who have an interest in new development either because they’re honest and seek tax revenues or because their dishonest and receive donations from the developers, have big interests in development.

Therefore, they have extended the use of eminent domain, from its traditional use in clearing land for roads and schools to the modern manifestation in preferring developers over small home and business owners.  There is much more tax revenue and/or graft to be had from a $100,000,000 office building than a $60,000 home.

City and state lawmakers in NJ have agreed that eminent domain should be used to tip the balance of power in a property negotiation.

With eminent domain in the mix the power shifts to the developer

The homeowner wants to sell for $60,000 but know that if he doesn’t reach a deal he’ll be forced by the city to sell at a price set by a third party.  Furthermore, he knows that it will cost up to $5,000 in lawyer’s fees to challenge the price offered by the developer.  Let’s say the homeowner spends $500 for an appraisal that says the house is worth $50,000.  The implicit BATNA is therefore $50,000 – $5,000 – $500 = $44,500.  The homeowner’s BATNA is now $5500 worse than without eminent domain.

On the other hand the developer has a different BATNA as well.  Assume the same appraisal and legal costs and the same $50,000 excepted sale price should the government have to step in.  The developer’s BATNA is therefore $50,000 + $5,000 + $500 or $55,500.

If all parties are thinking clearly they will come to a deal  likely at $44,500 because the developer has no reason to go higher than the homeowner’s BATNA.  This is $15,500 worse than $60,000 he wanted.

So what’s the problem here?

There is a gap in value of $155,500 in potential deal price for the homeowner before and after eminent domain.

In this case, we as citizens would have sanctioned the right of the developer through the power we have vested in our government to use force in such matters, to overcome that $145,000 difference.  We have said to the homeowner that his land isn’t really his to sell, it’s ours and the politicians that represent us, to do with as we please.  This legal concept has been upheld as being consistent with property rights from our days as English colonies when the King literally controlled the use of all property.

In Trenton, we can choose to use eminent domain or not.  The same is true for NJ.  However, we as Trentonians have the opportunity to decide whether our neighbors will be forced to negotiate with the effect of having a gun to their head or not.  We can choose to take eminent domain off the table or not. City council can resolve to deny eminent domain requests.

The effect of this decision will be that smaller development projects will be more likely in Trenton because large ones have the bigger requirement to acquire large parcels of land.  The overall cost of development for large projects will necessarily go up.

The negotiated deal price without eminent domain isn’t as dire as I have left it.

Remember the BATNA for the homeowner was $50,000 and for the developer it was $200,000.  There is therefore a wide range of prices, from $50,000 to $200,000 that will make both buyer and seller happy.  Studies show that more often than not (and depending on all sorts of negotiating tactics) the price will be exactly in the middle of the two BATNAs or $125,000.

The homeowner will be ecstatic and the developer will be OK.

There will certainly be homeowners that will stand in the way of progress no matter how much money they are offered.  And yes we as citizens will be held hostage to what is often a deranged approach to negotiation.  It happens.  However, we all have our reasons for loving and wanting to hold our property.  The city can wait until we’re over it.

For such a drastic action to be taken against homeowners the Train Station committee should have shown some benefits. They have a lot of questions to answer.

• Will the new buildings pay taxes? How much and when?
• What is the likelihood of long term success?  Please show your work and assumptions.
• What impact on income in Trenton will the development have?  Won’t most white collar workers commute to Trenton?  Again, show your math and be prepared to explain why secretaries in the new buildings from Trenton will simply changing jobs for the shorter commute.
• How would income levels rise?  Are these new white collar jobs going to Trenton’s unemployed?
• What costs will the city bear in upgrading infrastructure?  Be honest and include everything.
• If all we’re doing is creating secretarial jobs in Trenton so some folks can have a shorter commute then don’t we feel silly asking our neighbors to give up their homes.

There are many policy choices a city can make short of taking away peoples homes that will favor development.

• We can limit eminent domain to abandoned properties
• We can change our tax system to favor dense development (i.e. the land tax)
• We can reassess property in Trenton to force older homes to pay their fair share and put old and new development on an equal tax footing
• We can clean up our neighborhoods making them more attractive for investment
• If it’s really important to us, we can sweeten the deal for a developer (though let’s make sure the property will pay taxes)

Finally and well beyond the economics of the situation …

• Ask yourself who in the current and future crop of politicians has an interest in any aspect of the development
• Are they associated with development of any part of the project including Hope VI?
• Have they received campaign contributions from any entity involved?
• With so much money involved and so much pain likely to be caused, are we doing it for the right reasons?
• Hopefully, our journalists, competing candidates and bloggers will be able to uncover any hidden truths.

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