The United States was founded on the basis of individual decision-making "free will." Free will is proclaimed as our "unalienable Rights" in the Declaration of Independence:
"We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness."
This article is grounded by the time-tested works of the market economists, Adam Smith and F.A. Hayek. The rule of law is inspected as necessary to achieve optimal resource utilization and as essential to the purpose of our economic system and market interactions. When allocating marketplace resources, decentralized competition and central planning are shown to be at opposite ends of the choice environment spectrum. It is shown that the proper location of resource allocation-based rules on this spectrum is essential for achieving optimal resource utilization and a healthy marketplace.
“Primacy of use” is introduced as a test to determine where on the choice environment spectrum a rule or law is found. As per Smith and Hayek, decentralized competition is recommended as the default choice on that spectrum. The homeowners' association, considered the most local form of government, is offered as an example of the primacy of use test. We utilize several examples from HOA rules to demonstrate how to move toward the more decentralized end of the spectrum. We also show that HOA officials are incented to implement rules found at the central planning end of the choice environment spectrum. The article concludes by recommending Definitive Choice, a resource to help exercise your free will.
About the author: Jeff Hulett is a career banker, data scientist, behavioral economist, and choice architect. Jeff has held banking and consulting leadership roles at Wells Fargo, Citibank, KPMG, and IBM. Today, Jeff is an executive with the Definitive Companies. He teaches personal finance at James Madison University and provides personal finance seminars. Check out his new book -- Making Choices, Making Money: Your Guide to Making Confident Financial Decisions -- at jeffhulett.com.
Table of Contents:
1) Introduction
2) A market economics historical perspective
3) Primacy of Use
4) An HOA Example
5) HOA Governance Incentives
6) Decision-making Resources
7) Notes
2) A market economics historical perspective
F.A. Hayek and Adam Smith [i] described the decentralized nature of capitalism as the most efficient approach for resource allocation. Adam Smith's groundbreaking work, "The Wealth Of Nations," significantly influenced America's founding generation when developing the U.S. government. First, let's unpack some key terms. Resource allocation is the outcome of individual economic choices. We have a certain amount of income for purchasing goods and services - also known as "resources" - in our lives. Allocating our income, generally via a series of trade-off decisions, is necessary for making resource allocation decisions. The quality of our allocation choices maps to how resources are utilized among a group (or market) of people. Our choice environment, whether a decentralized competitive environment or a centrally planned environment, is indicative of how we allocate resources. As we alluded to in the introduction, our free will is tied to our choice environment. As a rule of thumb, free will-based individual choice is a) optimized in a decentralized competitive choice environment and b) discouraged in a centrally planned choice environment.
The degree to which a group of people can exercise their free will is directly tied to the quality of those choices sculpted by the choice environment. Behavioral economists recognize our choice environment is a powerful influencer of our decisions. Richard Thaler is a Nobel-winning behavioral economist from the University of Chicago, Dr. Thaler said: "People have a strong tendency to go along with the status quo or default option.... Just as no building lacks an architecture, so no choice lacks a context." [ii]
The idea is that decentralized decision-making is essential because no central body could possibly best allocate resources across very heterogeneous groups of people. Central government creates more standardized "one size fits all" policies. Whereas each person's needs are very different and dynamic. Another essential idea is that a successful decentralized competitive environment implements rules of law ex ante. This means the rules are published in time to allow people to respond to them. This enables people to reserve their choice with full knowledge of government rules and penalties for violating those rules.
Smith's competitive model for resource allocation between buyers and sellers is known as the invisible hand. [iii] Smith believed the invisible hand works best when government rules are kept to an essential minimum to encourage trade. The challenge is maintaining the "essential minimum" legal environment. [iv]
Neither Hayek nor Smith disputes the need for some government guardrails, but they suggest care needs to be taken to remand much of the resource choice to a decentralized, competitive process. A well-functioning competitive process enables our free will to make our own choices. The free will to make choices is a cornerstone of democracy. Free will is proclaimed in the Declaration of Independence and the U.S. Constitution. As expressed in the Tenth Amendment to the U.S. Constitution, those laws not explicitly available to the Federal government are reserved for the States and the people. At the time of the founders, states were considered the "voice of the people." Arguably, this "state = people" assumption may not be as true today. For example - a state like California, which has a state income rivaling that of France, is more like a country when it comes to governance. The point is, that the Tenth Amendment makes a decentralized choice environment the default environment. Free will is the starting point. Government, regardless of level, should only reduce free will via the "essential minimum" guardrails.
Hayek goes on to demonstrate how central planning is on the slippery slope leading to communism, fascism, and other forms of totalitarianism. Hayek showed how the natural incentive for central planners is to expand the bureaucracy and reduce individual choice. Hayek shows how central planning leads to arbitrary government as compared to the rule of law that leaves individuals free to pursue personal ends and desires. The rule of law is not for telling someone how to do something, but the rule of law should aspire to provide guardrails as to what is out of bounds in the pursuit of 'life, liberty, or the pursuit of happiness' individual goals. [v] Hayek was an Austrian-British economist who fought in World War I and emigrated to England. He lived in London during the rise of Nazism and the Battle of Britain. He readily admits capitalism is not perfect. However, Hayek concluded that the alternative of central planning is far worse than the imperfections of decentralized resource allocation. Essentially, based on Hayekian principles, while people may sometimes make dumb decisions, central planners will make far dumber decisions for those people. Especially because the definition of 'dumb' varies by people, time, and situation.
As found in today's modern world, how our free will-based decisions drive economic efficiency has changed substantially from the recent past. In the time of our founders -- inclusive of the times of Smith and Hayek -- and proceeding until the late 20th century, the world was generally characterized by information scarcity. In an information-scarce environment, the collection of a small amount of information was all that was available to make the most common decisions. The challenge was collecting the data. Once the limited data was assembled, the decision was generally straightforward. In earlier times, censorship was like the traditional "book-burning" zealotry learned from our history books.
Today, the information world has changed by 180 degrees. We are now in an information-abundant world associated with the Information Age. In an information-abundant environment, data curation and decision structuring are paramount. It is more important to subtract unneeded or wrong information than to add new information. As pointed out by University of North Carolina Sociologist Zeynep Tufecki, information censorship has radically changed with the Information Age: "The most effective forms of censorship today involve meddling with trust and attention, not muzzling speech itself."
Thus, free will is still very important. But how we need to exercise free will has dramatically changed of late. The acquisition of data, information curation, and decision process skills are essential needs for making the best use of our free will in decision-making. [vi] In the resource section, a technology is suggested to help you make the best, free-will-inspired decisions in today's information-abundant environment.
3) Primacy of Use
This article describes how to test the degree to which a rule or law is appropriate in the context of optimizing resource utilization. It is assumed decentralized decision-making is superior to central planning. The article examines examples from the form of government at the level closest to the individual. This is the Homeowners' Association (or "HOA"). Your first reaction may be "Well, I do not own a home in a community governed by an HOA, so this article is not for me." Not so fast! If you ever rent an apartment or vacation home, then you are likely impacted by an HOA. HOAs are likely reducing your rental choice set and you did not know it.
“Primacy of use” is the essential test for whether a law or rule is likely to fall into a category of a) the less desired central planner approach to resource utilization or b) the more desired decentralized competitive resource utilization. Also, it is assumed governance officials have choices about the rules they implement. Governance objectives can be met with either higher OR lower primacy of use-impacting rules.
The extent to which a law or rule impacts choice regarding the primacy of use is the test for the degree to which the rule or law is likely to lead to optimal resource allocation. The choice environment, owing to the makeup of various rules of law, acts as a filter to our resource allocation and ultimate consumer benefit. The primacy of use starts by defining the use expected of the resource in question.
For the rest of the article, an HOA example is used to explore the primacy of use test to determine the optimal resource allocation approach. The primacy of use test may be used when evaluating the choice environment and evaluating choice alternatives. For example, if someone is looking to buy or rent a new home or condo, the primacy of use test will help you evaluate the HOA as part of your choice alternatives.
Let's say someone is considering the purchase of a condominium. The condo is located in a condo complex. The primacy of use is defined as how people optimize their use of the condo. Think of primacy of use as a broad objective, aggregated from a small number of weighted criteria, of how a buyer receives benefit from the purchase. The weighted criteria could include criteria such as:
Local school quality
Access to shopping or amenities
Quality of medical access
Distance from work
Others
The point is that people are more likely to share broad criteria objectives but are less likely to share the weighting of that criterion. Everyone's tradeoffs are different and dynamic, even though what is being traded off may be similar. The idea is NOT to try and collect only people that permanently share the same primacy of use - that is not possible. As Benjamin Franklin said, "...in this world, nothing is certain except death and taxes.”
Liam and Mia share the same condo preference categories. Does this mean they are ‘like-minded?’ Not at all. Their preference trade-off weighting is very different. Also, over time, their preference weights are dynamic. Most people’s preferences change significantly throughout their lives.
The idea is to create an environment that enables people to adjust their resource allocation as their trade-offs evolve. This recognizes that people are unique, diverse, and regularly change. This is why, even at the most local HOA level of government, central planning is generally ineffective. F.A. Hayek said: "Central planning means that the economic problem is to be solved by the community instead of the individual; but this involves that it must also be the community, or rather its representatives, who must decide the relative importance of the different needs." As the last graphic showed with Liam and Mia, it is not possible for a central planner to have a single rule that meets both their weighted needs. It is best left to Liam and Mia to allocate their own resources based on their own weighted needs via a competitive, decentralized resource allocation framework. In section 4, the primacy of use test is shown as an approach to identify the rules most likely to render a decentralized resource allocation result.
Most condo complexes have HOAs that govern the complex. By definition, the HOA governing board makes and enforces rules and taxes homeowners via fee assessments.
HOA context: The U.S. has historically had 3 levels of government. Those levels are Federal, State, and Local. The government levels have taxing authority and make rules for people within the scope of the government level. For example, I live in the United States (Federal), the Commonwealth of Virginia (State), and Fairfax County (Local). Each level has rules (laws) and taxes. In general, the more local the government, the more the direct impact on my everyday choices.
In recent decades, the HOA (Homeowners' Association) has become the 4th level of government. Like higher levels of government, the HOA has taxing authority (fee assessments or dues) and laws (HOA rules). Every HOA is different, but in more recent times, many HOAs have implemented increasingly stricter rules and have become more expensive from a taxation standpoint. Research shows that communities governed by HOAs are more racially segregated. HOA rule design is intended to protect the wealth of the homeowners. (Whether or not wealth protection actually occurs is debatable.) By HOA design, property appreciation rates are intended to be higher for those in the HOA as compared to those living outside the HOA. [vii] Thus, HOA impact may include social inequality.
The primary use (or benefit) of the condo is to allow people to live in it. As such, the stakeholders may be the owner or someone who rents the condo from the owner.
4) An HOA Example
Let's say a condo association and stakeholders wish to have a peaceful living environment, where sound and disturbance to the stakeholder occupants (whether homeowners or renters) are kept to a minimum. [viii] For this example, two rules are considered to govern this objective:
Rule scenario 1:
Rule: "Quiet Rule" - An HOA rule that “One must be quiet during certain hours” or “One must keep sound below some decibel level.”
Primacy of use situation: In this situation, the primacy of use challenge is low. Low sound levels generally will not keep people from using a condo. Most people can use a condo and keep loud, neighbor-disturbing sounds to a minimum.
Implications: This is a rule of law guardrail that still allows primacy of use. Also, the rule of law provides an enforcement mechanism. Overly loud people will be punished under the rule of law. As long as the rules are communicated and enforced, there will be no (or very little) primacy of use impact across the stakeholders.
Versus
Rule scenario 2:
Rule: "Time Rule" - An HOA rule that “One can only rent the condo to others for more than an X period.” This is an HOA rule like "a condo must be rented for no less than 1 month" or similar restrictions.
Primacy of use situation: In this situation, the primacy of use challenge is higher. This time period-based use rule is a rule of law discouraging primacy of use.
Implications: Renter stakeholders have limited periods when they may be able to use a condo. They may work out of town, they may have family needs, they may not have the financial resources to afford an extended stay, it may be something else. This impacts both the renters and owners who wish to rent. Like rule scenario 1, rule scenario 2 does encourage the goal of reducing sound and disturbance. However, unlike rule scenario 1, having time usage restrictions impacts the primacy of use for the majority of the stakeholders. Please see the next graphic for a stylized description of the much higher primacy of use impact. [ix]
In other words, for most stakeholders, it is more achievable to keep your voice down and reduce disturbance while using a condo than adapting your life to use a condo only over some time period.
Keeping your voice down and reducing disturbance is more of a guardrail, but still allows the primacy of use. Restricting usage negatively impacts the primacy of use.
The former is acceptable for competitive resource allocation. The latter is a social planning approach to resource allocation. This social planning approach is what Hayek and Smith warned against.
To be fair, “primacy of use” is user-defined. The example of restricting the time available to rent is a more obvious primacy of use restriction for many renters and those homeowners who wish to rent their condo to a renter. However, some HOAs have pet, painting, parking, trash can, exterior structure, and other rules. Perhaps some people would claim one of these categories impacts their primacy of use. For example, let's say someone is a dog lover. They say: "I can't live without Fluffy. Any rule restricting pets in a rented condo impacts my primacy of use." The primacy of use test outcome is measured as the proportion and significance of the stakeholder universe impacted by the use restriction. It is also not just owners, it is all stakeholders, whether an owner or a potential renter. Thus, pet rules may have higher primacy of use impact if a significant proportion of the stakeholder universe finds the pet rule impedes them from achieving the condo's primacy of use.
When comparing primacy of use across typical HOA rules, a time restriction is assumed to be more restrictive to the primacy of use than a pet restriction. This is because a higher proportion of people's primacy of usage is impacted by the condo time restriction than the pet restriction. For example, it is easier to kennel a dog for a pet restriction than to change a job or increase personal wealth for a time rental restriction. However, given the growth of pets, this primacy of use assumption could be tested with a survey of the stakeholder universe.
Summary rules of thumb:
HOAs with rules designed to keep people out are more likely to violate primacy of use.
HOAs with rules designed to maintain living standards and in a manner achievable to the majority stakeholder community are less likely to violate primacy of use.
Primacy of use stakeholder perceptions is dynamic just as our culture is dynamic. That is, a rule that is "achievable to the majority stakeholder community" is subject to change as our culture changes.
The minority impacting the majority primacy of use leads to reduced choice and reduced resource allocation efficiency for the majority.
N.N. Taleb does a nice job exploring minority rule, symmetry, and asymmetry in human affairs. He introduces the concept of “minority rule." This is where a small, stubborn minority is responsible for changes that propagate across an entire population. The HOA minority rule model fits well within Taleb's framework. [x]
5) HOA Governance Incentives
In general, those who govern HOAs do not think of themselves as central planning socialists, anti-competitive, or anti-choice. However, the reality is that HOAs are often resource-starved. HOA budgets are small and the governance is usually provided by a volunteer board. Not many wish to volunteer to be on the HOA governance board. At other levels of government, officials are paid. As such, someone who is willing to serve on an HOA governing board has incentives to make their work as easy as possible as a match to their remuneration. As forewarning to the challenge of the HOAs natural incentives, F.A. Hayek said: "we shall all have to conform to the standards which the planning authority must fix in order to simplify its task. To make its task manageable, it will have to reduce the diversity of human capacities and diversities to a few categories...". These incentives naturally attract HOA officials down a central planning-like path. Also, those serving on HOA governance boards are more subject to conflict of interest. Governance of the HOA will directly impact the HOA official as one of the governed. Thus, getting a rule changed that is good for the HOA official may be a high-impact incentive to be on the HOA board. That is, other than the feel-good camaraderie of volunteering for one's community.
As such, given the two rule scenarios from the HOA example, the choice of the "High Primacy of Use" time usage restrictions may be most likely because of the HOA participation incentives. Perhaps it is not surprising that enforcing the rental time frame for a small number of homeowner stakeholders is much easier than enforcing sound and disturbance rules across a large and heterogeneous group of homeowners and renter stakeholders.
Also, since HOA associations are usually made up of homeowners only, they only represent a subset of the total stakeholder group which includes renters. It is often up to the owners who wish to rent to represent the renter's interest. Since the renter-focused homeowners may not be on-site, this creates an "out of sight - out of mind" potential reduction of attention for the renter stakeholder representatives. To be fair, a progressive board would include representation from the renter community, such as shorter-term renters.
However, rules creating high primacy of use restrictions run the risk of inefficient resource allocation. Those renter stakeholders who would be willing to pay honest wages and follow the sound and disturbance rules are kept from doing so. This is the essence of economic inefficiency that concerned Hayek and Smith. This is also the basis for systemic biases encouraging social inequality and discrimination.
To take it to the extreme, if all neighborhoods implement high primacy of use impact rules desiring to increase home values and have the impact of reducing racial diversity, then those living outside HOA-governed communities will only be poor minorities. In this extreme case, those living within the HOA-governed communities will have lower free will, lower economic efficiency, and reduced choice. In this extreme case, this creates a greater 'have and have-nots" social environment. To someone from poor communities outside HOA-governed communities, the HOA governance may be perceived as patently totalitarian. There is no free lunch.
No one said capitalism, competition, and liberty were easy! The good news is, HOAs can achieve higher appreciation and decentralized free will by adhering to low primacy of use impact rules. Certainly, home buyers can choose communities with lower primacy of use restrictions.
It probably would not surprise the reader that I, the author, do not personally support HOA rules that that reduce the broad stakeholder community's primacy of use-related benefits. Lower primacy of use reduces choice of the most for the benefit of the few. It could lead to systemic biases associated with discrimination - both economic and social. Be that as it may, if all stakeholders are represented in the chartering of the HOA - a big if - and that representative group decides to implement rules restricting primacy of use, then so be it. At the end of the day, I still have the choice to keep the money in my pocket. No one is forcing me to buy a condo in a complex with distasteful, economically inefficient HOA rules.
6) Decision-making Resources
Buying a condo is challenging. The HOA (or COA) is often an afterthought. The HOA should be prioritized in your decision process criteria. Start by weighing your benefit criteria to create your primacy of use model. Then, review the HOA rules. Armed with your primacy of use weighted model, you can quickly determine the primacy of use impact of the HOA's rules. The HOA rules are generally published on the neighborhood website. The general homebuying decision is a classically complex decision. Definitive Choice provides a homebuying template to help you buy the best condo decision for you. You can use Definitive Choice for both:
Determining the HOA's primacy of use impact, and
Weighing all your criteria, along with the HOA's primacy of use impact, to help you assess the many condo alternatives.
The following are resources providing for optimal decisions using tools that enable you to exercise your free will. They are high-value and easy to use. For most decisions, they are well worth the time and expense to ensure the best decision and confidence validation. Solutions are provided for individual decision-making, enterprise-level group decision-making, and everyone in between. They all share the core capabilities enabling people’s confidence and the best decisions.
Definitive Choice: For individual or small organization groups - This smartphone app provides a convenient way to enter and weigh your preference criteria, then, enter your potential decision alternatives and their costs. Behind the scenes, it uses decision science to apply your tailored preferences and preference weights to score each of your alternatives. Ultimately, it renders a rank-ordered report to help you understand which alternatives will give you the biggest bang for your buck. Using a decision support app will 1) save you time, 2) optimize your economic value achieved, and 3) increase your decision-making confidence!
Definitive Pro: For corporate and larger organizations - This is an enterprise-level, cloud-based group decision-making platform. Confidence is certainly important in corporate or other professional environments. Most major decisions are done in teams. Group dynamics play a critical role in driving confidence-enabled outcomes for those making the decisions and those responsible for implementing the decisions. Definitive Pro provides a well-structured and configurable choice architecture. This includes integrating and weighing key criteria, overlaying judgment, integrating objective business case and risk information, then providing a means to prioritize and optimize decision recommendations. There are virtually an endless number of uses, just like there are almost an endless number of important decisions. The most popular use cases include M&A, Supplier Risk Management, Technology and strategy portfolio management, and Capital planning.
7) Notes
[i] Smith, The Theory of Moral Sentiments, 1759 ("TOMS")
Hayek, The Road To Serfdom, 1944
[ii] Thaler, Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness, 2008
[iii] Hulett, Adam Smith and how choice architecture makes the invisible hand more visible!, The Curiosity Vine, 2023
Hulett, Market Failure - How Adam Smith would approach government and personal responsibility, The Curiosity Vine, 2023
Next is the introductory paragraphs of the market failure article:
The risk of market failure is a policy advocacy criticism for a decentralized and individual choice environment. A market failure is found in the free market setting and the competitive economic model context. The classic definition of market failure is "the economic situation defined by an inefficient resource allocation in the free market. In market failure, the individual incentives for rational behavior do not lead to rational outcomes for the group."
A standard example of a market failure is the climate crisis. Higher carbon emissions of the free market economies of the industrial age have left a world in a climate crisis. The question is, if the free market works so well, why did the climate crisis occur? Wouldn't an efficient market prevent this via its pricing mechanism? Adam Smith provides a framework to answer these questions in his book, The Theory of Moral Sentiments ("TOMS"). As we discuss next, Smith challenges the notion that "rationality," as used to define market failure, is a single point found on the aggregated spectrum of individual decisions. This means the 'lack of rationality' premise as a cause for market failure is not correct because rationality itself is misunderstood. The article concludes with a comparative debate between later students of Adam Smith - F.A. Hayek and J.M. Keynes. We explored Hayek's and Keynes' likely perspective on Smith's framework.
[iv] Here is an example of "essential minimum" guardrails. "The moderating convergence of self-interested market interactions - or, as Smith says, "bringing down our passion to that pitch" - is a signaling mechanism. The outcome signals the equilibrium market pricing and market quantity. Also, a legal system governs their market environment by which their preferences are reconciled. An important nuance is that the legal system provides guardrails to nurture signaling, not prescriptions for how to signal. Example guardrails usually include:
a) It is illegal for Billy to sell meat that would cause Connie to get sick.
b) It is illegal for Connie to steal meat from Billy."
Hulett, Adam Smith and how choice architecture makes the invisible hand more visible!, The Curiosity Vine, 2023
[v] "The distinction we have drawn before between the creation of a permanent framework of laws within which the productive activity is guided by individual decisions and the direction of economic activity by a central authority is thus really a particular case of the more general distinction between the Rule of Law and arbitrary government. Under the first the government confines itself to fixing rules determining the conditions under which the available resources may be used, leaving to the individuals the decision for what ends they are to be used. Under the second the government directs the use of the means of production to particular ends."
Hayek, The Road To Serfdom, 1944, Chapter 6
[vi] Hulett, Solving the Decision-making Crisis: Making the most of our free will, The Curiosity Vine, 2023
[vii] Clarke, Freedman, The rise and effects of homeowners associations, Journal of Urban Economics, Volume 112, 2019, Pages 1-15, ISSN 0094-1190
[viii] Condo association motivations for restrictive rules generally relate to the belief that homeowners make better neighbors than renters. This belief is controversial and not substantiated. According to a Washington Post article:
"(HOAs)... believe that owner-occupied units tend to be better cared for and that owners tend to be better neighbors than renters. Also, renters tend to stay in units for shorter periods of time than homeowners and the turnover uses more resources. Some of these statements are true, but we've found many "bad" homeowners and great tenants. We've also seen tenants live in one place for much longer than owners. So it's not an exact science."
Glink, Tamkin, Rules on short-term vacation rentals can cause the most consternation in condo associations Washington Post, 2019
[ix] Hayek specifically seeks to avoid "time and place" government restrictions of individual freedom.
"The state should confine itself to establishing rules applying to general types of situations and should allow the individuals freedom in everything which depends on the circumstances of time and place, because only the individuals concerned in each instance can fully know these circumstances and adapt their actions to them" (emphasis added)
Hayek, The Road To Serfdom, 1944
[x] Taleb, Skin In The Game, 2018