Property Rights and Collective Action in Natural Resources with Application to Mexico

Lecture 1: Introduction to the political economy of natural resources

Lecture 2: Theories of collective action, cooperation, and common property

Lecture 3: Principal-agent analysis and institutional organization

Lecture 4: Incomplete contracts with application to Mexico

Lecture 5: A political economy model

Lecture 6: Power and the distribution of benefits with application to Mexico

Lecture 7: Problems with empirical measurement with application to Mexico

Lecture 8: Beyond economics: An interdisciplinary perspective

Common Property Resources

•Not excludable – If access is open, anyone can use them.

•Rival goods – One person’s use reduces other’s use.

The Tragedy of the Commons•Garrett Hardin, “The Tragedy of the Commons” (Science, 1968)

•Example of common pastureland, open to all. The rational herdsman seekingto maximize gain will calculate the utility to him of adding one additional animal, not taking into account the effect of his use on other herdmen.

•Thus, each is compelled to add as many animals as possible, leading to overgrazing.– “Freedom in a commons brings ruin to all.”

•Other examples of commons:– Fisheries– Free parking meters– Admission to national parks

•Thus, laissez-faire, “Invisible Hand” approaches to resource allocation need not always provide the expected optimal solution.

Community Common Property Resources

• The word community is used in many ways:1. Ecological communities in an ecosystem 2. Community with defined membership and constitution 3. Sense of community 4. Communities of interest 5. Communities of space 6. Community forestry

 • In this workshop we will use (2): community as a group of

people distinguished by a collective property right.   

• However, configurations of access and control of property are central: • Who owns it?• Who claims it?• Who makes decisions about it, and how?• Who benefits and incurs cost from it?

 

Owens Valley: Evolved Community of Interests

•In 1900, Los Angeles was doubling in population every fiveyears, and was running out of water, so Mulholland bought water rights from rural ranchers in Owens Valley to the North.

•The aqueduct to Los Angeles opened in 1913; by 1926 Owens Lake had disappeared. Mono Lake water levels fell.

•Massive dust storms result as the valley dries up.•Lawsuits brought by rural towns and local environmentalists in the

1980s force Los Angeles to divert some water to the lakes, to raise water levels and reduce toxic dust.

•Current status: community of interests controlOwens Valley lakes.

•A story of devolution. The solution was not governmental, but a local community acting to preservecommon property resources.

Owens Lake today

Imperial Valley: Nonevolved Community of Interests

•Water from the Colorado River irrigates the Imperial Valleyand the inland Salton Sea. In 2003, the amount of waterwas cut by 11%, while Valley farmers negotiated with San Diego to sell water to the city for $50 million annually.

•Salinity in the Salton Sea increases, killing wildlife andthreatening to make a “dead” lake.

•Estimates of the environmental cost of repairing the lake reach $1 billion.

•No devolution, no community of interest

Salton Sea

Groundwater in Los Angeles: Initially commons, evolves to self governance (bottom-up)

•Legally, the right to pump from groundwater basins was established by a history of continuous withdrawal and beneficial use.

•“Rule of capture” governs ownership of the stock, when property rights are undefined and access nonexclusive.– Pumpers are granted exclusive rights to what they pump; what they do not

pump will be taken (in part) by rivals.– The result was pumping far beyond sustainable levels, with saltwater incursion

and threatened collapse of groundwater basins.•Solution: In 1943, negotiations began to reduce pumping from Raymond Basin

– With the threat of lawsuits looming, stakeholders negotiated an agreement toshare the cutback to safe levels proportionately, rather than determine incourt whose rights took precedence.

– By negotiating their own agreement, the parties ended the pumping race fasterand at a lower cost, while gaining firm and marketable rights to definedshares of the safe yield of the basin.

– Later litigation in nearby basins resulted in management costs 25 times higher.

Irrigation in Sri Lanka: Initially commons, evolves to self governance (top-down)•Maldistribution due to lack of collective action. •Gal Oya irrigation system is the largest in Sri Lanka, completed in 1950•The acreage actually irrigated turned out to be only one-third of projections

– Engineers presumed that water would be treated as a scare good with strict allocation rules; neither presumption was appropriate.

•Incentive structure for rice farmers reinforced a short-term “individualistic” strategy– Take as much water as their paddy fields will hold, legally or illegally, while refraining

from participation in any system that would limit water use.•In 1980s, Agrarian Research and Training Institute organizes farmers into small-scale,

informal, grassroots organizations, to educate and problem-solve.

•Under self-governance, water distribution becomes more equitable.

Canal Belihul Oya, Sri Lanka

Fisheries: Commons

•In Sri Lanka, open access to ocean fisheries combined withimproved boats and nets has led to a precipitous decline in stock.

•Fisherman have to go farther out to catch fish, increasingtheir risk of death.

•The limit of entry is the risk of death.•Attempts to set rules have been proposed but not

implemented, due to ongoing civil war.

Sri Lankan fishing boats

Formal Definitions of Terms

•Coalition formation•Participation constraints•Incentive compatibility•Alignment of incentives•Mechanism design•Property rights

Coalition Formation

•A subset of stakeholders whose interests are more closelyaligned with each other’s than with other stakeholders.

•Nash/Harsanyi model of bargaining and policy formation

Participation Constraints

•The point at which a player’s payoff for participation is equal to their payoff in the disagreement outcome.

•Unless this constraint is satisfied a person in the communitywill not become a member of a coalition.

Incentive Compatibility•An allocation mechanism for which participants in the

process would not find it advantageous to violate the rules of the process.

•Any institution or rule designed to accomplish groupgoals must be incentive compatible if it is to perform as desired.

•If a mechanism is incentive compatible, then each agentknows that his best strategy is to follow the rules accordingto his true characteristic, no matter what the other agents do.

Alignment of Incentives

•Stakeholders share a common interest

•If there is a conflict of interest, there cannot be alignment of incentives

Principal-Agent Problem

•Agent: an individual employed by a principal to achieve theprincipal’s objective

•Principal: an individual who employs one or more agents to achieve an objective

•Problem arises when agents (e.g., a firm’s managers) pursue their own goals rather than the goals of the principals (e.g., the firm’s owners).

Mechanism Design•Explicitly recognizes the possibility of institutional failure•Asymmetric information:

– Moral hazard/Hidden action– Hidden information

•Adverse selection•Signaling

•Strategic Behavior and False Signals

The Analytical Dimensions of Community Policy

Analytical frameworks for the study of community policy typically focus on one of four dimensions:1. Incidence2. Implementation3. Political Economy4. Governance Structures

Incidence

•Uses partial equilibrium frameworks, based on a number of simplifying assumptions:

•Markets are perfect in the absence of governmentintervention; any introduction of policy is byconstruction a government failure.

•Assumes:– Perfect implementation (PI)– No feedback effects from interest groups (NF)– A given governance structure (GG)

Implementation•Explicitly recognizes the possibility of institutional failure•Does not presume perfect implementation (PI)•Policy analyses that recognizes agents actively respond

to incentives.•Asymmetric information:

– Moral hazard/Hidden action– Hidden information

•Adverse selection•Signaling

•Incentive compatibility•Participation constraints

Political Economy•The assumption of no feedback effects from interest

group formation (NF) is relaxed.•Seeks to explain the selection and implementation of actual

public policies by endogenizing the instrument choice as a function of the actions of stakeholders.

•Political economic theories include: University of Chicago,rent-seeking, public choice, liberal-pluralist, “theory of thestate”, political-economic bargaining

•Empirical formulations: structural, constraints, policy reactionfunctions, reduced form representations

•Political preference function (PPF)

Governance

•A constitutional analytical dimension, that relaxes the givengovernance structure assumption (GG)

•A constitutional design establishes the rules by which rule are made, setting the boundaries for economic, political and civil freedoms.

•Conceptual frameworks: views current policies as a rational outcome of the collective decision-making process.

•If power is unevenly distributed among the special interests and societalinterests, organizational failures naturally arise.

•The resulting distribution of political power and influence creates a tradeoff between public and special interest in the selection of particular policies.

•Formal Determination:– Bargaining Issues– Stakeholder Access– Admissible Coalitions– Default Options

Constitutional Rules and Policymaking Centers

•The major ideas that emerge in constitutional prescription can be illustrated by means of a simple example of three policymaking centers faced with a two-dimensional, group-choice problem in which any one of four possible constitutional rules may be selected.

•Even though this is a simplified example, it nevertheless graphically captures the essential features of the constitutional selection problem.

•The preferences of the individual policy centers among the various policy combinations are represented by the indifference curves drawn in Figure 9.1.

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U21 U22 U23 U24

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U34

U35

Preferences and collective choice for three policymaking centers

•Points A, B, and C represent the policy combinations most favored by policy center 1, 2, and 3, respectively; and the utility levels associated with the various indifference curves satisfy the relation,

•As travel costs are borne by the consumers of the public goods, policy centers 1 and 3, who happen to represent neighboring consumer interests, prefer essentially the same site location.•Policy center 1 is more impatient than policy center 2 who, in turn, is more impatient than policy center 3.•The policy center’s time preferences are revealed by their attitude toward the timing of the government’s investment in the public good.•The more impatient the policy center, the sooner they prefer the investment and associated financing take place.

U U U ii i i0 1 2 1 2 3 ...( , , )

Preferences and collective choice for three policymaking centers, continued

•The lines, AB, AC, and BC, connecting the most favored combinations are loci where the indifference curves of policy center i and policy center j are tangential to each other; i.e., they are the corresponding contract curves.

•Note that for any policy combination outside , there is at least one combination in which is Pareto superior to it and will, therefore, be unanimously preferred by all policy centers.

i j, , ,1 2 3b g

Preferences and collective choice for three policymaking centers, continued

Rules•There is a large set of constitutional rules that could be evaluated—expert rule (or almost expert rule), tie-breaking chairman rule, rule of the chairman and two aids, unanimity, restricted simple majority rule, multiple majority rule, simple majority rule.•Assume that only four collective choice rules are admissible at the constitutional phase. These rules are:

r1• : Elect one policy center who will serve as the sole decision maker on all policy issues (“president”).

• : Conduct a referendum over pairs of policy alternatives where the winner in each pair is decided by simple majority, and no bargaining and/or coalition formation is permitted (“referendum”).

• : Use the same procedure as under referendum, but bargaining and coalition formation are allowed (“voting cum bargaining”).

• : Select a policy combination with which all policy centers concur (“unanimity”).

r2

r3

r4

Evaluation of Alternative Constitutional Rules: Presidential System

•Under a presidential system ( ), there are three possible political solutions: A, B, and C.

•The policy center’s expected utility is then

r1

V r U A U B U Cii

ii

ii

( ) ( ) ( ) ( ) .11

3

1

3

1

31

9 LNM

OQP

Evaluation of Alternative Constitutional Rules: Referendum

•If a referendum ( ) is selected, every point in is a likely candidate for a solution since the path selected in the operation phase cannot be foretold with certainty.

•The policy center’s expected utility is then

r2

V rS

U x x dx dxi

i( )( )

( , , ) ,21

3

1 2 1 2

1

3 z z

( )S where is the area of .

Evaluation of Alternative Constitutional Rules: Voting cum bargaining

•Under voting cum bargaining ( ), the set of possible political solutions depends on the solution concept employed.•There are three possible solutions: policy combination D corresponding to the coalition structure ; policy combination E corresponding to coalition structure ; policy combination F corresponding to coalition structure . Under this constitutional rule, the policy center’s expected utility is

r3

V r U D U E U Fii

ii

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3

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OQP

1 3 2, ,l ql q1 2 3, ,l qlq

2, 3 , 1

Evaluation of Alternative Constitutional Rules: Unanimity

•The political solution under unanimity ( ) is the outcome of a bargaining game and depends again on the solution concept employed.

•The policy center’s expected utility is then

r4

V r U Jii

( ) ( ).41

31

3

Bargaining Costs

•Let denote the cost of reaching a decision (“decision cost”) per policy center associated with the selection of constitutional rule; then one expects . •Note that consists mostly of the negotiation cost but may include other types of costs, such as losses due to calculation errors.

• is the smallest since, under the presidential system assumed here, collective decisions are made by a single person. • is the greatest, since, under unanimity, each individual enjoys a veto power. • is greater than since involves bargaining while does not.

C rkbgC r C r C r C r1 2 3 4bg bg bg bg

C rkbg

C r1bgC r4bgC r3bg C r2bg r3

r2

Bargaining Costs, continued

•Even though the mean values of the political solutions under alternative constitutional rules are similar, large differences exist among the corresponding spreads.

•When is small, a political solution maximizing the well-being of policy centers in at the expense of those not in is easily attained.

•When is large, its policy centers’ preferences are more diverse and the solution agreed upon by policy centers in is less likely to maximize their preferences at the expense of the policy centers excluded from .

Dk

DkDk

Dk

Dk

Dk

Bargaining Costs, continued

•The disparity is greatest under the presidential system and smallest under the unanimity rule , with the voting rules ( and ) occupying an intermediate position.

•The difference in the spreads of political outcomes associated with the two voting rules derives from a completely different source—the wide range of possible “decision paths” under referendum as compared to the limited and centrally-oriented set of possible solutions under voting cum bargaining .

•The general pattern of variation in the policy center’s utility level under the alternative constitutional rules reflects the spread of the policy combinations under these rules.

r1r4

2r r3

2rr3

Bargaining Costs, continued

•Note that spread spread spread spread . •Given the “mean preserving spread” argument implied by the above observation, it follows that for sufficiently risk-averse policy centers .

r1bg r2bg r3bg r4bg

V r V r V r V r1 2 3 4bg bg bg bg

Constitutional Space Prescription

•The scope for prescription at the constitutional phase may be decided by alternative rules selected in accordance with the sensitivity of the policy centers’ expected utility to the ultimate decision and its associated cost.

•The sole decision-maker case, , exhibits maximal spread but minimal bargaining costs, and it is usually confined to matters of less importance.

•To evaluate, define .

r1

( ) ( )k k kM V r C r

The structure of (C, V) over the constitutional rules and policy issues spaces

0

V

C

Exp

ecte

d U

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ty

Decision Costs

M1

M2

M3

M4

M1

M2

M3

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M4