A preface

When the subject matter of this essay was first suggested to me I found it interesting, but it was quite unclear how the question “What are the economic limits to modern politics?” could be made sufficiently precise to call forth a grammatical answer. As I set about thinking and reading, some kind of order came to be imposed on the question – indeed, so much so that the answers seemed almost inevitable. What I had not bargained for was that I would not at all like the answers. Indeed, they bear a close family resemblance to propositions found in Hayek's Road to Serfdom (1944), a book which in my youth I detested. Yet it seems that recent work on agency and information has strengthened rather than weakened the force of Hayek's arguments. I still hope that there are counterarguments which I have neglected or flaws in my own reasoning, for in this case my inclinations and findings are in conflict. The reader is invited to consider what follows with a critical eye in the knowledge that the author would not be displeased to find that he has been mistaken.

We must eat and drink to live. If follows that arguments designed to convince us that the good life can be led only in arid deserts are intrinsically uninteresting as political arguments. Much of political theory and discourse is concerned with the good society which facilitates the good life.

INTRODUCTION

This chapter examines the contracting problems encountered in efforts to unitize the production of crude oil in the United States. Since the first discovery of petroleum in the United States in 1859, oil production has been plagued by serious common pool losses. These losses arise as numerous firms compete for migratory oil lodged in subsurface reservoirs. Under the common law rule of capture, private property rights to oil are assigned only upon extraction. This follows similar practices in allocating property rights to other naturally occurring resources, such as fish, wildlife, and even frontier federal land. For each of the firms on a reservoir, a strategy of dense-well drilling and rapid production allows it to drain oil from its neighbors and to take advantage of the low extraction costs that exist early in field development. In new, flush oil fields, subsurface pressures are sufficient to expel the oil without costly pumping or injection of water or natural gas into the reservoir to drive oil to the surface.

Under these conditions, when there are multiple firms on a reservoir, each firm has incentive to drill competitively and drain to increase its share of oil field rents, even though these individual actions lead to aggregate common pool losses. Rents are dissipated as capital costs are driven up with the drilling of excessive numbers of wells (more than geologic conditions require or price and interest rate projections warrant) and with the construction of surface storage, where the oil can be held safe from drainage by other firms.

The Cambridge series in the Political Economy of Institutions and Decisions is built around attempts to answer two central questions: How do institutions evolve in response to individual incentives, strategies, and choices? How do institutions affect the performance of political and economic systems? The scope of the series is comparative and historical rather than international or specifically American, and the focus is positive rather than normative.

Gary Libecap's Contracting for Property Rights is a study of the way property rights institutions are formed. The very substantial literature on these economic institutions has made abundantly clear that property rights matter; that they provide the basic incentive system that shapes resource allocation. What has been largely missing is why they take the form that they do. Why do some property rights structures lead to productive activity and underpin economic growth, while others result in waste and unproductive activity? Libecap's study emphasizes that property rights are formed and enforced by political entities and reflect the conflicting interests and bargaining strength of those affected. Moreover, because today's choices are constrained by yesterday's decisions, history matters.

Libecap's study is a synthesis of theory and history that illustrates and illumines the complexities of property rights formation in four natural resource industries in the American economy. These four empirical cases are contrasting studies of differential success in mitigating the losses from the common pool – losses that occurred even though in each case there were large aggregate gains to be made from reaching agreement.

INTRODUCTION

Although the previous chapters focused on efforts to establish property rights to land and to change in U.S. land policies, this chapter examines some of the contracting issues encountered in attempts to control access and harvests in fisheries, where there often are serious common pool problems. The losses from common pool conditions in fisheries include declining total catch, falling income for fishermen, overcapitalization through too many vessels and too much gear, and excessive labor input. These losses provide important incentives for fishermen to contract among themselves and with politicians and bureaucrats to reduce fishing in order to bring total catch to more optimal levels. Nevertheless for many of the reasons identified in this chapter, the contracting record in numerous fisheries is one of only partial success. Differences among fishermen according to skill, capital, and size create conflicting interests and incentives for regulating fishing. These differences limit the informal agreements that might be reached among fishermen to reduce fishing and diminish the effectiveness of fishermen as cohesive lobbyists for influencing more formal regulatory controls on access and harvest in open access fisheries. As a result for some species, catch and incomes for fishermen have fallen sharply and stocks have been depleted. In response, regulatory policies have been adopted to rebuild the stock and to raise incomes, but they frequently have been very costly and relatively ineffective. In other more extreme cases, overfishing has so depleted stocks of some species that they are no longer commercially viable.

INTRODUCTION

The nature in which property rights are defined and enforced fundamentally impacts the performance of an economy for at least two reasons. First, by assigning ownership to valuable assets and designating who bears the rewards and costs of resource-use decisions, property rights institutions structure incentives for economic behavior within the society. Second, by allocating decision-making authority, the prevailing property rights arrangement determines who are the actors in the economic system.

Because of these very basic and critical roles in influencing economic activity and the distribution of wealth and because of the wide variety of property rights arrangements that exist, it is important to analyze how various property institutions emerge. Although these issues have been introduced in Chapter 1, to go further a framework for analyzing the development and modification of property rights institutions is necessary. In this chapter, a conceptual framework is outlined to analyze four different property rights solutions to common pool problems encountered in exploiting natural resources in the United States. While addressing these four cases, the approach taken here can be generalized for examining other property rights issues.

The analytical framework is a very microoriented one. It focuses on the political bargaining or contracting underlying the establishment or change of property institutions, and it examines the motives and political power of the various parties involved. This approach is taken because ownership structures are politically determined, and they assign both wealth and political power in a society.

INTRODUCTION

Mining camp agreements to assign private mineral rights on federal lands in the midnineteenth century were completed quickly and later, incorporated routinely into state and federal laws, particularly into the federal Mining Law of 1872. Similar efforts made toward the end of the nineteenth century to gain formal recognition of local property rights arrangements to federal range land and to modify the law to allow for the sale of federal timber land, however, were much less successful. Indeed, in many cases the federal government opposed the division of the land practiced and advocated by ranchers and timber companies. Their demands never were incorporated formally into federal land law in the manner afforded the private mineral claims made under mining camp rules. This chapter examines the history of efforts to change federal policy regarding range and timber lands to facilitate private claiming. It outlines the reasons those changes were not made and identifies some of the costs of failing to establish procedures for defining clear property rights to land.

The objectives of ranchers and timber companies were to adjust federal land transfer policies to allow for patents or titles to larger private claims of timber and range land than the 160 acres commonly allowed under the land laws and to relax the requirement for agricultural development as a condition for receiving title. The lands in question were timber lands, largely in the Pacific Northwest, and arid range lands west of the 100th meridian, running from North Dakota to Texas.

This volume joins a growing literature on institutional analysis by examining how particular property rights emerge or are modified. The gains from reducing common pool losses through the structure of property rights provide important incentives for institutional change. Common pool losses span those associated with classic open access resources, where no formal property rights exist and informal arrangements pose only limited constraints on behavior, to cases where formally defined property rights already are in place, but are too incomplete to prevent wasteful production practices. Although both existing informal property rules agreed to by the relevant parties or more formal, codified rights may be sufficient to channel behavior toward socially productive use of valuable resources, these status quo equilibria can be upset by changes in relative prices. Price changes through shifts in demand or supply conditions can generate greater competitive pressures for assets and thereby reduce ownership security. Depending on its extent, greater insecurity will lower time horizons in production decisions, reduce investment, and encourage too rapid exploitation.

Although the focus of the analysis has been on the political contracting behind four efforts to devise or to change property rights to natural resources in the United States, the implications of these studies can be applied to the broader examination of property rights institutions. In each of the cases, political bargaining involved both informal negotiations among claimants to devise local rules for resource use and lobbying to influence politicians and bureaucrats in legislation, court rulings, and administrative regulations regarding property rights.

INTRODUCTION

Property rights are the social institutions that define or delimit the range of privileges granted to individuals to specific assets, such as parcels of land or water. Private ownership of these assets may involve a variety of rights, including the right to exclude nonowners from access, the right to appropriate the stream of rents from use of and investments in the resource, and the right to sell or otherwise transfer the resource to others. Property rights institutions range from formal arrangements, including constitutional provisions, statutes, and judicial rulings, to informal conventions and customs regarding the allocations and use of property. Such institutions critically affect decision making regarding resource use and, hence, affect economic behavior and performance. By allocating decision-making authority, they also determine who are the economic actors in a system and define the distribution of wealth in a society. Because of their important social role, property rights institutions have been the subject of attention by economists and economic historians, as well as by political scientists and sociologists. Surveys of the economics and economic history literature are provided by Furubotn and Pejovich (1972), North (1978), De Alessi (1980), and Libecap (1986). The focus of this literature largely has been on how various property rights arrangements affect behavior, which ranges from the wasteful practices associated with open-access or common pool settings to the wealth-maximizing actions possible with secure private property rights.

INTRODUCTION

Of the four cases examined in this volume, efforts to assign locally recognized private mineral rights and subsequently to adjust state and federal land law to recognize those contracts were the most routine and uncontroversial. Agreements within the mining camps to outline procedures for claiming and enforcing private mineral rights were completed rapidly, and there appears to have been broad-based political support for incorporation and refinement of the mining camp rules into state and federal law. The history of these efforts is examined in this chapter. The reason for contracting was potential common pool losses, which emerged with the discovery of fabulously rich gold and silver deposits on previously unclaimed and unsettled federal land in the Far West between 1848 and 1890. Private claims to parcels of land were made as miners rushed to the region following the ore discoveries, but there was no existing legal framework for formally recognizing or protecting those mineral “rights.”

Competitive pressures for what were effectively, open access mineral lands were intense. For example, within months of the first ore discoveries on Sutter Creek in 1848, the population of California rose from a few thousand to 107,000 and by 1860, to 380,000, with most people concentrated in the mining camps of the central Sierra Nevada foothills. In the absence of legal rules to assign ownership of the valuable mineral lands, there was the potential for violent contention for control.

Tables 2.1 and 2.2 provide some background information on the Malaysian and Thai economies. In the context of this study, the information on the manufacturing sector would be of particular interest.

Malaysia

The Malaysian gross domestic product (GDP) growth rate has been reasonably high, as shown in Table 2.1. It was in the region of 6–7 per cent until the recession of 1985 when a negative growth rate of −1 per cent was recorded. Subsequently, there was a marginal improvement in growth in 1986 as the impact of the recession continued to be felt. However, the economy has begun to recover since mid-1987 as a result of improvements in external demand for manufactured exports and increased prices for commodities. The 1987 GDP growth rate improved significantly over the 1986 figure to record an impressive 5.2 per cent. The following year, 1988, proved to be even better. With the buoyant external demand for manufactured goods and stable and high prices for commodities, particularly rubber and oil palm, the Malaysian GDP growth rate climbed back to its pre-1985 levels by turning in a growth achievement of 7.4 per cent.

It will be noticed that growth rates in the manufacturing sector were higher than the overall GDP growth rates. Prior to 1985, manufacturing growth had increased steadily to peak at 12.3 per cent in 1984. However, the recession in 19 85 affected the sector adversely and resulted in a negative growth rate of −3.8 per cent, but it rebounded quite rapidly and has been growing impressively since then. Growth has been particularly encouraging after 1986: in 1987 a growth of 12.8 per cent was recorded, and in 1988 the rate was even higher at 15.5 per cent. As a recent Wall Street Journal (1 August 1988) article put it “manufacturing has been the big story of the (Malaysian) recovery. Spurred by overseas demand, the manufacturing sector accounted for 22 per cent of Malaysia's inflation-adjusted GDP in 1987, narrowly surpassing agriculture for the first time”.

The development of resource-based industries has featured importantly in the industrialization strategies of both Malaysia and Thailand. Agriculture had been the leading economic sector in the two countries until very recently. Since 1987 manufacturing has overtaken agriculture and is continuing to expand rapidly. Both governments are giving prominence to industrial development in their economic development strategies (Ng, Hirono and Siy 1986). Given that the two nations are noted to be resource-rich countries, it is only natural that resource based industrialization should become a cornerstone of their industrial policies.

Resource-based industries (RBIs), defined simply, are generally taken to mean those industries that are involved with the downstream processing and manufacturing of the country's agro and mineral products, usually termed “primary industries”. The discussions here will focus on the manufacturing industries that make use of the products of the primary industries and convert them into higher value-added finished and semi-finished goods.

In a survey of resource-based industrialization in the developing countries (DCs), Roamer (1979) has attempted to shed light on the potential contribution of industrialization based on resource processing to efficient growth, employment creation, greater equity and economic independence. Two industrial strategies that are primarily based on the utilization of natural resources have been receiving emphasis in the developing countries. One is that of the more complete processing of raw materials for export; the other is the utilization of domestic resources mainly for domestic consumption. Generally, a major portion of resource commodities is exported in unprocessed form. There is, therefore, considerable scope for further processing or fabricating these products for export or for home use.

However, since it is not obvious that resource-based industrialization is better suited to achieve national development goals than other potential strategies, the Roamer paper surveys the development literature to throw light on related issues of economic development. The highlights of his survey are as follows.

With the exceptions of wood products, processing tends to have a high capital-labour ratio.