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
Why property rights important
• Allow markets to function
• Increase incentives to invest
• If transaction costs = 0, fully defining
property rights gets us to an efficient
outcome
Transaction costs
• If transaction costs > 0, asset ownership
confers power
• Transaction costs of an exchange:
– Negotiating the agreement
– Writing a contract
– Observing/monitoring the agreement
– Enforcing agreement of contract is broken
What is a property right?
• Residual rights of control
• Ability to specify unspecified uses
• Ability to alienate others from use of the
property
• Who owns what determines efficiency if
transaction costs > 0
• Incomplete contract (IC) theory:
concerned with the most efficient
allocation of property rights.
What is an incomplete contract?
• Transaction costs make contracts incomplete
• Bounded rationality:
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Background assumption to incomplete contracts.
Cannot think through all branches of a decision tree.
Cannot represent everything in a contract.
E.g. complicated bilateral relations.
• People deal with this bounded rationality in a
substantively rational way.
Incomplete Contract Theory
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Grossman and Hart (1986)
Hart and Moore (1990)
Hart (1995)
Different than Williamsonian transaction
costs analysis
• Allows renegotiation
Model
• 2 parties: i = A and B
• Each party may be an “expert” to work
with some physical asset KA and KB
respectively
• Both parties A and B can expend
investments (a and b, respectively) in
human capital
• These investments are nonverifiable
• Other party cannot buy this capital
Timeline of Production Relationship
Model Notation
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Let K = {KA, KB}
Ki is set of asset owned by i
Denote KA  KB = K
Denote KA  KB = 
Default payoffs
• Individual payoffs if do NOT work together:
VA[KA, a, 0]  VA[KA,a]
VB[KB, 0, b]  VB[KB,b]
Payoffs with Trade
• Total payoffs if work together:
V[K, a, b]
Payoff to us: less notation!
Physical Asset versus Human
Capital (or Relationship) Specificity
Investment ai party i is:
1. Nonspecific when the marginal return does not
depend on Kj nor aj
2. Purely relationship specific when the marginal
return is 0 unless parties work together
3. Relationship specific when the marginal return
positively depends on access to aj
4. Purely asset specific if the marginal return
depends (only) on party i’s access to Kj
Basic Assumptions
1. V[K, a, b] > VA[KA,a] + VB[KB,b]  Ki
GAINS TO TRADE: it is efficient to work together
Let ai = {a if i=A, b if i=B}
2. Vai [.]  Viai [ K, ai]  Viai [ Ki, ai]  Vai [Kj, ai] 
Vai [, ai]
Marginal returns from investments are weakly larger
the more human and physical capital a party has
access to, i.e. relationship specificity exists.
Asset complementarity
• An asset is complementary when:
Viai [K, ai] > Viai [Ki, ai]
(access to both assets K makes you more productive)
• An asset is strictly complementary when:
Viai [Ki, ai] goes to 0
(you need access to Kj as well)
• An asset is independent when:
Viai [K, ai] = Viai [Ki, ai]
(one asset suffices for your productivity)
Equilibrium analysis
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Backwards induction: start with Date 2
Date 2: Investments a and b are “sunk”
Since V(.) > VA (.) + VB(.)  a,b,Ki, then parties will
agree on “working together” but choose investments
noncooperatively  ex post efficiency
Division of joint surplus V(.): Nash bargaining solution
Party i obtains:
1.
2.
Default payoff: Vi[Ki , ai]
Fraction i  [0,1] of “excess surplus”:
V = V(.) - VA (.) - VB(.)
Who should own what?
• Compare investments levels under various
ownership configurations and contracting
conditions (e.g. specificity,
complementarity, cooperative v.
noncooperative investments)
• The configuration yielding highest total
surplus (both A and B’s payoffs combined)
is most efficient given the conditions.
A owns KA and KB: Integration
UIA = VA[K, a] + A[V[K,a,b] - VA[KA,a] VB[,b] ] - a
UIB = VB[0, b] + (1-A)[V[K,a,b] - VA[KA,a] VB[,b] ] – b
FOCs:
A: (1- A) VAa [ K, a] + A Va [ K, a, b] = 1 
aI
B: A VBb [,b] + (1- A) Vb [ K, a, b] = 1
bI
A owns KA, B owns KB:
Nonintegration
UNIA = VA[KA, a] + A[V[K,a,b] - VA[KA,a] VB[KB,b] ] - a
UNIB = VB[KB, b] + (1-A)[V[K,a,b] - VA[KA,a]
-VB[KB,b] ] – b
FOCs:
A: (1- A) VAa [KA, a] + A Va [ K, a, b] = 1
 aNI
B: A VBb [KB,b] + (1- A) Vb [ K, a, b] = 1
bNI
First-Best Efficient Outcomes
• Parties “work together” and choose investments
cooperatively  first-best outcome
• Investment levels are:
[a*, b*] = argmaxa,b V{K,a,b] – a – b
FOCs: Va = 1 ; Vb = 1
Simple!
First Result
• Under any ownership structure (i.e.
integration or nonintegration) there is
underinvestment in relationship-specific
investments (Hart 1995), that is:
a* > aI or aNI
and
b* > bNI or bI
Marginal productivity of
investments
1
aNI
aI
a*
Other Results
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If investments by one party are inelastic, then
integration by the other party is optimal
If assets are independent, then nonintegration
is optimal
If assets are complementary, then some form
of integration is desirable.
If one party’s HK is essential, then integration
by that party is optimal
If both parties’ HK are essential, then all
ownership types are equally optimal.
Critique of Incomplete Contracts
• Maskin and Tirole (1999):
– Agents have bounded rationality but deal with
noncontractibility in a rational way
– does BR constrain set of feasible contracting
outcomes relative to complete contracts?
– Counter-theorem: Nondescribability is
irrelevant under certain conditions
• Segal and Hart: as number of possible
states of world increase, null (incomplete)
contract is optimal.
Application to Mexico Community
Forestry Production
• What explains the vertical integration pattern
across Mexican communities with forest?
• Apply and extend incomplete contract model
• Assume two parties:
– A = community
– B = downstream firm/buyer
• Assets:
– Forest land, extraction equipment, milling and
processing equipment.
Assets and investments: Forest
management
Asset: Forest land
Investments: Safeguards against uncontrolled
clearing, marketing, scheduling, silvicultural
treatments, search and negotiation with trading
partner
Specificity: High
Verifiability: Low
Assets and investments: Extraction
Asset: Cranes, trucks, chainsaws, tractors
Investments: Logging roads, management
plan, sorting, placement of assets, marketing, job
training in logging, scheduling, coordination
Specificity: High
Verifiability: Low
Assets and investments: Milling
Asset: Sawmill, auxiliary equipment, drying kiln
Investments: Sawmill location, adjustments to
saw, marketing, job training in milling, scheduling
Specificity: High
Verifiability: Variable
Assets and investments:
Secondary processing
Asset: Processing machinery
Investments: Specialized equipment for
woodcutting, marketing for given products, job
training in cutting, scheduling
Specificity: Low to medium
Verifiability: Variable
Examples of Unforeseeables
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Rainy season
Access problems
Equipment failure
Scheduling problems
Timber condition
Failure to pay, deliver
Un-monitored extraction
An IC Model
• Survey data from 43 observations in Oaxaca
(see Antinori (2000))
• Ownership possibilities:
– Assume communities can own forest land and any
downstream equipment
– Assume outside private firms can own any
downstream equipment for wood production and can
contract with communities for raw material.
• Tradeoffs: need for specialized expertise and
overcoming collective action hurdles v. benefits
of ownership (see Antinori and Rausser (2007)
for details)
Econometric Model of Vertical
Integration
• Ordered logit (see paper for details)
• Dependent variable: level of community vertical integration (sale of
stumpage, roundwood, lumber of secondary goods)
• Independent variables:
• Influences on ability to coordinate, produce:
– Past mechanical training (+ and significant)
– Initial logging roads (not significant)
– Parastatal existence (+ and significant)
• Contracting costs, valuation:
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Forested hectares (+ and significant)
Forest quality (initial) (+ and significant)
Distance to pop center (+ and significant)
Non-commercial timber forest uses (not significant)
Conclusions
• Ownership of assets critical for control
over benefits when transaction costs
present
• Limitations of PR approach:
– Collective decisionmaking still not completely
modeled in firm.
– Beyond property rights as control over assets
Asset Wealth
• Oliver and Shapiro: Black Wealth/White
Wealth:
– Persistent wealth gap versus income gap in
the United States between black and white
– Limits opportunities