Incomplete Ownership, Rent Dissipation, and the Return to Related Investments

By Deacon, Robert T. | Economic Inquiry, October 1994 | Go to article overview

Incomplete Ownership, Rent Dissipation, and the Return to Related Investments


Deacon, Robert T., Economic Inquiry


I. INTRODUCTION

When ownership rights to a resource are costless to enforce, trades occur and an equilibrium price emerges. In such cases it is a price and a transfer of wealth from one agent to another that rations use of the resource. Absent ownership no price is charged and use is rationed by a transaction cost. Acquiring a barrel of oil or an acre foot of water from a shared reservoir is a transaction--a resource in the common domain is transformed into property by the act of lifting it to the surface where ownership can be enforced. The relevant transaction cost in this case is the cost of pumping. In a fishery the relevant transaction cost is the cost of locating and capturing a portion of the unowned stock.

The marginal transaction cost limits each individual's use and accomplishes the necessary task of equating demand to the resource's supply. Users of the resource are in equilibrium when this marginal transaction cost equals the resource's marginal value. The transaction cost also eliminates all or part of the rent the resource would earn if owned, however, and the size of this loss depends on the relationship between average transaction cost and the resource's marginal value.

This suggests that the amount of rent an unowned resource will yield in equilibrium, after netting out relevant costs, depends on the shape of the cost function for acquiring it. If marginal cost is much greater than average cost, as in cases where marginal cost is steeply rising, the equilibrium rent will be relatively large.(1) While the shape of the cost function depends on the nature of the resource, it is not immutable. For example, it can be altered by imposing constraints on the inputs or the technology used. It follows that users of a resource would benefit collectively if the technology or inputs used were constrained in a way that causes the marginal cost of obtaining it to rise steeply. The optimal choice of such constraints is a well-formulated second-best policy problem.

This specification of the problem is incomplete, however, because the intensity of competition for the shared resource can also be changed by actions that affect it only indirectly. An innovation or investment that lowers the individual's cost of acquiring it, for example by reducing the price of an input used, has this effect. So does an action that raises the resource's marginal value product, possibly by affecting the price or availability of a substitute. Such actions increase competition for the shared resource and raise the equilibrium cost of actions taken to acquire it. In this sense the rent dissipation that is normally thought to characterize competition for shared resources can spread to related actions or investments.

Both of these considerations are pursued in what follows. Second-best policy toward a shared resource is examined by considering regulations that can control some but not all of the inputs needed to acquire it. It is shown that the optimal input constraint and the fraction of potential rent such a policy can capture depend on two determinants--the elasticity of substitution between, and relative price of, regulated and unregulated inputs.

It is also shown that competition for the shared resource can eliminate all or part of the return to related actions, i.e., actions that result in a shift in the relevant private cost or benefit function. The size of such losses depends in a simple way on the elasticities of relevant cost and benefit functions. These additional losses can occur even in cases where direct competition causes complete rent dissipation. As a result, the loss that results from free access can exceed the rent the resource would earn in a complete markets equilibrium. This phenomenon, termed excess dissipation, is illustrated with a number of examples. Investments that reduce the percolation of groundwater back into a common aquifer or expenditures to prevent fish from escaping from a net and returning to the natural population during the process of capture are shown to have this effect. …

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Incomplete Ownership, Rent Dissipation, and the Return to Related Investments
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