Source: This essay first appeared in the journal Literature of Liberty: A Review of Contemporary Liberal Thought , vol. II, no. 4, October/December 1979 published by the Cato Institute (1978-1979) and the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio. It is republished with thanks to the original copyright holders. Richard Stroup is a professor at Montana State University and is active in the Political Economy Research Center (PERC) with a speical interest in environmental economics. John A. Baden is founder and chairman of the Foundation for Research on Economics and the Environment (FREE) based in Bozeman, Montana.
How much development should be allowed on the Yellowstone River? Is oil being used too quickly? Is the strip mining of coal properly controlled?
The world's limited patrimony of natural resources has stirred up a lively debate: how can we optimally manage our resources? It is no simple task for analysts to determine how best to manage or to allocate resources. Which uses are most "important"? How may the resources be best exploited? And what is the time path for budgeting the use of exhaustible resources? All these are important and complex questions, loaded with emotion. Charles W. Howe, Natural Resource Economics (1979), however, gives one recent and detailed study of how standard economics may be applied for problems in natural resource management.
In analyzing such natural resource issues, it is critically important for us to consider the form and ownership of property rights in resources. Whether the perspective is historical, predictive, or prescriptive, it is important to recognize who controls these property rights, and under what conditions. Only from this framework of property rights can we understand decision processes. Individuals, not large groups or societies, make the decisions. They do so, however, in an institutional framework. The property rights paradigm provides important analytical leverage in comprehending how individuals interact within institutions. The property rights concept, then, not only helps us understand history; it also helps us predict the consequences of today's institutions or to compare the likely outcomes of alternative arrangements. Given the increased pressure from larger populations, and from more powerful technologies which increase our ability to access and process more natural resources, an increased comprehension of our system and our alternatives is most welcome. For an assessment of United States renewable resources, and the increasing pressures on them, see the U.S. Department of Agriculture's The Nation's Renewable Resources–An Assessment, 1975. In the case of exhaustible resources, see Hans Landberg, et al., Resources in America's Future (1963).
In this bibliographical essay we will: (1) trace the outlines of the property rights paradigm as it relates to resource management, (2) sketch the workings of resource markets when property rights are private and readily transferable, (3) explain market failure and the potential gains in efficiency from governmental intervention in resource markets, (4) show why collective control of resources can also be expected to have problems, (5) illustrate by case studies how the theoretical analysis works in practice, and (6) draw some policy conclusions.
The most interesting challenge to the economic historian is to account for changes in the structure and enforcement of property rights over time. Douglass North1
Property rights theorists, unlike most other economists, do not necessarily begin with the assumption that decision makers seek to maximize profits, income, or even wealth. Instead, these theorists stress the importance of specifying goals (utility function) in each case. The decision maker is then assumed to maximize his own utility (not that of an organization or state) in whatever situation he finds himself. For an excellent review of this perspective, see Eirik Furobotn and Svetozar Pejovich, "Property Rights and Economic Theory: A Survey of the Recent Literature," Journal of Economic Literature (1972).
Property rights in a tract of land, a coal mine, or a spring creek consist of control over that resource. An important feature of a property right is the ability to exclude others from using the resource. The right to use, but not to exclude others from use, is a highly imperfect (or ill-defined) property right. Failure to recognize this leads to a weak, or even useless model and to wasted resources. For an example of such a failure, see Robert Dorfman, "The Technical Basis for Decision Making" in Haefele, The Governance of Common Property Resources (1974).
Such a right to control property is most valuable to an individual when its ownership is outright, and it is easily transferable in exchange for other goods and services. However, even a limited discretionary command over access to a resource confers status and power to the holder. Governments typically exercise at least some discretionary command in this regard. The theory of property rights to control over resources can in fact become a theory of the state. As Douglass North says, "In effect, one cannot develop a useful analysis of the state divorced from property rights."2
As individuals seek their own advantage, they generally do so within the prevailing institutional arrangement. In addition, however, they may seek gains by attempting to change the "rules of the game," or existing institutions which define property rights. For example, when privately held property rights to land are attenuated by zoning, land owners may gain by changing the zoning rules, or by influencing their administration. Since other individuals may seek the same advantages for themselves, the resulting competition may involve negative sum games: those who "win" may gain less than what is lost (invested) by the competitors as a group. There is a growing literature on the topic of resource use ("rent dissipation") in the manipulation of rules ("rent seeking") by individuals in the quest for individual gain. See, for example, Anne Krueger, "The Political Economy of a Rent Seeking Society" and Gordon Tullock, "The Welfare Costs of Tariffs, Monopolies, and Theft." If the rules allow government officials discretion in determining who has access to a resource, competing claimants can be expected to invest in means to seek favorable administrative outcomes. Informational lobbying, the shift of political support, lawsuits (actual or threatened) and simple bribery can all be brought to bear, though not without cost, by those wishing favorable treatment from decision makers who do not "own," but nevertheless control the rights (access) to resources.
Some property rights theorists, writing on the evolution of institutions, have pointed out that economic growth and efficiency are greatly affected by the way in which prevailing institutions allow property rights to be traded and allocated. When rights are privately held and easily transferable, for example, private decision makers have both the information and incentive to move resources to more highly valued uses. By contrast, if those who would lose from such change can prevent it through governmental means, without bearing the loss to society of such stagnation, then the potentially higher valued uses for resources may be foregone. We turn now to a discussion of privately held property rights, and the impact of freely tradable rights (the market) on resource management.
When resources are owned privately and the property rights are freely transferable, decisions on resource uses are decentralized. Rationing of the scarce resource and coordination of individual plans are accomplished through the market. The owner of a copper mine receives market information on the value of alternative uses, as well as the incentive to supply the highest valued use, through bids for copper ore (or offers to buy the mine). A more complete treatment of markets in a resource setting, as compared with collective management can be found in Richard Stroup and John Baden, "Externality, Property Rights, and the Management of Our National Forest," The Journal of Law and Economics (1973). In this market setting, the owner is able to minimize the social cost of exploiting his resource simply by minimizing the total cost to himself. Bid and asked prices in the market convey both condensed information (shorn of all questions of "sincerity" or genuineness" of the "needs" of the parties competing to be recognized in the decision process) and the incentive to use this information. Owners thus have the information needed for efficient resource allocation, and the encouragement or incentive to serve others by operating efficiently. Consumers, who must pay for what they use, are also informed by prices as to the value others place on what many desire.
Included in the advantages of this management system (based on private property rights) are diversity, individual freedom, adaptiveness, the production of information, and a certain equity. Diversity is fostered under private property rights because there is no single, centralized decision maker but many asset owners and entrepreneurs, each of whom can exercise his own vision. Those who correctly anticipate people's desires are most rewarded. Individual freedom is preserved under the market: those who wish to participate in and support such activities are free and able to do so since market prices provide immediate information and incentive for action as soon as changes are seen. If only a few see scarcities or opportunities ahead, they can buy, sell, —or just provide expertise as a small group of consultants—and thus direct resource use without convincing 51 percent of the voters (or their bureaucracy) of the advantages of their preferences. In this case profits will reward foresight and quick action, while losses discipline those who divert resources foolishly.
Information, another advantage of property rights, is produced as a byproduct of bids offered and prices asked in the market, and is vital to the coordination of plans made in the economy by individuals.3 Activities not marketed are proving very difficult to manage rationally for there is little or no concrete evidence on how people really evaluated nonmarketed activities relative to other resource-using activities. We know, for example, how much people are willing to sacrifice for a thousand board feet of lumber of a given species and grade, but how much would they pay for a day's access to a wilderness area? In the latter case of a nonmarket good we have only rough estimates. Even the best manager cannot make good resource management decisions without knowledge of the input and output values.
As a final advantage of management of resources through private property rights, there is a measure of equity in having those people who use a resource (or wish to reserve it for use) pay for it by sacrificing some of their wealth. The proceeds from the sale of public assets could be distributed, or invested and perpetually distributed to the poor or others. For example, those using the forests would be required to pay a fee, whether it be for recreation, timber harvest, or even research in a unique area.
The market, as we describe it here, is a marvelous mechanism. Its workings, however, crucially require that property rights to each resource (especially the right to exclude) be privately held and easily transferable. Only if these conditions are met can we be assured that a decision maker (the owner) with an appropriate stake in the resulting decisions (his estimate of what the resource is worth in his use or on the market) will have reason to devote the appropriate amount of attention (but not too much) to how the resource can be used in its highest value (including the potential value to others in their use).
If property rights to the resource are not fully defined and enforceable, those who put a relatively low value on its use may nevertheless use the resource without the need to compensate (or outbid) anyone else. Or, should rights be controlled by a public (or a nonprofit) decision maker who cannot personally gain from more efficient utilization of the resource, waste could occur. The decision maker maximizes his advantage from limited property rights by minimizing his hassles (which he would face from hard decisions in reallocation) or by insuring his future job promotion (by giving in to the desires of politically powerful groups).
If rights are privately owned but not easily transferable (as in the case of agricultural water rights desired for industrial use nearby) another problem emerges. In this case, the farmer is forbidden by law to sell water to the industrial user (because unmeasured return flows might decline, injuring downstream holders of water rights). This prohibition may lead the farmer to irrigate wastefully and thus lose much water to evaporation, even though he would be quite willing to sell the water he consumes to the industrialists at a price both would find compatible.
In brief, when private rights are securely held by private individuals, but easily transferable, the resulting pattern of resource utilization would be difficult to improve upon. This follows directly from the fact that resources are easily mobile, markets provide clear and condensed information on relative values, and each person has the incentive to seek out and fill (and profit from) better uses for each resource.4 The next two sections will point out in some detail the problems which result in both the market and nonmarket sectors when property rights are undefined, unenforced, not owned by private parties, or when transfer is impeded.
As we mentioned above, market failure occurs when property rights are not properly specified, or are not held by those who can benefit personally by putting the resources to the use most highly valued by participants in the market. These market failures have long been recognized, but are frequently not traced to their origins in imperfect property rights.5 In this section we discuss the consequences of not specifying clear property rights.
A common reason to distrust market outcomes is the possibility of monopoly. If one individual or firm controls the entire supply of a resource (natural diamonds, for example), that individual has an incentive to limit output not only to reduce production costs, but also to increase price. If there are no good substitutes available to users of the resource, a price well above the cost of added production may benefit the resource owner most. This would be inefficient, in the sense that some units remain unproduced even though they would be valued by users more than others value the inputs required for their production. In this situation the owner of resource rights is presumed to be unable to sell to individuals at any lower price without simultaneously lowering his price on all units.6
Another frequently cited cause of market failure is the existence of externality. An externality exists when some results (positive or negative) of a decision are not visited upon the decision maker. The classic case of negative externality is air pollution. Since John Evelyn wrote "Fumifugium" about the foul air of London in 1661, there has been public concern about the harm caused some people by smoke produced by others. When the copper producer chooses to send sulfur dioxide into the air, instead of bearing the costs of filtration, he saves money and thus benefits; yet the farmer downwind, whose alfalfa turns brown, pays the penalty and bears the cost. The results of such negative externalities are usually perceived to be inequitable. If the cost of reducing the pollution is less than the damage a reduction would avoid, the pollution also is inefficient. In general, negative externalities are overproduced. The standard economic approach to pollution, and to potential solutions, is set out skillfully, in a nontechnical fashion by Larry Ruff in "The Economic Common Sense of Pollution," The Public Interest (1970). An early property rights approach is in J. H. Dales, Prices, Property Rights, and Pollution (1968).
A related problem sometimes exists. Positive externalities exist if a decision maker's actions yield benefits to others, without compensation. If my neighbor continues to grow wheat on his land, rather than stripmine the coal below, I enjoy the view without having to pay him. He therefore does not consider my values when negotiating with coal buyers and deciding how to use his land. In general, external benefits are underproduced.
We can fruitfully consider both negative and positive externalities as property rights problems. In the example above, both the copper producer and the farmer use the air resource. The copper smelter uses the air as a garbage removal service, to carry away its waste, while the farmer's alfalfa plants "breathe" it. Farmers actually own the air in the sense that, if they are damaged by pollution, they can sue to recover damages.7 This right to clear (non-damaging) air is imperfect, however, since the farmer here would have to prove in court: (a) the total value of damages, (b) the fact that pollution caused the damages, and (c) that the smelter was indeed responsible for the foul air when damages occurred. This burden of proof is difficult (expensive), and so the property right seldom forces the air user to compensate the owner. Air pollution is similar to a hypothetical case where a copper producer could take labor or capital or copper ore for its own use without paying for it. Any such free resource is likely to be overused:8
We can approach the problem of negative externality in a slightly different manner by considering it a failure of law regarding liability. For example, the owner of an automobile does not have the right to use it to injure others (or their property), and is held liable for damages arising from the use of his auto. Similarly, we might also hold the owner of a copper smelter responsible (liable) for damages from the operation of his smelter. In a different setting, the implications of alternative liability laws are examined by Roland McKean, in "Products Liability: Implications of Some Changing Property Rights," Quarterly Journal of Economics (1970).
The second case given above of the "free" view enjoyed without compensation again reflects a failure of the rights to control (and to exclude others from the enjoyment of) all output from the land resource. The scenic view is a byproduct for which no credit is received—or foregone when production stops. A classic article showing the property rights aspects of action where a decision maker does not pay the costs or gain the benefits from those actions is Ronald Coase, "The Problem of Social Cost," The Journal of Law and Economics (1960). Coase shows that in the absence of transactions costs (the costs of reaching a final bargain among parties) it does not matter who owns a given resource, except that wealth will change. That is, resource allocation is unchanged to the extent that individual preferences are invariant to the change in wealth caused by different assignments of property rights.
Another class of market problems resembles a variant of externality. It includes the "public good" problem and the "common pool" problem. In each case, the actions of an individual decision maker have external effects on others. A public good is one which, once produced, is available for all to utilize. Paul Samuelson's original definition of a public good was such that one individual's consumption of it led to no reduction in others' consumption of that good. See Samuelson, "The Pure Theory of Public Expenditures," Review of Economics and Statistics (1964). Anyone can be a "free rider," so that no one has an incentive to provide the good unless the benefits to him alone exceed the cost to all society. Public goods, such as national defense, tend to be underprovided by market behavior. They are an extreme case of positive externality.
More germane to natural resource issues is the common pool problem. As in the case of oil, a common pool resembles one soda being consumed by several small boys, each with a straw. The "rule of capture" is in effect: ownership of the liquid is not established until it is in one's possession. If several oil wells, each with a different owner, tap into the same underground reservoir of oil, each owner has an incentive to extract the oil very quickly. Doing so, however, can reduce the total volume eventually taken from the well, due to geologic factors.9 Another famous example of the problem was the English "Commons" or pastures on which all in the community could graze animals without penalty. Grazing extra animals on the commons could greatly reduce the yield of the pasture in the future. However, since the cost was borne by all, while the individual herdsman gained all the benefit from his extra animals, the incentive was to overgraze. In the common pool, each user inflicts external costs on other users. A thorough treatment of this topic is Garret Hardin and John Baden, editors, Managing the Commons (1977), especially Hardin's study, "The Tragedy of the Commons."
In the case of both public goods and the common pool, the lack of property rights is critical. If whoever provided national defense privately could exclude from protection all who failed to pay, the public good aspect would disappear. If anyone pumping oil from a common pool had to compensate an owner for the lost opportunities tomorrow (less oil tomorrow) for each barrel of oil pumped today, he would not pump out the oil too rapidly.
All instances where markets fail to achieve ideal efficiency standards can be classified under the rubric "transactions costs." For further discussions on transactions costs (the cost of reaching a final bargain among parties), see Furnbotn and Pejovich, "Property Rights and Economic Theory: A Survey of the Recent Theory," in Journal of Economic Literature (1972), and Steven Cheung, "The Structure of a Contract and the Theory of a Non-Exclusive Resource," Journal of Law and Economics (1970). The monopolist artificially increases scarcity only when he finds it too costly to separate those potential customers who will pay the higher monopoly price. If only the cost of locating and bargaining separately with buyers submarginal to the monopoly price were sufficiently low, then both the monopolist and the buyers could profit from added exchange. Again, transactions costs are pertinent in the case of externality. Here, any action imposing an external cost that is greater than the benefit to the decision maker would not be carried out if the persons damaged could bargain costlessly with the (current) decision maker. All parties affected would become part of the decision process in a world of zero transactions costs. In such a world the public good and common pool problems would also be extinct. No potential bargain (nor any exchange offering greater benefits than costs) could remain unconsummated if the costs of defining and enforcing property rights together with the costs of identifying and making mutually beneficial exchanges were zero. Together, these costs are defined as transaction costs. They are the only impediments to ideal efficiency in the market. Unfortunately they always exist in resource markets, so that it always makes sense, in theory, to consider alternatives to market organization.
Another reason that some want to consider nonmarket alternatives for allocating natural resources is the matter of equity. If we think of efficiency as producing the largest "pie" (in value terms) from our given patrimony of natural resources, equity would then determine how to divide that pie among the population. Equity is not the same as equality, though some might believe that a more equal distribution of income is more "equitable." In terms of our pie analogy, the property rights approach emphasizes that decision makers tend to seek control over the largest possible piece, rather than to seek only efficiency. Thus, a major concern is how the pie (equity) is sliced. The growing importance of equity is indicated in Fred Hirsch, Social Limits to Growth (1967), Robert Nisbet, Twilight of Authority (1975), and Daniel Bell, Cultural Contradictions of Capitalism (1976). The desire to influence the distribution of costs and benefits is another reason that some want to turn away from market control of natural resources. This has been most vividly illustrated in recent years by growing governmental interference in energy markets. Worry over "windfall profits" from crude oil is just one symptom of a much broader concern about the equity of market outcomes.
In the hope of achieving both efficiency and equity, we might wish to turn to government institutions. As we examine government, however, a number of problems appear.
If markets are imperfect in allocating resources, so are the governmental mechanisms set up to improve markets. Whether we look at regulated firms or direct governmental control, displacing the market will not insure efficiency. Economists are still struggling with the theory of regulations, but not fruitlessly. See, for example, George Stigler, "The Theory of Economic Regulation" (1979), and Sam Peltzman, "Toward a More General Theory of Regulation" (1976), two technical articles on the topic. The problems of governmental (bureaucratic) control of resources are analyzed in William Niskanen, Jr., Bureaucracy and Representative Government (1971) and Thomas Borcherding, editor, Budgets and Bureaucrats (1977). These problems are illustrated in the context of natural resources in John Baden and Richard Stroup, "The Environmental Costs of Government Action," Policy Review 4 (1978).
Considerable progress has been made in analyzing collective action in a democracy. Now, even those analysts least enchanted with market solutions are aware that turning resources over to the public sector will not guarantee desirable results.
The pioneering contributions of Anthony Downs, An Economic Theory of Democracy (1957); Buchanan and Tullock, The Calculus of Consent (1962); and Mancur Olson, The Logic of Collective Action (1965); have clarified our knowledge of representative government and show some promise of approaching, in rigor and predictive capacity, the economic theory of the firm.10
What conclusion results from using the property rights approach, in which each decision maker (political or private) acts to advance his own interests as he sees them? We can see the same fundamental flaw in collective or political institutions that exists when imperfect property rights and transaction costs hinder private markets: decision makers are not held fully accountable for their actions. When control is political, rather than by private owners, those in charge (politicians and bureaucrats) cannot be expected to sacrifice their own personal career and other goals by resisting political pressures from special interests. Nor can we expect them to be diligent when the rewards for doing so are non-existent.
Why are public officials not held more accountable for managing natural resources efficiently, diligently, and in the best interests of all the voters? We can identify five components of the problem.
Citizens allocate their decision time and efforts, as they do all other scarce resources, toward those uses which yield personal benefits. Gathering and analyzing knowledge will be undertaken on those matters which are important to the concerned individuals and are significantly influenced by them. The average citizen will fail to study national water policy, not because it is unimportant, but because he will have virtually no personal impact on the policy. It is rational to be ignorant about complex matters which are beyond one's control. Although weather is the most important single determinant of a farmer's income in a given year, the farmer is rational to study fertilizer options and tax strategies instead of meteorology. The weather is simply beyond his control. Similarly, the same farmer will be rationally ignorant about most governmental policies. The exception is likely to be the tiny portion of government policy which influences the market for his own crop. In this case, he has a special interest.
Whereas most citizens are rationally ignorant about most governmental policies, on any particular issue there may be small groups with strong enough interest on that narrow issue to have an impact. Local cattlemen, for example, may have a strong interest in how grazing rights are administered on federal lands. When the issue is sufficiently narrow (grazing rights, not federal lands policy generally) and when the personal interests of a small group are sufficiently large (a large portion of some ranchers' assets are leased federal grazing rights), then a narrowly focused but highly motivated special interest group is likely to wield enormous political clout. The group may support or oppose a politician (or a bureau, in the legislative process) over this one small issue. The interests, however large in total, of the rest of the citizenry may have little bearing on resulting policy in this particular narrow policy area.11 Of course, governmental policy in general is the sum of such narrow concerns. Another problem for a representative democracy is the fact that each citizen can normally vote, not on each issue separately, but for one representative (or executive) to represent him on all issues.
Even if every citizen could somehow study every issue, and even if special interests could not buy influence through campaign contributions or other forms of political support, each citizen would still face another serious problem in expressing his informed opinion on the thousands of issues arising each year. The voter votes not on individual issues (which stripmine controls? which groundwater policy option?) but on one representative to speak for him on every issue (the Democrat or the Republican?). The lack of precision in achieving one's input into the system is obvious. On this point, see Gordon Tullock, Private Wants and Public Means (1970), pp. 107-114. Again, the payoff to a citizen for being fully informed on most issues is reduced because the bundles of policy choice from which he must choose, in the end, is severely limited even if by some small miracle he were the decisive voter.
If most people are ignorant about most policies—and many polls indicate that the average registered voter cannot name his current U.S. Congressman—then those policies whose major costs or major benefits fall in the futre will be even less well understood. Successful politicians and bureaucrats, to receive sufficient support, must show their supporters current net benefits. Future generations cannot vote in current elections. Thus efforts on our resource base which occur years down the road will have relatively little impact now, unless individuals are willing to sacrifice now for the future benefit of others. Such decisions sometimes occur, but they seem less likely to conserve resources than private speculation (discussed below) which allows the speculator a chance to benefit himself while protecting resources for future (sale and) use. Just as the Indiana woodlot owner can gain by selling wood to Texans, current private owners can gain by conserving or "hoarding" a resource which is becoming more scarce, and selling it later to other "hoarders" (speculators). By contrast, a current government decision maker can seldom gain political support by locking resources away from current voters to benefit the unborn. We can expect government policy to be shortsighted, especially in the long time horizons necessary for conservation and for many natural resource policies.
In the private sector, a firm that uses resources more valuable (as measured by cost) than the value of what it produces (as measured by revenue) loses money and goes out of business (unless rescued by government or supported voluntarily as a charity). No such "reality check" exists for government bureaus. A sufficient base of political support is required instead. Seldom can the public sector decision maker benefit personally from greater efficiency in governmental units. The political incentive is to expand rather than to economize. The public choice literature, taking aproperty rights approach, is developing an increasingly sophisticated set of models to explain bureaucratic behavior. See, for example, Mique and Belanger, "Toward General Theory of Managerial Discretion" (1979), William Niskanen, "Bureaucracy and Representative Government" (1971), Gordon Tullock, The Politics of Bureaucracy (1965), and Oliver Williamson, The Economics of Discretionary Behavior: Managerial Objectives in a Theory of the Firm (1964).
Is our analysis of government's inability to manage resources effectively too cynical? We think not. The scholars whose models we summarize here, have demonstrated (usually in areas of application other than natural resources) that their analyses have explanatory power as well as theoretical attractiveness. This way of thinking simply recognizes that individuals, not organizations or societies, make decisions and that in general, individuals act in their own best interest as they perceive it. To be useful and beneficial to society as a whole, an institution must succeed in connecting authority (command over resources) to responsibility (the capture of costs and benefits flowing from one's actions). The market relies upon private property rights to hold each person responsible for his actions. When rights are imperfectly defined, enforced, or transferable, we can understand why markets fail. Representative democracy counts on informed voters and their elected representatives to hold government decision makers responsible for their acts. We can predict how and why this institution, too, will be imperfect.
If humanity is expected to survive for at least several generations, the question of equity clearly has temporal as well as current spatial application. If policy analysts are to become increasingly concerned with issues of equity, there is no obvious reason to restrict this concern to a generation's timespan. Thus, we should consider transgenerational equity. Assume, for a moment, that no one knows into which generation he or anyone else would be born. Once behind the "veil of ignorance," our key question becomes: Which assignment of property rights will produce the greater degree of intergenerational transfer: an assignment of private rights or one with collective rights assigned to a democratic government?
Many hold it as an article of faith that we are running out of resources despite the compelling evidence of static or declining real prices for many natural resources. Certainly a perception of resource depletion is real, regardless of the facts, and it is perceptions which influence policy. Hence, if we are interested in policy we must consider the perceptions which underlie policy.
Given a belief that we are running out of natural resources, we can expect future generations to be seriously disadvantaged. Those unlucky enough to be born later will suffer from the consumption decisions taken by their predecessors, decisions that violate intergenerational equity.
If transgenerational equity is to be a goal, then, it becomes necessary to distribute the value of resources across generations. Obviously, it would be inequitable to distribute the volume or mass equally, for utilization efficiency will surely change. As a simple example, an equal volume of timber produces, due to higher productivity efficiency, a higher volume and value of products now than it did 40 or even ten years ago. Thus, were we to be allocated the same biomass of timber as was allocated to the previous generation we would, in terms of a simplistic notion of equity, be unfairly advantaged.
Due to increased capital accumulation, including information and human capital, we expect improvements in utilization of all resources. Under incentives that reward efficiency this outcome should occur partly due to the fact that resources become increasingly scarce. In this as in other areas, however, we expect to encounter diminishing marginal returns. The gain from moving utilization of standing timber reserves from 30 percent to 60 percent is likely to be easier to attain than a move from 60 percent to 90 percent utilization.
The great wealth of capital stock available today was generated by the savings and accumulation of past generations. Whether we call it altruism or poorly planned self-interest, the result is the same: each generation has been endowed with a continually growing stock of productive capital with which to satisfy its desires to consume as it sees fit. The natural resource equity argument holds that this enhancement of consumption options is purchased at too high a price in terms of raw materials and natural amenities. Indeed, it seems reasonable to consider a possible shift in the relative opportunities offered by capital accumulation and raw materials. It is at least possible that future generations would prefer present generations to bequeath them less additional capital and more natural resources. As the authors of the Federalist Papers understood so well, no person can be assumed the best judge of another's preferences. Hence, those in the future might want the option of developing the capital that they find most useful. Clearly, however, each generation's use of resources influences the welfare of those which follow.
It is a blunt fact that the present generation operating in a historical context establishes the rules regarding property rights with respect to resources. While there may be no logical way to apply a discount rate for the comparison of satisfactions among different generations, each generation implicitly does so.
With clear property rights the market mechanism will allocate resources efficiently provided that all parties can enter the market and that negotiations have negligible costs. But because future generations cannot bargain directly with the present, this approach is questionable.
Both the issues and the conditions should now be clear. Many consider equity to be increasingly important. Transgenerational equity (discounted by the probability of there being future generations) is one important form of equity. Property rights to resources are a component in an equity formulation. And finally, future generations cannot speak for themselves.
The transgenerational equity questions may be stated quite simply. If one did not know into which generation he would be born, how would he structure property rights to resources? We will undertake below a preliminary analysis that turns out to yield counterintuitive results.
We would all expect that a market system involving privately held rights would yield very different results than would a system whose rights were held by society and whose decisions regarding resource use were made collectively. And it is widely believed that a market setting causes future generations to be robbed of natural resources. Krutilla and Page, for example, recently put it this way:
". . . Generally, markets are considered fair only if all those affected by the outcomes are present in the market (without externalities) and the distribution of market power is considered fair. In the case of deciding which new (energy) supplies to develop, the distribution of market power is indeed uneven: the present generation controls the total stock of resources, leaving future generations with no voice in today's decision."12
Further, V.K. Lippit and K. Hamada in their essay, "Efficiency and Equity in Intergenerational Distribution," in Sustainable Society (1977), have argued that: "In the extreme case, future generations cannot compensate the present for foregoing the mildest satisfactions, even when the very survival of mankind is at stake."
The major implication of this and similar material is that a market mechanism, as compared with collective control, deprives future generations of resources. But this antimarket claim does not withstand examination. Our analysis results from both the different incentives faced by market as opposed to government decision makers, and from the different ways decision makers are chosen in the two settings.
In what follows, we employ simple models of market and collective democratic actions. For concreteness, we will refer to the resources stock in question as a copper mine. This example is chosen to capture the elements of inter-temporal resource allocation and intergenerational transfer of resources, while presumably minimizing the intrusion of side issues (such as environmental externalities and violation of the exclusion principle). A binary (yes or no) decision must be made periodically on whether to exploit the one ore body in the current period or not. Following the initial analysis, we will make the models less naïve by relaxing certain assumptions, and we will note the results.
To decide whether or not an existing resource should be exploited in the current time period the decision maker simply compares its value (net of development costs) in current exploitation with its expected value in highest future use (net of development costs, and discounted to the present). If current exploitation yields more net benefits than does any future use (as judged by the decision makers), then the decision maker chooses current exploitation rather than preservation of the stock resource. The major difficulty, of course, lies in how to estimate the value in future use. The value of a body of copper ore to be mined in any given future period depends on several factors, all of which are subject to uncertainty. Availability of other copper ore, the price of copper substitutes, the state of tastes and technology determining copper's usefulness—all those factors are important in determining a decision maker's estimate of the mine's present value in future exploitation. For a given mine, different people are likely to have differing opinions on when the mine should be developed, or more specifically for present purposes, whether or not current exploitation is best.
The views of the populace on the present discounted value of future use might be summarized in a diagram such as the one below. The abscissa (or horizontal axis) indicates E(PV), the estimated present value of preservation, which is a single value in dollar terms, expressing the sum of all the influences we listed above. The ordinate (or vertical axis) indicates the frequency of each estimate. No particular shape is required of the distribution for simple models. If we then locate on the abscissa a value, M, equal to the value (net of operating costs) of the ore body if mined now,13 all E(PV) greater than the value indicates that preservation is preferred. Similarly, those whose E(PV) falls short of M(the current development value) presumably must conclude that current development is the better choice.
Consider now the most straightforward kind of democratic political decision making regarding the copper mine. Each voter expresses his opinion of whether the mine should or should not be developed currently, and the majority rules. For a maximum bias against our outcome, assume that each individual is not simply self-interested, but that he votes for what he believes will benefit society most. To predict the outcome of such a vote, we simply must ask whether the majority of the estimates fall to the right, or to the left, of the value of the mine in current use. If the majority is to the left, current exploitation will be mandated; if to the right, preservation is supported. Put another way, if the median voter14 has E(PV) greater than M (the current development value) preservation will result, while current development wins if he feels the other way. In a very real sense, the median voter's judgement prevails.
By contrast, consider a simple market situation involving the same people with the same tastes, expectations, and discount rates, where the copper mine is controlled by the highest bidder. One type of bid is M, for current development, made on behalf of ore processors. The highest such bid represents the mine's worth in current exploitation. The other type of bid is from those who want to preserve the mine for the future. We can assume either altruistic or selfish motives for these bidders. In either case, each bid reflects the bidder's belief as to the mine's value. Obviously, if anyone (with sufficient funds, or credit, or the ability to convince fellow risk takers) believes the mine will be sufficiently more valuable in future use than now, so as to justify postponing its use, the resource will be conserved or preserved. Unlike political decision making the median opinion does not control decisions in the market. The tendency instead is for those with the strongest bias to preserve resources to control. Those conservers are usually called speculators.
We have long been puzzled regarding the general condemnation of speculators by environmentalists and preservationists. "Speculator" is, quite widely, a derisive term. But, with the singular exception of the monopoly case, such criticism seems to be at variance with the announced preferences of the critics. The critics claim to favor deferred consumption which is merely saving for the future. This, of course, is exactly the function of the speculator. Only by paying a higher price than those who prefer to consume now can he conserve the resource for his profit (and for the future). While current consumers have good reason to object to speculators for driving up the price and hence reducing current consumption, those in the future should shower them with praise and rewards—if the speculator guessed correctly. The central point, of course, is that successful speculators benefit consumers in the future at the expense of those in the present. Their action in markets over time is analogous to distributors of goods over space. The distributor of oranges buys in Florida on behalf of New Yorkers. Orange prices would be lower for Florida consumers if interstate trade were for-bidden; but this would not benefit New Yorkers who desire Florida oranges.
It is not important whether the speculators have a long view encompassing the future period when the resource will be developed, or a more short-sighted view, for their own personal financial plans. So long as they can transfer (sell) the property rights they hold of the mine's future value, the mine remains a saleable asset and a good investment. As time passes and the higher-valued time of use approaches, the present discounted value rises.
Of course if the purchasing speculator is wrong, and potential bidders begin to learn so, he suffers the loss as the mine's value rises less rapidly (or falls) compared to other assets he could have held. He and the deprived earlier generation bear society's loss if his decision to preserve the mine is incorrect. But the resource is preserved. Since this type of speculative activity can be expected whenever resource property rights are private and transferable, resource prices in such markets will reflect bidding for future use, and current exploitation will occur only when all future speculative bids are overcome. Contrary to the statements by Krutilla and Page, the equilibrium market price clearly includes pressure from future potential bidders, including those bidders yet unborn, since speculative bids are based on what future users, as bidders, are expected to be willing to pay. Hence, in a market system with transferable property rights over stock resources, those who are most optimistic regarding the future value of any storable good are the ones who control the resource. Given that they believe that the future value will be high, they expect to capture rewards by keeping resources out of consumption.
It is difficult to imagine how a mechanism other than market speculation could be devised to give current political voters an analogous incentive to consider future citizens. Future voters must depend on the good will of present voters to sacrifice current consumption of governmentally controlled resources. Our analysis of collective control has thus far assumed that such good will is present; that present voters view future generations' consumption as they do their own. The only discount factor assumed to apply to consumption in the distant future was that which people apply to their own consumption during their lifetimes. This form of altruism was not required of the private bidders.
Now if we allow more self-interested voters to enter our collective control model, the market's bias for preserving resources stands out in even sharper relief. If voters are less interested in future generations' welfare than in their own, current exploitation becomes more valuable relative to the benefits of preservation in the eyes of current voters. The value in current use, M, remains constant while their effective E(PV) falls because future usefulness, enjoyed by others, is in effect hore heavily discounted than if current voters themselves could enjoy the benefits.
It should be clear that as we allow for self-interested behavior the most realistic presumption is not that voters feel towards future generations as they do toward their heirs. It can be argued (particularly well in sociobiological terms) that such a presumption collapses back to the naïve altrustic view. People in general may value their descendant's consumption as they do their own. However, the voters deciding on the stock of natural resources to bequeath to the next generation are not considering their descendants' welfare alone, but the welfare of all those alive in the future. Such a diffused interest will surely result in a lower present value than that which leads people individually to leave bequests to their heirs. On the other hand, since costs are also diffuse, the net effect is not obvious.
Another assumption to be relaxed in our model is that of market structure in the private control model. Initially we posited a competitive bidding process for the resource. In fact, a competitive market is not necessary to our results. In a monopolized or cartelized market, the tendency towards preservation is increased. As Harold Hotelling demonstrated in his 1931 article, "The Economics of Exhaustible Resources," a constant-cost monopoly will restrict the exploitation rate due to its output-restricting behavior.
To summarize the situation with exhaustible resources, privately held, exchangeable property rights tend to encourage preservation, relative to a simple democratically controlled collective management system. This is because the gains from preservation are appropriate in a market system, but not with collective ownership, and because those with expectations of high future value for the resource tend systematically to control it through outbidding others. The preservation bias differential is even increased if people are viewed as self-interested, or if the private producing industry is a monopoly or a cartel.
An implication of this model is counterintuitive or at variance with commonly accepted wisdom. One respected source of that accepted wisdom is Robert Solow who in his 1973 Richard T. Ely lecture stated:
". . . We know in general that even well-functioning competitive markets may fail to allocate resources properly over time. The reason, I have suggested, is because, in the nature of the case, the future brings no endowment of its own to whatever markets actually exist.15
We have argued that, at least relative to collective control, the future does have a "representative" in present markets: the speculator. The endowment the future brings to the market is what the speculator expects the future to be willing to pay.
Later in his lecture Solow suggested a partial corrective to the perceived lack of representation of the future.16 Futures markets are claimed to save resources for future generations. Our analysis suggests the opposite. To institute a "futures" market is to allow speculators to be supplied, not only with actual claims on resources but speculative claims as well. Without futures contracts, the only role for the speculator is to bet on the rises in resource values. Futures contracts allow speculators to sell short those resources they expect to decline in value, thereby depressing current prices and encouraging greater current consumption of these resources. In short, the futures market gives influence in the resource market to those expecting a lower rise in resource price or having a higher discount rate.
When governmental bureaus (rather than simple democratic voting) manage resources, then resources use is a function of the incentives operating on the bureaucratic resources managers. In private markets with well-defined property rights, the incentives serve to maximize the value of output from flow resources, or to minimize the value of inputs for a given output flow. Public managers are no different from private managers in that they tend to respond to incentives. Both are largely self-interested. McKenzie and Tullock in The New World of Economics: Explorations into the Human Experience (1978), give perhaps the classic statement:
"Bureaucrats are not markedly different from other people. Most citizens of the U.S. are to some extent interested in helping their fellow man and in doing things in the public interest. Most citizens of the U.S., on the other hand, tend to devote much more time and attention to their own personal interests. The same is true of bureaucrats."
Why does more stocking and more production investments take place in collectively owned and bureaucratically managed forests? One explanation for this is the incentive structure faced by the bureaucratic managers.
For people in general, but for highly motivated individuals in particular, self-interest leads to the desire for an increase in discretionary control over resources. For the "selfish" individual, this provides the power and deference which accompany discretionary control. For the professionally oriented or "socially concerned" individual, this provides, in addition, the ability to make "good" things happen. More timber growth is presumably a "good" thing to a forester, for example. When resources are owned collectively as in a bureaucracy such as the U.S. Forest Service, a prime strategy of the bureaucrat for increased discretion is to promote the growth of his bureau.
There are reasons to believe that in most cases waste is generated from the bureau being above optimum size. Most will agree that powerful forces lead in this direction. For the bureau head, civil services rank, prestige, and pay—all are strongly related to the size of his bureau. Further, symbols of success such as office amenities are also related to the number of persons under his charge. (For example, in one university, for years only deans and higher level administrators could have IBM typewriters). In addition, expansion generates more possibilities for promotion. This enhances the bureau head's ability to control those under his charge, since under Civil Service rules firings are nearly impossible to execute successfully. Thus to gain control over his inferiors, the bureaucrat may promise promotions as inducements. And promotions are more common in a growing office.
Or perhaps equal importance for the ambitious bureaucrat is the fact that a large proportion of his budget is "locked in" from previous years. This, of course, reduces the range of discretionary expenditures. In contrast, new funds offer far more opportunities for flexibility and for innovation.
Among other results, this tendency toward bureaucratic growth can be expected to encourage decisions that favor a more intensive management of this resource. Likewise, there is a reluctance to surrender territorial authority (unless the cut in manpower is small, or exercise of the authority leaves no discretionary resource claims), as well as a reluctance to merge with any larger entity or to transfer resources to activities outside the agency's scope. Such incentives are consistent with maximum preservation of the resource or large (relative to private) inventories.
This strong desire for growth does not depend on the presence of evil administrators or megalomaniacs. We must remember that the bureaucrat, because he lacks market information on the relative value of his produce and those of other public agencies, suffers from the absence of an obvious and immediate "reality check" on what he wishes to believe. Thus, it is easy for him to harbor the illusion that his agency mission is above average merit and thus argue that his office deserves above average budget increases. He of course has the help of clientele groups at budget time. Collective ownership and the lack of a pricing mechanism result in both anti-efficient incentives and distorted information—or a lack of the latter—which deal to even a well-meaning, intelligent bureaucrat blows from which recovery is difficult and rare. In sum, the bias is toward expanded bureaucratic growth and activity. When dealing with resources that require active management (usually renewable resources) this means high flows and high inventories since there is no interest charged to the inventories.
To predict whether private markets or governmental control will save more of a resource for the future, one must consider the bias which a private market has (in the absence of well-functioning futures markets in natural resources) relative to a simple democratic voting system. Also, however, the bias of bureaucracies toward high levels of activity and bureau growth will complicate prediction in the more realistic world of bureaucratic (not simple democratic) governance. Where stocks must be actively managed, bureaucratic pathologies may lead to even greater inventory carryovers than the private market.
As we indicated above, the market system shifts resources among owners under the rule of willing consent. Trades are voluntary and are expected to leave both parties better off. Prices provide condensed information regarding the relative value of resources and they provide incentives to move those resources to more highly valued uses. When property rights are clear and easily enforced, the market mechanism will (with initial endowments taken as given) efficiently allocate resources, including natural resources.
Energy production provides an excellent example of: (1) the efficient and responsive operation of the market system, and (2) the problems generated by the coercive intervention of the government. An examination of the production of what is now called "alternative" or "soft path" energy is especially enlightening.
In this section we will: (1) introduce the "problem" of alternative energy production in the U.S.; (2) provide a historical sketch of alternative energy production; (3) review governmental programs that precipitated the decline in alternative energy research production; and (4) make some generalizations regarding the functions of governmental subsidies.
Of the many complaints regarding American energy systems one seems especially interesting. Often stated as a question, that complaint becomes, "Why have U.S. companies failed to invest in 'alternative' or 'renewable' sources of energy, particularly 'soft path' and solar?" This is an interesting question because the answer is not intuitively obvious and it is substantially important. Further, the usual reaction to this question is to press for governmental subsidies for alternative energy research and development (R and D). Let us quickly review existing and proposed energy subsidies.
In the years from 1918 through 1977 the Federal Government expended $217.4 billion for incentives designed to stimulate energy production. See for example, Battelle Memorial Institute, An Analysis of Federal Incentives Used to Stimulate Energy Production (1978). Since the 1970s, the "energy crisis" has been a prime political issue. President Carter addressed our energy problems when announcing the "first principle" of his energy program: "We can have an effective and comprehensive energy policy only if the Federal Government takes responsibility for it . . . "17 In the fiscal year 1977 alone, the Energy Research and Development Administration called for appropriations of $6.0 billion, an increase of more than 70 percent from the 1975 level of $3.5 billion. See Murray Weindenbaum and R. Harnish, Government Credit Subsidies for Energy Development (1976). Thus, the proposed direction of public policy is quite clear. Further, the idea of fostering energy development through government subsidies is not a new one.
The years since 1977 have produced a substantially increased set of proposals for subsidizing these "alternative" or renewable energy sources. Many of these proposals would dwarf earlier actions even when measured in constant dollars.
The fundamental question we pose is quite simple: can these and other proposed subsidies, meant to encourage the expansion of energy supply in the private sector of the American economy, be justified in terms of social welfare or economic efficiency?
Perhaps we should begin with the issue raised earlier and deal with the fundamental question of why the domestic energy industry is reputed to "need" federal financial assistance. That is: Why would profit-seeking capitalists fail to invest in the development of alternative energy systems? Of course, there is one obvious answer. Such investments seem unlikely to generate normal profits. Pushing the question a bit further, we ask: Why would entrepreneurs not expect alternative energy systems to produce normal profits? To respond to this question we must consider historical evidence.
First, consider the fact that until October of 1973, the real price of conventional fossil fuels was declining at an accelerating rate. It was not only becoming less expensive but the percent of decrease increased annually. (This was due in part to imperfect property rights to oil pools and hence was a transistory condition) Obviously, such a market does not foster the development of substitute products. Given that the recent shortage was caused by political rather than by physical factors, it could not be predicted using standard models of resource consumption. Thus, investors, entrepreneurs, and speculators could not be expected to effectively buffer the consumer from the impacts of shortages.
As an example, let us look at synthetic-fuel production, a current governmental "band-wagon" item. Why the reluctance of private industry to jump into the development and subsequent production of synthetic-fuel substitutes? Government energy policies of the last twenty years, including quotas and price controls on oil and gas, have interfered with the smooth market adjustment to substitute fuels. Through the price control programs, government policy is bringing about, at least temporarily, the very shortages it is seeking to prevent through the proposed synthetic-fuel programs.
Other factors are at work to delay the development of synthetic fuels. In five years the estimated price of crude oil from shale increased 310 percent.18 A similar picture is painted for price estimates of gas derived from coal. In 1971, a price of $.33 per thousand cubic feet was reported; by 1975 the President's task force on synthetic fuel reported a cost of approximately $2.70 per thousand.19 Thus, in four years these rough cost estimates have soared 710 percent. The potential investor justifiably pauses at such a path for projected costs. Other price uncertainties are caused by the possibility of continued controls on crude-oil and natural-gas prices. From the above estimates, it is projected that by 1985, prices for conventional hydrocarbons are still likely to be lower than the cost of synthetic fuels. Again, we find understandable reasons for private industries' reluctance to invest in synthetic fuel R and D.
In spite of history, economic theory, and the high risks seen by private industry, many influential people feel that the government should subsidize synthetic fuel and alternative energy programs. Barry Commoner, in an October, 1979 interview in Challenge magazine, judges President Carter's synthetic fuel subsidy program as a "cynical attempt to use public money to bail out the oil companies from their impending difficulties." He does not view shale oil and other synthetic fuels as "alternatives" but rather as a "simple way of bolstering up the conventional system." Commoner feels that the passage of the Synthetic Fuels Program will parallel or repeat economic costs and so override any possible advantages:
"You know the Atomic Energy Commission obligated itself to develop nuclear power without taking into consideration environmental questions and consequent economic questions. The idea was just to forge ahead. See where it's gotten us—into an essential bankrupt industry which has failed . . . . It will be tragic if we have another failure like nuclear power before we can get onto the proper course."
When the government allocates resources, market signals are distorted: the resources now flow to the most politically powerful rather than to consumer directed uses. With synthetic fuels, there are inherent resource and environmental difficulties, the risk of cancer, the disruption of land, as well as water pollution and drainage difficulties. But, why should a private company invest in other alternative sources of energy, such as wind or solar power, when the government is paying his competitors' costs in synthetic-fuel production? Investments in the private sector are made only when the projected benefits are greater than the costs. Through government subsidization of synthetic fuels or alternative sources of energy, energy costs are borne by society at large through taxation. This bypasses direct cash payment by the individual consumer of energy. As Joskow and Pindyck write in a paper summarized in The Wall Street Journal, July 2, 1979: "But Americans would in fact be much worse off with high taxes than with higher energy prices. Individuals can choose to avoid paying higher energy prices by limiting their consumption, but they have no choice regarding the taxes they must pay."
Proposed subsidies designed to encourage energy production by the private sector of the American economy seem unjustifiable in terms of social welfare or economic efficiency. As we indicated above, when resources are allocated by the market, they tend to be used more efficiently, flowing towards those uses where they can be put to the best advantage. Without government intervention through subsidization, market-stimulated research and development is allowed to follow its own course of satisfying the demands of consumers. In contrast, when subsidies are involved, then political power (rather than consumer decisions made on the margins) allocates resources. It is yet to be demonstrated that such decisions optimize social welfare. Perhaps we can best illustrate some of the destructive qualities of subsidies by briefly examining some of the historical consequences of government intervention through subsidizing energy. Let us now consider historical developments in "soft path" alternatives to conventional energy production.
With the advent of the "energy crisis" of the 1970s, many people became informed of "soft path" alternatives to conventional energy forms. These include solar collectors, wind power, hydroelectric and tidal power, and organic fuels such as methane and alcohol. Contrary to popular belief, these solar energy forms are not recent developments, nor are they presently a great deal more technologically advanced than they were 45 years ago. The Industrial Arts Index from 1913 to the 1940s shows a significant amount of research and practice occurring in all of the solar energy forms mentioned above:
Number of Articles Concerning Solar Energy Forms in The Industrial Arts Index 1913–194020
For further evidence that U.S. individuals and firms did indeed respond to opportunities to develop alternatives to the conventional large scale power systems see Baden "Subsidizing the Destruction of Alternative Energy Production," (1979) for a more detailed example of historical developments in wind power, solar energy, and hydroelectric and tidal power.
There are three sets of basic factors that may account for the observed atrophy of R and D in alternative energy systems. One is technological and two are political.
(1) Substantial economies of scale have developed in the production of energy. If these economies are sufficienctly large, they could be sufficient to override the substantial delivery costs associated with remote locations. If energy was "too cheap to monitor," then the only relevant cost was the cost of delivery. Given that some power generating facilities came on line at 2¢/kw (two cents per kilowatt hour), delivery costs would have to be huge indeed for small scale local generators to be economically preferable. Further, new generator technology made it much more economical to transmit power over long distances. These technological considerations, however, constitute neither the complete nor the interesting explanations for the failure of alternative energy systems.
(2) Another component of an explanation involves the structuring of utility rates. For a market to encourage the movement of resources to more highly valued uses, individuals must face the consequences of their economic decisions. Thus, a person who demands power that is expensive to produce and deliver must face prices which include that relatively high expense. If this does not occur, then he need not take account of the real opportunity cost of his action. Thus, he has little incentive to use resources efficiently or to conserve. When individuals do not confront real marginal costs, we cannot expect them to act as though they do.
The politically determined rate structure was set to preclude an accounting that would foster efficient resource utilization. People using expensive-to-deliver power are subsidized in their consumption by those who consume less expensive power. After an initial installation charge, all using the same amount pay the same rate regardless of the cost of delivery. This outcome is politically mandated.
Now let us consider the healthier effects of market pricing of energy without subsidies. Assume that people faced rates that reflected true marginal costs. Were this the case, then those living in remote and, consequently, expensive locations would have strong incentives to become potential consumers of small scale alternative energy production units. The continued existence of this market would have fostered the continuence of R and D efforts by those firms and their potential competitors active in the 1920s, 30s, and 40s.
(3) Perhaps the most important factor fostering the decline of our indigenous alternative energy industry was an unintended consequence of a desire to "do good." The Rural Electrification Administration (REA) was established during the 1930s to subsidize power delivery to people in rural areas. The federal government guaranteed two percent loans and eliminated income taxes to rural power co-ops. Thus, the general citizen picks up a portion of the cost of delivering expensive power and hence reduces the market incentive to develop alternative systems.
Although REA legislation was enacted in the 1930s, the demise of the windmills and wind generators was postponed for another two decades, the time required for electric wires to be strung throughout the Central and Western states. Marcellus Jacobs, founder of the once successful "Jacobs Wind Electric Company," stated that without question, the spread of REA subsidized power facilities signaled the end of his business.21 The solar water heating industry, resurging after World War II, was also stunted by cheap electric rates. Like wind power and solar water heaters, the ultimate demise of eighteenth and nineteenth century tidal power can also be attributed to the subsidized introduction of cheap electricity.
It is clear that there were worthy goals underlying REA. The ideal of bringing power to all of the people is, perhaps, inherently attractive. Unfortunately, however, not all good things go together. There were unanticipated costs associated with the decision to subsidize power delivery. The first cost, that of inefficiently employing power poles, labor, and copper wire, seems relatively trivial when compared with the second. The crucial cost is the loss of forty years of research and development in the area of alternative energy development. By providing subsidies for rival energy forms a market in alternative energy was severely restricted. The absence of a competitive market allows little incentive to develop and produce a product. As a result, REA eliminated a once thriving wind power industry and contributed to a decline in R and D efforts in alternative energy sources.
Our current retarded position, caused largely by subsidies, has led to arguments that we should now subsidize the development of alternative energy systems. But clearly there is a problem with subsidies. Specifically, a subsidy inhibits developments in areas not subsidized. Since the future is uncertain we can never know what the cost of our bias will be. We can only know that there will be a cost.
Had we perfect vision in the 1930s and predicted the energy crisis of October, 1973 we could have accomplished the objective of distributing power while fostering R and D efforts. It now seems clear that had we given each recipient of subsidized power his subsidy in cash and provided him the option of systems, he would have the benefits of power and we would have the fruits of forty additional years of research. Given that: (1) bureaucracies find it difficult to be time and place specific, and hence to encourage variation, and (2) that the future cannot be predicted, we want to exercise extreme caution before making a commitment to additional subsidies. We cannot at this time anticipate the future costs of present subsidies.
An increasing proportion of people understand the linkage between property rights and efficient and equitable resource management. Although this perspective is recognized as "new," it actually is "neo." The process of social evolution led to the development and implementation of this understanding among various ethnographic units, including some of the American Indian tribes. In this section we consider two cases. The first deals with a fugitive resource whose characteristics are such that control costs (and hence management difficulties) are very high. As we would suspect, property rights were not established in this case. The second case involved a relatively sedentary or "locatable" resource where property rights were more easily defined and enforced.
The Indians of the American Plains are among the most well known and eulogized of all tribal peoples. The culture for which they are famous was of only short duration and was based on the horse and the buffalo.
Prior to the introduction of the horse, the hunting of bison was uncertain, and relatively unproductive. In the pre-horse period the capture of a buffalo was comparatively rare. The buffalo was highly valued and hence fully utilized.
In effect, the introduction of the horse, steel tools, and later firearms lowered the "price" of the animal. As the price fell due to technological adaptation, patterns of utilization changed dramatically. During this period many buffalo were killed by Indians merely for the tongue and the two strips of back strap. By 1840 the Indian had driven the buffalo from portions of the original habitat and there is evidence of concern about this occurrence. Earl F. Murphy states that "[O]nly the simplicity of weaponry and the small number of these nomadic peoples kept the buffalo from meeting its fate two centuries earlier." See Haines, The Buffalo (1970),pages 156-159 for a general description, and Earl F. Murphy, Governing Nature (1967), page 99. Compounding this shift in technology was the Indian's new market of hides sought by the white man. Thus, there was both a supply shift from lower costs of production and a new use of buffalo (sales) which led to an increase in demand.
Thus, in observing the Plains Indians we witness efficient behavioral adjustment to changing prices by inefficient management of a common property resource. Given multiple tribes, a fugitive resource, and high transaction costs, the Indians were incapable of establishing property rights and managing the buffalo as a renewable resource. Regardless of the ideology of the resource users, it is obvious that wise use is difficult to achieve when property rights are undefined and unenforced. Communally owned resources (i.e. where private property rights are not established) tend to foster ecologically damaging behavior. In this case the benefits from harvesting additional buffalo accrued to the individual hunter and his group while the costs of depletion of the herd were distributed among all potential hunters. In such a common property context, since the full costs of hunting are not borne by the hunter, over-use is predictable.
One of the first systematic accounts of the development of property rights is Harold Demsetz's treatment of the North American fur trade in "Toward a Theory of Property Rights," American Economic Review (1967). The institution of private hunting territories among the Labrador Peninsula (Montagnais) Indians was described by the anthropologist, Frank Speck, in "A Report on Tribal Boundaries and Hunting Areas of the Malecite Indians of New Brunswick," American Anthropologist (1946).
These Indians were primarily hunters subsisting on large game such as caribou and small fur-bearers such as beaver. Prior to the development of trade with Europeans there was little pressure upon these resources. Demand was below carrying capacity and the tribes hunted communally, sharing the harvest. With the establishment of the French fur trade routes in the early 1600s came the incentive for over-exploitation of the resource. Localized extinction of the beaver could be predicted with the increasing value, scarcity, and depletion of the beaver under the existing system of property rights. But unlike the buffalo, which was virtually condemned to extinction as common property, the beaver were protected by evolving awareness of private property rights among hunters. By the early to middle eighteenth century, the transition to private hunting grounds was almost complete and the Montagnais were managing the beaver on a sustained yield basis. Eleanor Leacock notes that trappers readily adopted conservation practices when they were able to personally collect the benefits. She notes in "The Montagnais 'Hunting Territory' and the Fur Trade," American Anthropologist (1954), that "[t]he Western Montagnais farms his territory by marking his houses, ascertaining the number of beavers in them, and always leaving at least a pair." The system of private ownership developed parallel to the fur trade. Leacock22 observed "an unmistakable correlation between early center of trade and the oldest and most complete development of the hunting territory.".
The difference in behavior between the beaver and the buffalo hunters may be traced to the different institutional structures. The inherent characteristics of the resources are fundamentally different, i.e., while the buffalo is a fugitive resource, beaver are sedentary and thus are amenable to private appropriations. Further, the transaction costs for a relatively homogeneous group of tribes such as the Montagnais are lower than among the warring Plains tribes. Thus, institutional accommodation should be easier to achieve.
With the significant intrusion of the white trapper in the nineteenth century, the Indian's property rights were violated. Because The Indian could not exclude the white trapper from the benefits of conservation, both joined in trapping out the beaver.
A similar shift to the mining of beaver by the Algonquin relatives of the Montagnais, the Malecite, is described by Speck.
"The occasion for this change in Indian sentiment regarding conservation was made plain by the informant's declarations that the native hunters, seeing that the whites were bent on wholesale destruction of the game animals and fur-bearers, deliberately decided to take their share and profits from the forests before it became too late, and did so. And thus the epoch of conservative, regulated hunting by the Malecite . . . came quite abruptly to an end."23
In essence, the Indians lost their ability to enforce property rights and rationally stopped practicing resource conservation.
As we have indicated, when there are not clear property rights, where there are substantial public or easily nonpackageable goods associated with a resource, or where there are pervasive monopoly problems, there are pervasive monopoly problems, there is a valid argument for governmental intervention. Unfortunately, the governmental solution to this failure is quite often more costly than the original failure.24 For an elaboration of the logic presented here see the following studies by Baden and Stroup. "Externality, Property Rights and the Management of Our National Forests," The Journal of Law and Economics 16 (October 1973): 303-312; "Private Rights, Public Choices, and the Management of National Forests," Western Wildlands 2, No. 4 (Autumn 1975):5-13; "Property Rights, Environmental Quality, and the Management of National Forests," Ch. 22 of Managing the Commons (1977). See also by Baden and Stroup "The Environmental Costs of Government Action," Policy Review (Spring 1978): 23-38; "Response to Krutilla and Haigh," Environmental Law, Vol. 8, pages 417-421; "The Development of a Predatory Bureaucracy," Policy Review (Winter 1979).
Some of the best examples (and worst cases) of governmental failure are found in the lands managed by the federal government. In this section we will: (1) review one case of governmental mis-management and (2) describe a mechanism for correcting this problem. The case is the Bureau of Land Management lands in the West.
For many years the Bureau of Land Management (BLM), quite unlike the Forest Service, was large immune from public controversy and conflict. The BLM, which developed from the Grazing Service established by the Taylor Grazing Act of 1934, has two primary client groups. The first is the stockmen of the West. The second has involved those who used BLM lands for mineral and other resrouce-extracting purposes. Recreation has been a relatively minor component of BLM management plans. BLM holdings have been known as "the land no one wanted." Indeed, few even knew they existed.
For good or ill, this situation has changed dramatically. Beginning with the environmental movement, the Classification and Multiple Use Act of 1964, and especially with Earth Day in April 1970, BLM lands were "discovered." With added understanding by the growing environmental movement, BLM lands became identified and recognized. Their managers became exposed to criticism and litigation.
The inherent conflict of BLM management goals was further codified with the BLM's organic act of 1976, especially with section 202. The BLM is mandated to provide multiple use on the lands it manages. No longer need they satisfy only the stockmen and the miners. Under the current wilderness review, a substantial portion of BLM land has become the focus of significant conflict over use and management.
In this issue as in most others there are no perfect solutions and none that are cost free. There simply is no way BLM managers can satisfy all the competing factions. Public controversy will continue and public relations will become more important than range management. Fortunately, however, there is a solution. While it is not cost free, and while there will be winners and losers, the solution is likely to be preferable to the existing circumstances.
Ideal management of the BLM lands would provide a diversity of uses, would have management that is adaptive to changing national needs and priorities, and would distribute the benefits nationally. We suggest that these goals can be approached most nearly by the divestiture of BLM lands. Only in this way can all of the people of the nation capture the benefits into perpetuity produced by the 170 million acres of land in the West now managed by the BLM.
A divestirue plan which conveys selected rights to BLM land into the private sector would avoid many problems, while retaining for the general public the value of future productivity from those rights. What we are suggesting is the sale of BLM lands with protective covenants. If rights to a tract of land are thought of as a bundle of sticks, most of those sticks would be sold, but not all. In an area providing important recreational access, for example, the land might be sold without the right to exclude properly behaving hikers. The right to kill certain ecologically important predators might also be with held from sale.
Would those people currently enjoying BLM leases be disadvantaged? We think not, if the sale terms are properly established. In general, current lease holders would be offered permanent property rights to do what they are now doing plus all other land rights not specifically retained by the federal government. Making these property rights permanent would increase the value of land use to the user, since the benefits of long term management practices, such as range improvement, would clearly be captured by the user into the future. Users with a short time horizon might well choose to sell their new asset, but they would still have the incentive to avoid overgrazing, erosion, or any other practice which would reduce the value of their land. By the same token, such expensive (and sometimes very destructive) practices as chaining and rest-rotation grazing would be carried out only when the long-term plus short-term benefits outweighed the long-term plus short-term costs. This would be true because the land owner would both pay the costs and receive all the benefits.
The terms of sale under our divestiture plan would make available to current users the land they now utilize in return for payment equal to the present value of all future lease payments, discounted at the rate of interest on long-term agricultural loans being made in their area. Parcels of land not bought on those terms by current lease holders would be offered at auction with a starting bid equal to the price offered to the current lease holder.
Diversity of land use on lands thus conveyed into the private sector would be guaranteed, for the same reason that diversity exists in an urban area: any entrepreneur with a vision of appropriate land use can bid for the right to implement his vision. Adaptiveness to changing conditions is fostered for the same reason. Those wishing to try new ideas can do so without having to convince either a giant bureaucracy or a majority of elected representatives. Ideas that turn out to be crackpot schemes are quickly exposed and stopped automatically due to the drain on the wealth of entrepreneurs and financiers. In a private setting we need not count on the good will or morality of decision makers; their greed will suffice. Decision makers who move the resources into higher valued uses will prosper, whereas those who devote resources to uses others do not value highly will be systematically separated from wealth and thus from their ability to make socially important decisions in the future.
A crucial feature of our divestiture plan is the equity of its outcome. Current users will be advantaged by having available the opportunity to gain by better long-term management of the land they are using. Citizens will gain not only by increased productivity, but by being able to capture the value of their productive resource into perpetuity, to at least the same degree they are doing now. In addition, taxpayers will not have to pay the high management costs they now bear through funding the BLM.
In summary, we believe that a plan to privatize the lands currently managed by the BLM can be arranged to the benefit of everyone with the possible exception of the bureaucracy itself. The continuing and expensive hassle of intensive lobbying by environmentalists, producer groups, and others can be avoided. The ongoing debate over environmental law as it applied to private lands will continue, of course, but the perpetual struggle over lease rates and the appropriate land use pattern will be ended, as will the occasional scandals which inevitably arise when public figures and bureaucrats continually control billions of dollars and assets without any means of being held personally accountable for their use.
Since individuals rather than groups or societies, make decisions on natural resource management, the property rights approach is highly relevant to the analysis of those decisions. Each decision maker can be expected to be concerned with appropriate management from his own point of view rather than from an "efficiency" or a societal point of view. Because individuals differ, it is important to know who controls a resource (has the right to allocate its use). With privately owned property rights, a resource is generally controlled by those with the most optimistic view of how they might be used, as constrained by ability to finance resource use or ownership. (Banks and financiers act as a filter on crackpots.) New ideas and new opportunities bring shifts in resource control, as the identities (and plans) of high bidders for a given resource change. Positive transactions costs, however, hinder the flow of resource rights to higher valued uses. In the extreme case property rights are effectively undefined and obvious resource waste (e.g. excessive pollution) occurs.
Market failure results when property rights fail to cause decision makers with authority over resource use to be faced with the full responsibility for their decisions. Since governmental control almost never makes fully effective the linking of authority to responsibility, public sector control clearly will fail also to reach ideal efficiency goals.
Any realistic approach to the formation of good (or improved) natural resource management will take these important facts into account. As Demsetz has indicated, one should not commit the "grass is always greener" fallacy and assume that if one institutional arrangement is imperfect the desire for improvement should lead to an ideal alternative.25 We must compare realistic alternatives with the imperfect status quo, instead of an ideal (but unattainable) alternative with the imperfect status quo. When the market is known to fail, for example, we should not leap in to replace it with collective control assuming that well-intended and omniscient bureaucrats, oblivious to career goals and political pressures, will solve our problems. Similarly, if we move toward a market solution, the existence of transaction costs must not be forgotten as if they did not exist.
In a sense, the property rights and related public choice approaches to natural resource management are worthy of the "dismal science" title which Thomas Malthus gave to economics. We are reminded that a responsible analyst must segregate hopes and ideals from expectations. Yet the new approach is quite constructive in useful ways. It counsels us mainly to recognize incentives to individuals, and to shape them when necessary. It tells us that institutions are crucial in decision making. Indeed, one can maintain with Alan Randall, in "Property Rights and Social Microeconomics," Natural Resource Journal 15 (1975):746, that this new approach is a rebirth, with the infusion of neoclassical microtheory, of the tradition of institutional economics long associated with J.R. Commons.
Policy Principles suggested by the works we have summarized include the following:
(1) Privatization of property rights, taking them from the public sector, may improve management from society's viewpoint. As indicated in the section above on grazing rights; in Alred Cuzán on water rights, "A Critique of Collectivist Water Resrouces Planning," Western Political Quarterly (1979); and by Bruce Yandle on air pollution, "The Emerging Market for Air Pollution Rights," Regulation (1978); a plausible case can be made that market constraints are superior to collective controls in resource management. Always, however, the problem of transactions costs must be carefully examined before final judgement can be made. The ideal market with perfect competition does not (and will never) exist.
(2) In a world of change, it is crucial to minimize transactions costs so that resources can flow to higher valued uses. Price controls, regulation of all kinds, and curbs on profits to those controlling the resources moved to higher valued uses are all virulent forms of what is frequently called "The British disease." The net gains to society from increased efficiency should, we think, be sought by the reduction of such measures. Increased efficiency is, after all, a positive sum game.
(3) When collective control is deemed necessary despite its drawbacks, it is frequently possible (and usually desirable) to mimic the market. This normally amounts to privatizing a collectively determined set of rights, as in marketable pollution rights and transferable development rights, or using taxes and subsidies in place of direct controls. Bureaucrats and politicians will normally prefer direct controls, since that path enlarges their discretion and their budgets. As even such governmentally oriented economists as Charles Schultze and James Schlessinger have cogently argued,26 however, shaping incentives is generally a more effective solution. No matter how elegant the operations research solution might be, it will seldom be implemented properly without the flow of information and the set of incentives only a market can provide. No one is omniscient. No one lives to maximize efficiency.
In brief, the property rights approach indicates that privately held rights, far from being the root of ecological problems and natural resource misuse, may be a key element in their solution. Markets will never be perfect, but government failures are both obvious and intractable. Resources held as part of a decision maker's wealth will seldom be squandered.
* [This footnote was part of the original publication of the essay]. Richard Stroup is Associate Professor of Economics and Co-director of the Center for Political Economy and Natural Resources; John Baden is Director of the Center, at Montana State University. They wish to thank their colleagues, Terry Anderson and P.J. Hill for helpful suggestions, while retaining responsibility for any flaws.
1. Douglass North, "A Framework for Analyzing the State of Economic History," Explorations in Economic History 16 (1979):249–259.
2. See North (1979):250. This article discusses the factors influencing the way in which rulers of a state advance their own control over resources by selecting from among alternative sets of property rights rules. Economic growth and efficiency can be means to the ruler's ends, but only if the ruler can capture enough of the consequent benefits relative to more easily monitored, controlled, and taxed systems.
3. Economists of the Austrian school emphasize the role of the entrepreneur who, in his search for profit, finds higher valued uses for resources previously used in a less valuable fashion. See, for example, Ludwig von Mises, Human Action, and Israel Kirzner, Competition and Entrepreneurship.
4. The workings of the market are explained nonmathematically, with a minimum of jargon, from a property rights approach, in four books on economic principles: Armen Alchian and William Allen, University Economics; James Gwartney and Richard Stroup, Economics: Private and Public Choice; Paul Heyne, The Economic Way of Thinking; and Svetozar Pejovich, Fundamentals of Economics.
5. A systematic treatment of the "accepted wisdom" on market failure is Francis Bator, "Anatomy of Market Failure," The Quarterly Journal of Economics (August 1958):351–379.
6. Nearly all introductory economics texts cover this general problem of monopoly, including the four cited in the previous note.
7. See Corpus Juris Secundum, Vol. 66, p. 9461. This common law approach is being supplemented by statutory laws which proclaim the mere existence of a pollution source a nuisance, apart from demonstrated damage. Such laws are currently being challenged in the courts.
8. Note that if property rights in clean air were easily enforced, pollution would still be produced, but only in efficient amount: polluters would compensate those damaged, and would reduce pollution until further reductions were more costly than fully compensating all those harmed.
9. If many well-owners pump more rapidly from many pools, ignoring the "user cost," or reduced availability from each pool later, then oil market prices can be depressed. That happened in the United States in the 1930s, leading to government control of oil well production. See Edward Mitchell, U.S. Energy Policy: A Primer (1974).
10. A relatively nontechnical presentation of the economics of government failure, paralleled by this section but with emphasis on different applications, is Gwartney and Stroup, Economics: Private and Public Choice (1980), 2nd edition, chapter 32. See also McKenzie and Tullock, Modern Political Economy—An Introduction to Political Economy (1978), chapters 5 and 6; Charles Wolf, " A Theory of Non-market Failures;" and William Mitchell, The Anatomy of Government Failures (1979).
11. For more rigor and detail on this and related aspects of the political process see Gordon Tullock, Toward a Mathematics of Politics (1967).
12. John Krutilla and Talbot Page, "Paying Tomorrow for Energy Today," Resources, No. 49 (June 1975).
13. In reality, the value of the mine in "current" development is subject to some uncertainty, particularly since development is not really confined to one short time period. But the degree of uncertainty is small relative to development farther into the future. One could work with a similar, though much-compressed, distribution of estimates of value in current use, but that would seem to add complexity with no change in the basic outcome in comparing private and collective management systems.
14. Median voter is the individual whose E(P) splits the distribution, in the sense that half the other people lie above him, and half below.
15. Robert Solow, "The Economics of Resources or the Resources of Economics," American Economic Review 64 (May 1974):10.
16. Solow, "The Economics of Resources or the Resources of Economics," 13.
17. Anonymous, Detailed Fact Sheet: The President's Energy Program.
18. See Weidenbaum and R. Harnish, Government Credit Subsidies for Energy Development (1976).
19. See Weidenbaum and Harnish.
20. Table constructed by Shelia Hart.
21. John Baden, "Subsidized Destruction of Alternative Energy," mimeo, Center for Political Economy and Natural Resources (October 1979).
22. Eleanor Leacock, "The Montagnais 'Hunting Territory' and the Fur Trade," American Anthropologist (1954), page 12.
23. Frank Speck, "A Report on Tribal Boundaries and Hunting Areas of the Malecit Indians of New Brunswick," American Anthropologist (1946).
24. See also by Baden and Stroup "The Environmental Costs of Government Action," Policy Review (Spring 1978):23–38; "Response to Krutilla and Haigh," Environmental Law, Vol. 8, pages 417–421.
25. See Harold Demsetz, "Toward a Theory of Property Rights."
26. See Charles Schultze, The Public Use of the Private Interest, and James Schlessinger, "Systems Analysis and the Political Process."
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