02/08/2016 - Gary Libecap: Economic Analysis of Property Rights: First Possession of Water in the American West

We analyze the economic determinants and long-run e↵ects of prior appropriation surface water rights from 1852 to 2013 and show how formal property rights developed to generate the discovery of new information and serve as a coordinating institution for investment under uncertainty. The prior appropriation doctrine (first in time, first in right) replaced the existing, share-based riparian water rights doctrine over an area of 1,808,584 mi2 on the Western Frontier within 40 years—a rare and dramatic shift that suggests large economic benefits. We develop a model to demonstrate that when information about resources is costly, prior appropriation facilitates socially valuable search, coordination, and investment by reducing uncertainty about resource conditions and the threat of new entry. We derive testable hypotheses about the behavior of claimants under these conditions and test our hypotheses using a novel dataset that includes the location, date, and size of water claims along with measures of infrastructure investment, irrigated acreage, crops, topography, stream flow, soil quality, precipitation, and drought in eastern Colorado. We confront challenges to identification using the dynamic estimator proposed by Wooldridge (2005) to trace the evolution of water claims in the presence of unobserved heterogeneity and find that search e↵ort and infrastructure investment generated positive externalities for subsequent claimants by lowering claiming costs. We show that secure property rights facilitated coordination by reducing uncertainty and heterogeneity, doubling average infrastructure investment. This coordinated investment led to long-run gains of over $100 per-acre. We estimate that prior appropriation contributed between 3.5 and 20% of state income in 1930. Importantly, economic returns were lower in areas where pre-existing sharing norms dominated legal prior appropriation claims. Our analysis extends the literatures on institutional change, property rights, and first possession and informs the debate over the e"ciency of prior appropriation and the costs of proposed water rights reforms.