Malleable Property Rights and Smooth‐Pasting Conditions

Abstract

In their classic paper on the evolution of property rights in the American West, Anderson and Hill take a historical view of the changing costs of defining and enforcing property rights, and show that ...by expressing the amount of property rights definition and enforcement activity as a function of marginal benefits and marginal costs, and by specifying the shift parameters for each function, it is possible to explain the existing structure of property rights in a society and provide a vehicle with which we can analyze changes in property rights over time. The authors show convincing historical evidence for their marginal adjustment hypothesis applied to land and livestock on the Great Plains from 1850 to 1900. In this paper the same viewpoint of endogenous institutional evolution is taken, but it is specified as malleable, changing in discrete jumps due to nonconvex transaction costs and uncertainty in water supplies and property rights rather than through a smooth marginal evolution. Despite a gradual increase in the expected value marginal product of water in the West, this study shows that institutional change is influenced by nonconvexities in costs and the inherent stochasticity in water supply. Because of these conditions, the economically optimal development of water property rights will continue to follow the historical precedence of discrete switches rather than smooth changes in property rights. Discussion of the changes facing water allocation and development in the West has moved from the topic of whether water markets can aid in the reallocation of water to questioning why there are so few examples (Young, Colby, McCormick). Implicit in this question is the assumption that, given the gains from trade based marginal value differences between regions or uses of water and a physical connection between the two locations, trade should occur. Commentators on this subject all recognize that the existence of gains from trade is a necessary but not sufficient condition for trade. The costs