Property Rights and Collective Action in Natural Resources with Application to Mexico Lecture 1: Introduction to the political economy of natural resources Lecture 2: Theories of collective action, cooperation, and common property Lecture 3: Principal-agent analysis and institutional organization Lecture 4: Incomplete contracts with application to Mexico Lecture 5: A political economy model Lecture 6: Power and the distribution of benefits with application to Mexico Lecture 7: Problems with empirical measurement with application to Mexico Lecture 8: Beyond economics: An interdisciplinary perspective

Actors in a productive organization Internal governance of common property forestry –Logic of community –Logic of market Today: logic of market Community as a productive organization: –Workers –Managers –Decision makers –Stakeholders –The market

Principal – agency theory and organizational design Useful concepts: –Measurability of inputs –Asymmetric information –Enforcement and accountability –Separation of ownership and control –Contingencies in production

Principal - Agency Basics Hart and Holmstrom (1987). “Theory of Contracts”. Advances in Economic Theory (T. Bewley ed.) 2 economic actors: –Principal –Agent Agent provides Principal with an input. Problem: measurability of the input.

Asymmetric information “I know something you do not.” Principal: uninformed party Agent: informed party whose information is relevant to common welfare

Imperfect signals Agent performs task and chooses effort level = t Personal cost to Agent = C(t) Benefit to Principal = B(t) Information generated by t: x = u(t) + ,  ~ N(0,  2 ) u(t) is a reliable signal  is a random noise Agent’s compensation is based on x: w(x)

Tradeoff of Risk and Incentives Principal usually risk neutral Agent usually risk averse Tradeoff: –Fixed wage: no risk to agent, Principal bears all risk, less incentives for Agent. –Incentive scheme: more incentives for Agent, Agent bears more risk: U P = R(x) – w(x), where R = revenue U A = V(w(x)) – C(t), where V is concave

Moral Hazard Tendency of imperfectly monitored person to engage in “undesirable behavior” (POV of P) A’s objectives aligned differently than P’s Opportunistic behavior; happens when: –A takes decision that affects P and A –P observes outcome and outcome is imperfect signal; A’s utility function is private information –A’s decisions are not Pareto optimal

Productive organizations Contractual relations balance interests into an equilibrium –Balance risk sharing and providing incentives –Bring objectives into alignment –Many ways to do this. Firm as nexus of contracts among various actors

Decision Monitors: Ratify decisions Monitor decisions Decision Managers: Generate proposals Implement decisions Residual Risk Bearers: Reap profit Take loss Actors in Productive Organization

Political-Economic System Green=community; Yellow=state; Blue=Private Example: German Forestry Management Mayor/council Municipality citizens State Forest Office State workers State Managers

Decision Monitors: GA JV Advisory councils NGOs Semarnat Profepa Decision Managers: Foresters CBC General manager Jefe de Monte/Patio Documenter Risk bearers: Community members Outside private firms Mexican Agrarian Communities

Work groups and individual level organization (survey sample) Durango N=28 Michoacan N=13 Work groups5 (post-92)1 (pre-92) Individual2 (post-92)8* (7 pre-92; 1 post-92) *needs check

Work groups Peter Taylor (2002) Frustration and inefficiency of old system Takes operational decisions out of GA CBC does not manage funds “More transparent” “Broadens participation” “Distributes more fairly”

Monitors: State forestry office Mayor/Council Forest Council Municipal Supervision Auditors Certifiers Managers: State municipal official private manager private ranger Risk bearers: Municipality German Municipalities

Shared Issues Both economic and political organizations combined into one governance system Trends: –Germany: moving to more local control –Mexico: enhancing local management Challenges for both: –Decision control function –Accessing expertise

Ideas from Agency Theory Risk bearing ability Internal control External control Agent signaling Agent securities “Hard” incentives “Soft” incentives

Holmstrom and Milgrom (1991) Job design to enhance efficiency Based on measurement costs: –Task 1 is measurable –Task 2 is not Examples: –Grade school education: basic skill and test scores v. higher level thinking –Output and care for machines

Holmstrom and Milgrom (1991) Can jobs be separated? If not, pay fixed wage if: –Too difficult to measure other task –Task competes with agent’s time –Task increases opportunity cost of other task –Example: pay fixed salary/wage to teachers With application to Mexico (WAM): Can jobs be separated? –Political v. technical functions

Manne (1965) Is there market for managerial control? Managerial control is a valuable asset. Can you market it? Managers lack incentive for corporate control market Merger justifications: 1.Bankruptcy 2.Economics of scale 3.Manne: “Protect shareholders” (risk bearers)

Manne (1965) Share price and managerial efficiency positively correlated If low  takeover potential Merger is one way to takeover Overcomes free rider problem among stakeholders Control premium must be paid Mergers protect shareholders who do not have a controlling interest WAM: Is there a market for control in communities? –Logic of community v. logic of market

Hirschman (1970) Exit: –vote with feet –But where do you go (exit options)? Voice: –dissent, complain –But does anyone listen? Loyalty: –how fast you leave, how long you stay

Hirschman (1970) Examples: –Nigerian railway: exit; no voice –Vietnam War and US officials: no exit, ineffective voice Need to analyze: –Most likely client response –Most likely organizational response Need interplay of voice and exit to maintain quality of organization WAM

Cooperatives and communities Residual claims exchangeable? –If not, control features limited Who performs control functions?: –E.g. is board of directors restricted to set of users? If so, lessens access to diverse expertise Lending?

Conclusions “Community” in Mexico as a productive organization Principal-agent theory as a tool –Tells us about optimal incentives schemes –How develop monitoring and management roles?

Limitations of Principal-Agent Theory Does not inform us about the organizational form which will come about. What are boundaries of firm? Are contracts complete? Role of power and influence Misses the social context of property rights