The Economics of First Possession Rights to a Heterogeneous Resource: Prior Appropriation Rights to Water

Abstract: We analyze the economics of a first-possession property right to a large heterogeneous resource under incomplete information and competitive claiming by homogeneous agents. Our focus is on prior-appropriation surface water rights used in 18 western US states, with specific attention to Colorado. Prior appropriation was an institutional innovation. It was efficient and fair relative to feasible alternatives; it granted ownership by time of discovery and placing water into beneficial use; it encouraged valuable search and narrowed the information required to establish ownership to that describing the immediate water diversion, reducing bounding and enforcement costs. There was a tradeoff between claiming or waiting. At any time, water rights claimants were equal in their lack of knowledge of the best water diversion locations. Subsequent claiming, revealed new information, but quantities of high-quality sites were reduced. A hierarchy of rights emerged of different value. Individual claims were based on observable resource characteristics. So long as search revealed these characteristics, they were stable, and individual claims were recognized, there was no basis for rent dissipation, even in a rush to claim. In this regard we differ from the literature on first possession. Once in place, prior appropriation became the basis for water trade, investment in dams and canals, and expansion of irrigated agriculture and other activities. One key resource characteristic was neither stable, nor observable initially, stream flow variability due to drought. Stream flows were overestimated and excessive diversion claims and infrastructure investments were made, relative to a full information setting. Prior appropriation rights endure, affecting the distribution of water ownership and exchange. Assessment of its welfare effects requires accounting for its role in generating property rights, investment, production, and the transaction costs of exchange.