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

We analyze the economics of first-possession property rights to a large heterogeneous resource allocated under incomplete information and competitive claiming by agents. Our focus is on prior-appropriation surface water rights used in 18 western US states and generally in at least 3 western Canadian provinces, with specific attention to Colorado, 1852-2013. Prior appropriation was an institutional innovation, replacing common-law riparian rights, in a setting where water supplies were scarce, unevenly distributed, and remote from production sites where water was a key input. Prior appropriation emerged very rapidly within 20 years or less to be the dominant rights regime covering an immense area of over 1,197,000 square miles, suggesting large economic advantages relative to the incumbent institutional regime. Voluntary, large-scale property rights changes are unusual empirically. Prior appropriation encouraged valuable search and narrowed the information required to establish ownership to that described in immediate water diversion rather than an entire river basin. It thereby also lowered individual bounding and enforcement costs. Beneficial use revealed how much water remained for subsequent rights claimants. We examine the economic advantages of prior appropriation. The benefits of prior appropriation in general depended upon how rights were obtained, an issue that we examine in detail. At the time of claiming water there was little information about water source characteristics, and the process of claiming revealed such information. Hence, there was a tradeoff between claiming at a particular time and waiting. At any time, water rights claimants were equal in their lack of knowledge of the best water diversion locations. Each round of claiming revealed new information, but the quantities of remaining high-quality diversion sites were reduced. Individual claims were based on observable resource characteristics, such as current stream flow or quantity, distance to stream head, terrain topography, and proximate soil quality. Because claiming initially took place under open-access conditions, there was potential for rent dissipation. Nevertheless, so long as search revealed critical resource characteristics, they were stable, and individual claims were recognized, there was no basis for rent dissipation, even in a rush to claim given the number of claimants and resource size. In this regard we differ from the literature on first possession that generally points to full dissipation. Prior appropriation water rights became the basis for water trade, investment in dams and canals, and expansion of irrigated agriculture and other activities critical for economic development. Prior appropriation rights endure, affecting the distribution of water ownership and exchange. Assessment of the prior appropriation’s welfare effects requires accounting for its role in generating property rights to water, investment, production, and the transaction costs of water exchange.

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