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Optimal Resource Extraction Contracts under Threat of Expropriation

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Abstract

The government contracts with a foreign firm to extract a natural resource that requires an upfront investment and which faces price uncertainty. In states where profits are high, there is a likelihood of expropriation, which generates a social cost that increases with the expropriated value. In this environment, the planner's optimal contract avoids states with high probability of expropriation. The contract can be implemented via a competitive auction with reasonable informational requirements. The bidding variable is a cap on the present value of discounted revenues, and the firm with the lowest bid wins the contract. The basic framework is extended to incorporate government subsidies, unenforceable investment effort and political moral hazard, and the general thrust of the results described above is preserved.

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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1636.

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Length: 32 pages
Date of creation: Jan 2008
Date of revision:
Publication status: Published in W. Hogan and F. Sturzenegger (eds.), The Natural Resource Trap, Cambridge: MIT Press, 2010
Handle: RePEc:cwl:cwldpp:1636

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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Keywords: Taxation; Mining; Rent extraction; Royalty; Non-renewable natural resource; Present-value-of-revenue auction;

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References

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  1. Devarajan, Shantayanan & Fisher, Anthony C, 1981. "Hotelling's "Economics of Exhaustible Resources": Fifty Years Later," Journal of Economic Literature, American Economic Association, vol. 19(1), pages 65-73, March.
  2. Fraser, Rob & Kingwell, Ross, 1997. "Can expected tax revenue be increased by an investment-preserving switch from ad valorem royalties to a resource rent tax?," Resources Policy, Elsevier, vol. 23(3), pages 103-108, September.
  3. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 1998. "Least-Present-Value-of-Revenue Auctions and Highway Franchising," Documentos de Trabajo 37, Centro de Economía Aplicada, Universidad de Chile.
  4. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 2007. "The Basic Public Finance of Public-Private Partnerships," Levine's Bibliography 843644000000000313, UCLA Department of Economics.
  5. Salant, Stephen W, 1995. "The Economics of Natural Resource Extraction: A Primer for Development Economists," World Bank Research Observer, World Bank Group, vol. 10(1), pages 93-111, February.
  6. Heaps, Terry & Helliwell, John F., 1985. "The taxation of natural resources," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 1, chapter 8, pages 421-472 Elsevier.
  7. Petter Osmundsen, 1998. "Dynamic Taxation of Non-renewable Natural Resources Under Asymmetric Information About Reserves," Canadian Journal of Economics, Canadian Economics Association, vol. 31(4), pages 933-951, November.
  8. Bohn, Henning & Deacon, Robert, 1997. "Ownership Risk, Investment, and the Use of Natural Resources," Discussion Papers dp-97-20, Resources For the Future.
  9. Boadway, Robin & Flatters, Frank, 1993. "The taxation of natural resources : principles and policy issues," Policy Research Working Paper Series 1210, The World Bank.
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Citations

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Cited by:
  1. Alexandre Janiak, 2008. "Welfare in models of trade with heterogeneous firms," Documentos de Trabajo 253, Centro de Economía Aplicada, Universidad de Chile.
  2. Chris Hajzler, 2010. "Resource-based FDI and Expropriation in Developing Economies," Working Papers 1012, University of Otago, Department of Economics, revised Sep 2010.
  3. Christensen, Jonas Gade, 2011. "Democracy and Expropriations," Working Papers in Economics 06/11, University of Bergen, Department of Economics.
  4. Luca Di Corato, 2010. "Profit Sharing under the Threat of Nationalization," Working Papers 2010.5, Fondazione Eni Enrico Mattei.
  5. Alexandre Janiak, 2008. "A large firm model of the labor market with entry, exit and search frictions," Documentos de Trabajo 245, Centro de Economía Aplicada, Universidad de Chile.
  6. Markus Ludwig, . "The Visible Hand: National Oil Companies, Oil Supply and the Ermergence of the Hotelling Rent," Working papers 2012/11, Faculty of Business and Economics - University of Basel.
  7. Chris Hajzler, 2010. "Expropriation of Foreign Direct Investments: Sectoral Patterns from 1993 to 2006," Working Papers 1011, University of Otago, Department of Economics, revised Sep 2010.
  8. Hanna Krings, 2014. "Environmental Aspects of Resource Extraction Contracts," MAGKS Papers on Economics 201434, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  9. Raddatz, Claudio, 2009. "Multilateral debt relief through the eyes of financial markets," Policy Research Working Paper Series 4872, The World Bank.
  10. Viviana Fernández & Brian M. Lucey, 2008. "Emerging Markets Variance Shocks: Local or International in Origin?," Documentos de Trabajo 251, Centro de Economía Aplicada, Universidad de Chile.

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