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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.

Suggested Citation

  • Eduardo Engel & Ronald Fischer, 2008. "Optimal Resource Extraction Contracts under Threat of Expropriation," Cowles Foundation Discussion Papers 1636, Cowles Foundation for Research in Economics, Yale University.
    • Handle: RePEc:cwl:cwldpp:1636
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    1. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 2013. "The Basic Public Finance Of Public–Private Partnerships," Journal of the European Economic Association, European Economic Association, vol. 11(1), pages 83-111, February.
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    5. Salant, Stephen W, 1995. "The Economics of Natural Resource Extraction: A Primer for Development Economists," The World Bank Research Observer, World Bank, vol. 10(1), pages 93-111, February.
    6. 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.
    7. Harold Hotelling, 1931. "The Economics of Exhaustible Resources," Journal of Political Economy, University of Chicago Press, vol. 39, pages 137-137.
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    9. Eduardo M. R. A. Engel & Ronald D. Fischer & Alexander Galetovic, 2001. "Least-Present-Value-of-Revenue Auctions and Highway Franchising," Journal of Political Economy, University of Chicago Press, vol. 109(5), pages 993-1020, October.
    10. Robert T. Deacon & Henning Bohn, 2000. "Ownership Risk, Investment, and the Use of Natural Resources," American Economic Review, American Economic Association, vol. 90(3), pages 526-549, June.
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    Cited by:

    1. David Martimort & Jérôme Pouyet & Francesco Ricci, 2018. "Extracting information or resource? The Hotelling rule revisited under asymmetric information," RAND Journal of Economics, RAND Corporation, vol. 49(2), pages 311-347, June.
    2. 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.
    3. Claudio Raddatz, 2011. "Multilateral Debt Relief through the Eyes of Financial Markets," The Review of Economics and Statistics, MIT Press, vol. 93(4), pages 1262-1288, November.
    4. Ludwig, Markus, 2012. "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.
    5. Croutzet, Alexandre & Lasserre, Pierre, 2017. "Optimal completeness of property rights on renewable resources in the presence of market power," Resource and Energy Economics, Elsevier, vol. 49(C), pages 16-32.
    6. Hajzler, Christopher, 2014. "Resource-based FDI and expropriation in developing economies," Journal of International Economics, Elsevier, vol. 92(1), pages 124-146.
    7. Janiak, Alexandre, 2008. "Welfare in Models of Trade with Heterogeneous Firms," IZA Discussion Papers 3803, Institute of Labor Economics (IZA).
    8. Leiva, Benjamin, 2020. "Natural resource rent allocation, government quality, and concession design: The case of copper in Chile," Resources Policy, Elsevier, vol. 68(C).
    9. Di Corato, Luca, 2013. "Profit sharing under the threat of nationalization," Resource and Energy Economics, Elsevier, vol. 35(3), pages 295-315.
    10. Christensen, Jonas Gade, 2011. "Democracy and Expropriations," Working Papers in Economics 06/11, University of Bergen, Department of Economics.
    11. Christopher Hajzler, 2012. "Expropriation of foreign direct investments: sectoral patterns from 1993 to 2006," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 148(1), pages 119-149, April.
    12. 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.
    13. 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).

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    More about this item

    Keywords

    Taxation; Mining; Rent extraction; Royalty; Non-renewable natural resource; Present-value-of-revenue auction;
    All these keywords.

    JEL classification:

    • Q33 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Resource Booms (Dutch Disease)
    • Q34 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Natural Resources and Domestic and International Conflicts
    • Q38 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Government Policy (includes OPEC Policy)
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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