Loggers vs. Campers: Compensation for the Taking of Property Rights

Governments often have the power to take property rights from private citizens but their responsibility to pay compensation is typically not well specified. In this paper we examine how the compensation rule adopted by a country affects both private investment decisions and takings decisions. We build on a widely accepted argument that any lump sum compensation, including zero, is the socially optimal compensation scheme. The lump sum compensation result hinges critically on the assumptions that the government maximizes social welfare and that the level of private investment does not affect the alternative use of the property rights. We find that when either of these assumptions is relaxed, the optimal compensation scheme will generally depend upon market values. The model presented here provides strong support for market value compensation for the taking of property rights in modern societies.