Public Choice 93: 335355, 1997. c 1997 Kluwer Academic Publishers. Printed in the Netherlands.

335

Club theory: Thirty years later

TODD SANDLER1 & JOHN TSCHIRHART2

Department of Economics, Iowa State University, Ames, IA 50011-1070, U.S.A.; Department of Economics and Finance, University of Wyoming, P.O. Box 3985, Laramie, WY 82071, U.S.A.
2 1

Accepted 21 July 1995 Abstract. This paper presents a self-contained survey of club theory with an emphasis on the contributions of the last fteen years. Club goods are contrasted with pure public goods, and equilibrium and optimality notions are contrasted. After presenting three basic representations of club theory, we focus on recent advances and generalizations that include heterogeneous memberships, transaction costs, uncertain utilization, asymmetric information, and noncompetitive inuences. An agenda for research is indicated that includes further analysis of asymmetric information, institutional structure, and applications.

1. Introduction A club is a voluntary group deriving mutual benets from sharing one or more of the following: production costs, the members characteristics, or a good characterized by excludable benets. Although thirty years has passed since James Buchanan (1965) published his seminal paper on the theory of clubs, testimony to his achievement is the keen interest that continues today in developing, rening, and applying the theory. Recent contributions concern the study of sharing among clubs (Sterbenz and Sandler, 1992), nonanonymous crowding (Scotchmer, 1994), exclusion cost (Helsley and Strange, 1991), multiproduct clubs (Brueckner and Lee, 1991; Sandler and Tschirhart, 1993), and asymmetric information (Lee, 1991; Silva and Kahn, 1993). The modern theory of clubs originated with at least three sources in addition to Buchanan (1965). With a voting-with-the-feet hypothesis, Charles Tiebout (1956) developed a theory of jurisdiction size, whereby a heterogeneous population partitioned themselves into homogeneous clubs by choosing the jurisdiction with the tax-public good package that best suited their tastes. The resulting partition is Pareto optimal. For a public utility, Jack Wiseman (1957) put forward a club principle for sharing cost among
 Todd Sandler was a Visiting Fellow at the Federalism Research Centre, Australian National

University during the writing of this paper. He gratefully acknowledges the support of the Centre. We proted from comments from an anonymous referee.

336 users: an increase in membership reduces the cost per unit of service as scale economies are achieved. In the Logic of Collective Action, Mancur Olson (1965) indicated the need for exclusive clubs that restricted membership size owing to congestion or crowding as a greater utilization of an impure public good by one user decreases the benets or the quality of service still available to others. Club theory rests on two basic premises. First, the presence of crowding requires a restriction of group size, so that membership size is an endogenous variable. In some models, the choice of the toll or congestion price serves to determine membership size; in other models, the utilization (or visitation) decision xes membership size.1 Second, both membership size and provision are interdependent allocation decisions. The study of clubs was intended to bridge the gap between private and pure public goods. For the former, consumption rivalry is complete and exclusion is costless; while for the latter, consumption is nonrivalrous and exclusion is infeasible. Buchanan (1965) viewed clubs as a private, nongovernmental alternative to the optimal provision of a class of public goods, later known as club goods, that are excludable and subject to some rivalry in the form of congestion. Club theory has been applied to a wide range of problems including military alliances, international organizations, recreation facilities, infrastructure, national parks, and wilderness areas. Club goods encompass hospitals, health clubs, trauma clinics, libraries, universities, movie theaters, telephone systems, and public transport. Because roads and cities are subject to crowding and exclusion, two crucial allocative decisions of urban economics can hinge on club theory. Clubs gure prominently in other subelds of economics e.g., unions in labor economics, common markets in international economics, monetary union in monetary economics, collectives in public choice, industrial size in industrial organization, producer collectives in agricultural economics, and jurisdictional size in regional economics. 2. Club and pure public goods: A contrast To better understand the special features of clubs and club goods, we indicate a host of features that distinguish club goods from pure public goods. First, privately owned and operated clubs must be voluntary; members choose to belong because they anticipate a net benet.2 As a consequence, the net gain in utility associated with membership must exceed or equal membership fees or toll payments. Voluntarism need not characterize a pure public good, inasmuch as such goods may harm some recipients who cannot avoid the goods spillovers at a reasonable cost. Examples include defense provision received by a pacist, or sound carried from an open-air concert to a surround-

337 ing neighborhood. In the Samuelsonian sum of marginal rate of substitution (MRS) condition, some MRSs can be negative for a pure public good. The same is not the case for privately provided club goods, because the right of costless exit is always available. Second, club goods, unlike pure public goods, involve sharing that results in congestion or crowding. As such, crowding depends on some measure of utilization, which could include the number of members, the total number of visits, or the ratio of members (utilization) to the number of units provided. The latter indicates the average utilization per unit of provision. In many formulations, congestion depends positively on a utilization measure and negatively on the provision level. The negative dependency implies that larger facilities can withstand a given level of utilization with less crowding. A host of congestion functions exist; the simplest sets congestion equal to the membership size. In applications such as highway provision, the form of the congestion function is a crucial consideration for the determination of a congestion-internalizing toll and self-nancing. Highway congestion functions reect trafc ow attributes regarding transit time and safety. A particularly important function is homogeneous of degree zero in utilization and provision, since full nancing is then assured (Cornes and Sandler, 1986: 126127). Two kinds of congestion are distinguished in the literature: anonymous and nonanonymous. For anonymous crowding, congestion per visit is independent at the margin from who is making the visit; for nonanonymous crowding, the identity and the attributes of the member are important determinants of crowding. Tolls, consequently, differ among users in just the case of nonanonymous crowding. Third, club goods require an exclusive group whereby nonmembers are excluded. In contrast, pure public goods are associated with inclusive groups, since additional users can bring down per-person fees and impose no crowding costs on others. Memberships are nite in clubs so as to balance, at the margin, the cost-sharing gains from larger memberships with the losses associated with crowding. Nonmembers of a given club have two options: join another club providing the same club good, or not join any club providing that club good. If a population is allocated among a set of clubs with no overlapping or nonassigned individuals, then the population is partitioned by the set of clubs. The number of clubs then becomes an important choice variable that represents a fourth distinguishing feature. Partitioning is what permits competition among clubs; there is no analogous partitioning for pure public goods. If a partition exists, then the number of clubs equals the population divided by the optimizing membership size of a single club. For a homogeneous population (i.e., identical tastes and endowments), the resulting club partition is a

338 core solution in which no alternative club arrangement can improve the welfare of any constituent clubs members; hence, no blocking coalition exists and the clubs are stable as members have no reason to move among clubs. When, however, some individuals do not belong to any club supplying the club good, then the population is not partitioned and instability results (Pauly, 1967; Wooders, 1989). A fth distinguishing feature of club goods is the presence of an exclusion mechanism that monitors utilization so that members can be charged tolls and nonmembers kept out. In traditional club models, exclusion mechanisms are costless. For more recent models, positive exclusion costs have an important inuence on institutional form; e.g., they may determine whether fees should be a per-visit charge (ne exclusion) or a single membership fee (coarse exclusion) (Lee, 1991; Helsley and Strange, 1991). Exclusion costs are reasonable when they are less than the benets gained from allocating the shared good within a club arrangement. Sixth, club goods involve at least two allocative choices in contrast to the provision choice of pure public goods. Because exclusion is and should be practiced, membership size must be ascertained along with the provision level of the shared good. Insofar as the membership size affects the provision choice and vice versa, the decisions must be made simultaneously. If models are made more complex, additional interdependent choices are required e.g., the number of products for multiproduct clubs; the number of clubs (rms) for a noncompetitive club structure; or the capacity level for random-utilization clubs. As complexity is added, authors often x one or more of the clubs choice variables for tractability. The dual decision nature of club theory is the source of much novelty and difculty when applying modeling techniques and insights from the study of private goods. 3. Clubs: Optimality and equilibrium From its outset, the literature on clubs has not always been clear as to whether an equilibrium or an optimum was being analyzed. The early treatment of clubs (e.g., the Buchanan model described in Section 4) hypothesized a cooperative or coordinated action by the members to maximize the welfare of the group. When the club decisions are represented as a cooperative action, the resulting outcome will be a Pareto optimum for the members members belong because they perceive a net benet from membership. If, moreover, the club decisions are centralized to account for the welfare of those within and those outside of the club, then the outcome will be a Pareto optimum for the economy as a whole. A core solution can result if the population is partitioned among a set of clubs, in which each individual is a member

339 of an optimally congured club in terms of membership size and provision level. When rms provide the club good in a competitive environment, a core allocation results as each rm maximizes its prot subject to the utility level of members in a member-owned cooperative club. Clubs can assume a variety of forms member ownership, rm provision, or public provision. If information is complete, exclusion is costless, and a large number of clubs exist, institutional structure makes no difference for optimality (Berglas and Pines, 1981; Cornes and Sandler, 1986: Ch. 12). In more recent years, Nash equilibria have been examined for clubs, in which the agents (e.g., the members, the clubs) choose their choice variables subject to the best-response choices of their counterparts (Fraser and Hollander, 1992; Scotchmer, 1985a; Sterbenz and Sandler, 1992). For example, rm-provided clubs may choose provision and tolls in a multi-club setting subject to the best-response choices of these variables by alternative clubs. The number of clubs is determined in an earlier stage based on a non-negative prot constraint (Scotchmer, 1985a). For a nite economy where each club (rm) has some market control over tolls, the resulting Nash equilibrium is not a Pareto optimum. At a Nash equilibrium, no decision maker would unilaterally want to alter its choices. These nonoptimizing Nash equilibria have a common characteristic uncoordinated actions among the agents. In the above example, a Pareto optimum may, nevertheless, result if the number of replicable clubs becomes sufciently large that market power is lost; but then the economy is no longer nite.

4. Three basic models By the way of summary, we briey present three standard models of club theory that allow us to highlight the features of club analysis and to indicate the extensions accomplished in recent years. The most basic model, the Buchanan model, assumes two goods: a private good and a club good. Members are drawn from a homogeneous population whose individuals possess the same tastes and endowments. Clubs are replicable and can partition the population with no leftover individuals. Exclusion is costless and information is complete. A representative members taste is indicated by a utility function,

U i = U i yi ; X; s

(1)

where yi is the ith members consumption of the private good, X is his consumption of the club good, and s is the membership size. Utilization rate, xi , is the same for all members and is set equal to provision, so that xi = X,

340 where X also serves to denote the size of the club facility. The utility function is increasing in yi and X, and decreasing in s after a threshold membership is attained.3 Moreover, utility is assumed to be quasi-concave and twice continuously differentiable. Each member maximizes his or her utility subject to a resource constraint,

F i yi ; X; s = 0

(2)

that depends positively on the two goods and negatively on the overall club membership size.4 The negative relationship follows from club costs being shared, so that an augmentation in membership reduces resource expenditure for each member. The implicit price of membership in a Buchanan club is effectively C/s, in which C is the provision cost of the club good. When a representative member chooses the optimizing yi , X, and s, the following rst-order conditions result: MRSi Xy MRSi sy
=

MRTi Xy

i = 1; :::; s; i = 1; :::; s:

Provision

(3)

MRTi sy

Membership

(4)

In the provision condition for the shared good, each member equates the marginal rate of substitution (MRS) between the club good and the numeraire private good to the marginal rate of transformation (MRT) between these two goods. That is, the member equates the marginal benet of the club good, evaluated in terms of the numeraire, to its marginal cost. If, at the margin, the club is self-nanced when providing the club good, the sum of the members marginal cost or payments  s=1 MRTi  must equal the i Xy clubs marginal provision cost (MRTXy ). Equation (3) then indicates by substitution that the usual Samuelsonian provision condition for public goods (i.e., s=1 MRSi = MRTXy  holds for the club good. i Xy The novelty of club theory is associated with the membership condition, whereby a representative member equates the MRS between group size and the private good to the analogous MRT. In doing so, the member achieves an equality between the marginal benet and the marginal cost from having another member admitted. This marginal benet is typically negative because of congestion, whereas the corresponding marginal cost is also negative because of per-member cost reduction derived from cost sharing. In contrast, a pure public good can accommodate the entire population, since the marginal crowding costs are zero and, thus, always less than marginal gains from reduced per-person provision costs.

341 It is important to highlight the interrelationship between (3) and (4) that requires the two conditions to be determined simultaneously. This follows because the MRS and MRT expressions in both conditions depend on the same variables. Even the Samuelsonian provision condition for fully nanced clubs depends on the number of members in the summation and the MRS expressions. By focusing on the representative member and the maximization of average net benets, the Buchanan model assumes away nonmembers through an implicit assumption that clubs are replicable and the entire homogeneous population is a multiple of the optimal membership size, determined in (4). The resulting choice of membership and provision gives a solution in the core; no alternative conguration of clubs could do better. An important variant of the Buchanan model is the McGuire (1974) model, which is capable of representing the Tiebout (1956) model for jurisdictions that provide a single shared good. As in the Buchanan model, homogeneous members are assumed to share club cost and utilization rates are xed, but, unlike the Buchanan model, the club cost is assumed to be always covered by the members. In the McGuire model, a representative member solves the following problem:
y;X;sg

max U y; X  subject to : I

y + C X; s=s;

(5)

where I is the members income; the price of the private good is normalized to one; C(
) is the cost function of the club; and the other symbols are previously dened. The cost function in (5) captures not only provision cost, but also congestion cost so that @ C/@ s = Cs represents the marginal crowding cost, whereas @ C/@ X = CX denotes marginal provision cost. In (5), the budget constraint replaces the individual resource constraint, Fi (
), in the Buchanan model. The solution to this model yields a standard Samuelsonian provision condition. In addition, a membership condition requires marginal crowding cost per member, Cs , to equal average club cost per person, C/s. This is precisely the Tiebout requirement that per-person average cost be minimized with the membership fee or toll set equal to this minimum average cost. For a homogeneous population, a collection of communities, all of size s where Cs = C/s, is in the core, provided that s divides into the population without remainder. If population were heterogeneous, then homogeneous communities should form so that each homogeneous subset of the population is partitioned into clubs or communities of size s , where s is the optimal club i i size for i-type individuals. The shared goods quantity should vary among communities according to taste; taste differences among communities are adjusted through the provision of the local public good, and hence the tax levy. If each subset of the population can be partitioned into a collection of

342 homogeneous communities of optimum size, and no one is left over, then the outcome is in the core. The third model allows for a variable visitation or utilization rate, denoted by v (Berglas, 1976). We again assume a homogeneous population that can be partitioned into a set of nonoverlapping clubs. The representative member now chooses private good consumption, visits, membership size, and provision to satisfy:
f

in which c(
) is the congestion function and C(
) is the cost of provision and club maintenance. Congestion increases with total visitation, sv, and decreases with provision; whereas, cost increases with total visitation and provision. The rst-order conditions possess two independent requirements. The provision condition is a Samuelsonian one with a weighting term that indicates the marginal decrease in congestion from increased provision. In this and the other two models, congestion is anonymous and independent of the individuals identity. The second condition is a toll or utilization condition that equates the toll per visit to the sum of marginal crowding cost (itself summed over members) and marginal maintenance cost. The toll can be shown to equal the average cost per visit or C/sv. The toll condition also xes the membership condition, inasmuch as the latter equals the former multiplied by s on both sides. For this standard model, the unimportance of institutional form can be shown by assuming that rms in a competitive industry are providing the club good. Firms are utility takers in this scenario, since they must maximize prot,  , subject to the constraint that members must be as well off as under member ownership. Each rm then faces the problem:
f

y;v;s;X g

max U y; v; csv; X  subject to : sI

sy + C sv; X ;

(6)

subject to : U I

s;v;X;Pv g

max

Pv sv , C sv; X 

, vPv ; v; csv; X  = U

(7)

in which Pv is the per-visit toll, U corresponds to the optimal utility level associated with the solution to (6), and Pv sv is the revenue collected from visitation fees. The associated rst-order conditions yield a provision and toll (membership) condition identical to those associated with (6). In long-run equilibrium, prots must be zero so that Pv sv = C(
), which implies that the toll per visit is again C/sv. Competition among clubs achieves a Pareto-optimal outcome through decentralized decision making. For pure public goods, a pseudo-market arrangement, in terms of bargaining conducted by a Lindahl auctioneer, is needed to assign cost shares to achieve optimality. The Lindahl thought exper-

343 iment, however, fails when strategic behavior keeps participants from reporting their true MRSs. Strategic behavior is especially important when small numbers of individuals are involved (Cornes and Sandler, 1986). With larger numbers, the Lindahl experiment is an abstraction that is difcult to implement in practice. Club exclusion mechanisms circumvent strategic behavior, regardless of the number of users, by monitoring visits and assigning tolls accordingly.

5. More general formulations In the 1970s, attention was directed at whether members and nonmembers utility should be considered in the objective function or whether a representative members utility function is sufcient when deriving the membership condition of a homogeneous club.5 The answer hinged on whether the population is partitioned by the system of clubs and whether the number of clubs is xed or variable. If population is partitioned, then the Pareto-optimal core requires maximizing average net benets or the representative members utility net of club costs. If, however, the number of clubs is xed and cannot accommodate the entire population, then both members and nonmembers utility must be considered in the objective. This latter approach is known as the total-economy viewpoint, while the former is the within-club viewpoint. 5.1. Heterogeneous or mixed clubs Major effort was exerted on extending the basic model to a case in which heterogeneous clubs are drawn from a heterogeneous population. Two different cases must be distinguished corresponding to the two viewpoints. If the number of clubs is xed, say at one, and a total-economy viewpoint is adopted, then the population must be ordered in some fashion when determining the membership, provision, and toll condition. Sandler (1984) used a rank ordering based on a net willingness to pay for the club, as measured by the individuals net gain from membership. More recently, Fraser and Hollander (1992) assumed that people have the same taste but different income. For normal goods, these authors could then rank order the population by income. Once a rank ordering is put forward, a Benthamite social welfare function that weights members and nonmembers utility subject to a resource constraint can be maximized to determine the optimizing conditions. The toll condition is of special interest, since the provision and membership condition do not provide much in the way of new insights. For mixed clubs and anonymous crowding, all individuals pay the same congestion-internalizing toll, but total tolls paid by various members differ according to ones revealed intensity

344 of utilization the number of visits made. High demanders visit more often and pay more in total tolls. Members are those with the greatest income or net willingness to pay, according to the manner in which the population was ordered. For replicable mixed clubs and a partitioned population, mixed clubs may be in the core, provided that crowding is anonymous and members demands for facility size and congestion coincide at a feasible division of the economywide endowments.6 The associated model is a variant of the third basic model. Most notably, it indexes the private good, income, and visits for two types of individuals. For a mixed-club core, the welfare achieved can be as good as a segregated-club core, but not better. This result contrasts with a statement to the contrary in Berglas and Pines (1981). Once heterogeneity is allowed in clubs, sharing arrangement can account for members consuming both the shared good and the characteristics or attributes of other members (DeSerpa, 1977). Members characteristics may be viewed by the other members as generating either an increase (e.g., intelligence in a learned society) or a decrease (e.g., rudeness) in utility. Crowding can be treated as one characteristic of the membership that arises from the mere presence of other members. Thus, the third basic model, can be extended so that the congestion function accommodates nonanonymous crowding by introducing a vector s = (s1 ,...,sn), where si is the number of i-type members. Some members with desirable traits may be paid to join, since they generate enough positive characteristics to offset any crowding caused by their presence (Basu, 1989). The important impact of nonanonymous crowding concerns the toll that now differs among members. A competitive equilibrium does not typically exist for clubs with nonanonymous crowding for two reasons: (1) the standard integer problem (i.e., the optimizing club size does not divide evenly into the population), and (2) a population composition problem (i.e., the optimizing conguration of tastes is not replicable) (Scotchmer, 1994). Work on nonanonymous crowding leads to a common outcome with the introduction of complexity: a failure to partition the population along added dimensions. 5.2. Transaction costs Until recently, most of the analysis on clubs assumed zero transaction costs in administering and monitoring club use.7 Interest is now being shown on the effects of exclusion, monitoring, and enforcement costs on institutional structures of clubs. Helsley and Strange (1991) examined the competitive provision of a club good by a set of replicable clubs that maximize prots when exclusion costs are present. Each club contains identical members drawn from a homogeneous population that far exceeds the optimum membership size.

345 Two types of exclusion mechanisms were considered: (1) a ne exclusion that charges a membership fee and a per-visit toll, and (2) a coarse exclusion that charges just a membership fee. With zero exclusion costs, coarse exclusion is not optimal because a member will visit the club until his or her marginal valuation is driven to zero. Overuse then results since the member does not internalize the marginal crowding costs that he or she imposes on other members (Berglas, 1976). The essential insight of recent studies is that both coarse and ne exclusion may yield a constrained Pareto optimum when the associated exclusion costs are taken into account, in which ne exclusion is more costly than coarse exclusion. With sufciently high exclusion costs, coarse exclusion may be desirable even though members are not motivated to internalize per-visit crowding. In essence, the gains in efciency from ne exclusion may not outweigh the costs of providing these incentives; thus, coarse exclusion may be justiable. Many real-world clubs (e.g., museums, country clubs, recreation facilities, zoos) employ a coarse exclusion mechanism for members. These ndings depend on a model of complete information. A two-stage game is specied in which the exclusion mechanism is determined on the rst stage, and the standard club variables are decided on the second stage. A subgame perfect equilibrium bases the exclusion choice in the rst stage on the membership, provision, and toll decisions of the second stage. The analysis of exclusion costs was advanced by introducing imperfect information in the choice of ne versus coarse exclusion, where the club cannot distinguish between high and low demanders (Lee, 1991). For low levels of transaction costs, the per-visit price is a superior regime. The membership fee regime may lead to a pooling equilibrium in which high demanders impose uncompensated externalities on low demanders; thus, an adverseselection problem results. If the level of demand differs among members, we nd it difcult to understand why the provider cannot observe this difference through revealed use. Higher demand levels are fairly easy to spot by the number of visits or time spent at facilities if exclusion is practiced. Another instance of imperfect information concerned a club provider that is unable to distinguish members from nonmembers without expending enforcement costs resulting from random inspections (Silva and Kahn, 1993). These inspections inconvenience the members, while attempting to exclude free riders. This analysis is concerned with the moral hazard problem that arises from the imperfect information as to the identity of subscribers. Examples might include public transport systems or information linkages. In this scenario, the choice of an exclusion mechanism involves more than a technology decision, because incentives must be chosen to deter free ridings. Such incentives can be inuenced by the extent of monitoring (which inuences the probability

346 of being caught) and the ne if caught. Again the choice can involve two regimes: a coarse exclusion to verify membership, and (2) a ne exclusion to verify the intensity of use. A nonsubscriber would free ride if the expected utility of the free ride is at least as large as the utility of an honest nonsubscriber, and if the expected ne does not exceed the user fee. The rst requirement is the individual rationality condition, while the second is the incentive compatibility constraint. For homogeneous populations, complete exclusion of nonpayers is optimal for rivalrous and nonrivalrous public goods (Silva and Kahn, 1993). For heterogeneous populations, these authors found that less than complete exclusion is desirable. 5.3. Uncertain utilization In the basic models, club utilization is certain, because all who show up are served. For some real-world clubs, membership is certain once fees are remitted, but capacity constraints may limit the number of members who can be accommodated at any given time. When capacity limits are reached, members must either be denied entry of else be forced to queue. First, we consider the case where members are turned away at capacity (Sandler, Sterbenz, and Tschirhart, 1985). If visitation is less than capacity, then additional users can enter. Club utilization on any given visit thus depends on the number of other members present, n, which is a random variable. For homogeneous population, each member must decide whether or not to visit. If a visit is decided, then the prospective visitor may or may not gain access. Thus, in formulating the expected utility expression for a representative member, three states of the world must be permitted: (1) not visiting, (2) visiting and entering, and (3) visiting and possibly entering. Members must choose membership size, provision, and capacity. Capacity indicates the upper bound to visits given at a point in time. Risk attitudes play a role in the choice of the club parameters. Increased riskaversion leads to greater capacity and increased facility size under reasonable scenarios, because members want to ensure against the possibility of needing the club and being turned away (e.g., re or police protection). Utilization uncertainty may also lead to an expansionary bias in terms of membership. The fraction of the club membership wanting to use the facility at any given time is the random variable n/s. By the central limit theorem, as s increases, the variance of n/s decreases. As membership grows, the fraction wanting to use the facility is subject to less uncertainty. This expansionary bias is similar to the principle behind insurance companies, where risks are reduced through pooling independent events.

347 Subsequent analysis investigated the case where the level of utilization is unknown prior to use, but users are not turned away by capacity constraints. In particular, Sterbenz and Sandler (1992) examined the institution of a sharing arrangement among clubs to smooth out crowding when utilization is subject to stochastic inuences that are independent among participating clubs. Essentially, their model concerns how to coordinate the ex ante design and the ex post utilization of two clubs confronted with random use by their memberships. An example of such sharing schemes among clubs involves hospital emergency rooms being prepared to accept overow patients from other hospitals. Other instances include lending libraries, alternative highway routes, emergency road services, re stations, and disaster relief services. A Nash-equilibrium membership and provision condition were derived for each sharing club, based on the optimizing or best-response choice of the other club. A free-rider problem characterizes the Nash equilibrium for the two-club collective, in which the component clubs will either expand membership size beyond Pareto-optimal levels or reduce provision below optimal levels or both. This follows because the component clubs can rely on their counterparts facilities through sharing. A sharing toll alleviates free riding, but at the expense of the optimal level of sharing. Institutional rules can reduce, but not eliminate, suboptimality. One institutional form has the visitor paying the toll, while the other has the club paying the sharing tolls collectively, thus reducing the effective price to a sharer. The latter scheme leads to less inefciency, since it reduces free-riding incentives while having a smaller impact on sharing. This latter exercise is representative of two club themes that have characterized much of the club literature in the last decade. The rst is that institutional structure matters,8 while the second is that Nash equilibrium may lead to suboptimality in the analysis of clubs. That is, clubs may not correct market failures under all circumstances. 5.4. Noncompetitive clubs These themes are especially germane to the study of noncompetitive clubs. Recall that for competitive clubs, institutional form did not matter a competitive rm or a member-owned club would achieve Pareto optimality. For competitive provision, the rm-provided club was constrained by a utilitytaking constraint. Noncompetitive provision is more appropriate as an alternative institutional structure for those instances in which the population is not partitioned, inasmuch as the number of clubs may be quite small. One study has put forward an analysis of prot-maximizing clubs in a noncompetitive scenario, where incumbent clubs are not utility takers (Scotchmer, 1985b). The rm views its action as having no impact on the utility achieved

348 by the homogeneous population; each rm evaluates its provision and toll package in terms of the other rms best-response packages or strategies. A two-stage Nash subgame perfect equilibrium is developed. In stage 1, potential rms must choose whether or not to enter. At stage 2, rms that enter play a Nash equilibrium game among themselves in terms of the provision and membership fee strategy.9 The entry decision during the rst stage is dependent on the optimizing provision-fee packages of the second stage for each of the competitors. The resulting Nash equilibrium requires that the marginal rm is deterred from playing enter by the prospect of negative prot which will accrue to the symmetric rms with one more incumbent (Scotchmer, 1985a: 27). This analysis showed that there is too much entry with smaller than optimal-sized clubs, where the membership fee exceeds the congestion cost imposed by the marginal member. Efciency is, however, achieved in the limit if the economy is large enough to permit sufcient replication.

6. An agenda for future research Although much has been done in analyzing clubs over the last three decades, much can still be accomplished. It is important that researchers focus on important conceptual issues and resist the temptation to add merely in terms of formalism; existence proofs of specialized equilibrium notions may not produce much in the way of applications and insights. We identify three areas in need of further development. 6.1. Asymmetric information Over the past two decades, asymmetric information has taken on a central role in economic theory. When all participants in market transactions do not possess the same information, the familiar efciency results obtained in competitive markets are compromised, and participants with superior information collect positive rents. We believe that introducing asymmetric information into club theory will yield similar results. Club size may deviate from the efcient level, and some members or owners may collect rents. Moreover, the extent of the deviation and rent may depend on institutional structure. We have already mentioned the case in which the club manager cannot distinguish subscribers and nonsubscribers and must devise an incentivecompatible scheme. Many other aspects of clubs could involve asymmetric information. To introduce some of the relevant notions, we briey sketch a model. Consider the case where a member-owned club is run by a manager (the agent) and the cost of the club is subject to a random variable, . The

349 members know that belongs to the two-point support f l , h g, where h l . The cost function could be written as

C X; ; e = aX +

,e

(8)

where e is the effort level of the manager. The greater is the effort, the lower the cost. The managers objective is to maximize utility,

in which t is a transfer from members to the manager and  (e) is the managers disutility of effort. The memberships objective is to maximize its utility net of costs and of the transfer to the manager. The membership observes the total cost, C, and provision, X, but cannot observe either the true value of or the effort level of the manager. A contract between the members and the manager must be based on the variables observable by both. From (8), a contract is specied as fC( ), X( ), t( )g. The manager reports and e, and the membership species fC( l ), X( l ), t( l )g for l and fC( h ), X( h ), t( h )g for h . Of course, when either or e is reported, the members can infer the other. Because the membership reimburses the manager for all costs and pays the manager a transfer based on reported effort or , incentive problems arise. For example, the manager may claim = h and a high effort level, when actually = l and low effort was expended. An incentive compatible contract is one for which the manager reports the true value of (or e) to the membership. Designing such a contract amounts to appending the following constraints to the memberships utility-maximization problem:

t , e;

(9)

tl , aXl + th , aXh +

, Cl  = th , aXh + l , Ch; , Ch = tl , aXl + h , Cl :

(10) (11)

Letting t( i ) = ti , X( i ) = Xi , and C( i ) = Ci for i = l, h, constraint (10) requires that when = l , the manager prefers contract fCl , Xl , tl g to contract fCh , Xh , th g. Analogously, constraint (11) requires that when = h , the manager prefers contract fCh , Xh , th g to fCl , Xl , tl g. In either case, truth telling is a dominant strategy, best regardless of the outcome of nature. Additionally, there are the individual rationality constraints:

tl , aXl + th , aXh +

l h

, Cl  = U o; , Ch = U o ;

(12) (13)

350
Table 1. Clubs and asymmetric information
Case 1. 2. 3. Principal Membership Membership Membership Agent Manager Manager Manager Information asymmetry Cost of provision, effort expended Membership size, effort expended Facility maintenance effort Efforts to spread crowding Efforts to reduce cost of provision Efforts to reduce cost, or efforts to reduce breakdown Efforts to reduce cost Random variable cost C = C(X, , e) membership, s = s( , e) probability of breakdown, p = p(n, e) visitation rate cost cost p(
) cost

4. 5. 6.

Membership Membership or electorate Membership

Manager Bureaucrat OwnerManager Manager or membership

7.

Owner

where Uo is the managers reservation utility. The rationality constraints indicate that for either contract the manager must be at least as well off as she would be not managing. This problem leads to the familiar principal-agent results (Laffont and Tirole, 1993). When = l , an efcient level in effort is expended and the manager receives a positive rent. When, alternatively, = h , less than an efcient effort is expended and the manager receives no rent. More pertinent to club theory, agent cost (from the additional incentive to make truth telling a dominant strategy) adds to the overall cost of provision, which, in turn, raises the benet of cost sharing, leading to an expansionary bias. This follows because the greater costs for each provision level means that an additional member leads to a greater reduction in cost per member. As a consequence, asymmetric information regarding cost may imply a larger membership and smaller provision, resulting in more congested clubs. In an alternative context (case 3 in Table 1), maintenance effort of the manager may be unobservable. Low maintenance can lead to greater breakdowns and more interrupted service. Since breakdowns have a random component, the managers efforts may not be observable, thus an incentive-compatible scheme needs to be devised. Different institutional forms for clubs have diverse principals and agents. In a rm-owned club (case 7), the agent might be the members who use the

351 club, while the principal might be the owner. In a public club (case 5), the principal might be the electorate and the agent could be a bureaucrat. Other institutional structures could have multi-layered principal-agent problems, giving rise to coalition formation between adjacent levels. Alternative institutional forms may imply different asymmetries of information. Consequently, institutional structures may vary greatly in their agency cost and efciency. Table 1 indicates seven scenarios, by identifying the principal, the agent, the information asymmetry, and the random variable. A large agenda for future research remains on this issue. 6.2. Institutional structure There still remains much to do concerning institutional structures. Thus far, the hierarchical or authority structure of clubs has not been studied. Most models, except where noted, treat members as homogeneous. Once members are distinguished by authority or payoff, homogeneous representations are no longer appropriate because average net benets are not maximized; members from different categories obtain different goals. The two-stage game-theoretic discussions make a start at this differentiation, but more needs to be done. For example, nonanonymous crowding may have a greater role to play when members are distinguished from one another by hierarchical placement. As members are differentiated, asymmetric information and coalition formation takes on an added importance. The same is true for transaction costs. To date, club analysis has focused on just one form of transaction costs exclusion cost. Administrative and decision costs are also important and are more apt to vary with the composition of membership (homogeneous and heterogeneous) and hierarchical considerations. As transaction costs are more fully considered, institutional forms for clubs will assume an increased importance. It is unlikely that institutional alternatives will be interchangeable in terms of efciency considerations. The nal choice will compare welfare levels associated with alternative institutional forms, evaluated at their, respective, optimized choice variable. As diverse classes of members are analyzed, the analysis of the core will probably assume a smaller importance, because the partitioning requirements would then have to be extended to each class of members. There will come a time when researchers must concede that the strict requirements of a core do not apply to the more complicated scenarios. Competitive assumptions will also likely be cast aside. 6.3. Applications To date, theoretical applications have been put forward for a wide range of activities as indicated in the introduction (see Cornes and Sandler, 1986, for

352 references and applications). Club theory has been applied to the study of recreation areas, highways, public utilities, and communication systems. By forming the theoretical basis for the Tiebout hypothesis, club theory has been used to analyze the formation of jurisdiction for the provision of local public goods. Club theory is also germane to the study of international organizations, including pollution-reduction pacts, common markets, and military alliances. For the latter, Murdoch and Sandler (1982) have measured congestion in terms of a thinning of forces along a common perimeter or exposed border (i.e., borders not adjacent to a friendly power). The desirability of expanding NATO to include the East European countries of the ex-Warsaw Pact can be answered with club theory. The addition of these countries would do little to thinning as NATOs perimeter moves eastward, since exposed border along the Eastern margin would not change much, while benets from cost sharing would increase (Khanna and Sandler, 1996). Because the added costs of new members are small, while the added benets are large, the membership should be expanded. Another recent application of club theory, illustrative of the theorys usefulness, is to airports. Airports represent a multiproduct club where commercial and noncommercial travelers utilize the terminal, the air trafc-control system, and the runways. Commercial travelers rely on all three club goods, while noncommercial travelers only use the latter two goods. In an interesting analysis, Lipsman (1994) modeled the airport as a multiproduct club, in which two sets of travelers share the runway and terminal gates during peak and off-peak travel periods. This analysis extended the study of full nancing to the case of these multiproducts and demonstrated that, in the absence of non-user externalities, user tolls could nance provision when both runways and the passenger terminals exhibit constant ray economies of scale. The study went on to generalize the nancing condition to cases of positive and negative externalities. For efcient toll charges set equal to marginal congestion costs, Lipsman (1994: 142149) showed the importance of economies of scope to the nancing issue. The presence of economies of scope may mean that efcient user fees on the separate facilities will fail to nance marginal provision costs, implying the need of government subsidies. Many interesting policy issues exist in terms of charges that should apply to diverse users of airports to promote efciency. Another novel use of club theory was suggested by Jones et al. (1992). These authors viewed state public utility commissions as club members in a regional regulatory agency. The impetus for the agency is that the operating areas of regulated utilities often cover multiple states and, without coordination among state commissions, regulators can create spillovers for one another when they place constraints on utility prices and entry and exit criteria.

353 Although club theory has been protably applied to a host of economic problems, an important agenda still exists in terms of empirical testing of club models, where direct measures of congestion are used. Most empirical work has not developed good tests of the basic ingredient of club theory its congestion function and the membership condition. Perhaps, the best empirical measurement of club theory involved the study of highways, in which progress has been made in estimating a congestion function based on trafc spacing, speed, and numbers (e.g., Boardman and Lave, 1977). The roadway literature examined the use of a congestion-internalizing toll to nance road provision. The optimal membership condition was ignored, while the focus was on provision and nance. In environmental economics, the study of wilderness areas modeled the congestion function based on the likelihood of encounters with other users. Estimates were made concerning users willingness to pay to avoid encounters (Cicchetti and Smith, 1976). A large empirical literature has focused on the Tiebout hypothesis of votingwith-ones-feet. In most instances, the literature assumed that the hypothesis applied and then attempted to infer the value placed on the public good package through the capitalized price of houses in the jurisdictions. Congestion was not measured directly, and the average cost per person was not estimated to determine if it has, indeed, been minimized. More recent theoretical advances have received no empirical investigation. For example, the impact of exclusion costs on institutional form has not been tested. In particular, the use of different exclusion mechanisms coarse or ne has not been empirically related to the theoretical predictions. The impact of uncertainty and competititve imperfections has also received no empirical attention. For earlier and more recent advances, the theory has outraced the empirics. This needs to be corrected if club theory is to continue to be relevant. Notes
1. This is especially true if the utilization rate is xed per member. 2. Ng (1973: 279) noted that a club good, unlike a pure public good, is rejectable so that an individual who does not obtain a net positive benet from consumption can choose not to partake. If a club good is publicly provided, voluntarism, at least in terms of taxes, may not be possible. 3. The marginal utility derived from additional members may be positive for small memberships owing to camaraderie but eventually crowding occurs and marginal utility becomes negative. 4. For sufciency, the resource constraint is assumed to be strictly concave in its three arguments and twice continuously differentiable. 5. Representative articles include Artle and Averous (1973), Berglas (1976), Cornes and Sandler (1986), Helpman and Hillman (1977), Ng (1973, 1974), Sandler and Tschirhart (1980), and Sandler (1984).

354
6. See McGuire (1991), Scotchmer and Wooders (1987), and Wooders (1989). 7. Notable exceptions include Oakland (1972), Kamien, Schwartz, and Roberts (1973), and Helsley and Strange (1994). 8. Institutional structures are also shown to matter in recent work on multiproduct clubs, depending on whether members are restricted to consume all products or not (Sandler and Tschirhart, 1993; Silva, 1994). 9. Membership fee xes membership size in this coarse exclusion model.

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