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Abstract
The overuse of open-access resources is a classic example of externalities. Inefficiencies arise not only from resource use by existing participants but also from their investment in capacity and the entry of new firms. Standard models of externalities, however, typically abstract from firms’ entry, exit, and capital accumulation. This paper develops a model of strategic firm dynamics with production externalities, in which firms interact through stock depletion and congestion. I estimate the model using firm-level panel data from the American whaling industry (1804–1909), an unregulated global commons. Using the estimated model, I quantify the shadow prices of externalities and propose a tractable framework for optimal policy design. The results show that per-unit Pigouvian taxes alone cannot achieve the long-run social optimum, as they correct stock externalities but leave persistent overcapacity and congestion unaddressed. Optimal regulation combines per-unit taxes with state-dependent lump-sum taxes that vary with vessel capacity and productivity to internalize firms’ dynamic interactions. The welfare effects of these policies depend critically on technology, demand, and resource regeneration, underscoring the importance of adaptive policy design.