The Problem with Water Markets

The historic drought in California has brought much welcome attention to the problems of water allocation in the American West. I can’t even count the number of articles explaining the “wasteful” water use by California’s almond and alfalfa farmers, or the ones laying out a better way forward.

Two days ago, an international affairs fellow at the Council on Foreign Relations, a think-tank in Washington, DC, wrote an op-ed in the New York Times entitled “Water Pricing, Not Engineering, Will Ease Looming Water Shortages.” The gist of the piece is that we need to stop relying on “engineering” like more pipelines, dams and canals in times of water shortage, and instead move water through market mechanisms. Water markets appear throughout the academic literature and, supposedly, have not developed on the ground, which means that water continues to be allocated according to “outdated” water laws instead of going to its best economic use.

For the purposes of this post, I’m going to ignore the fact that water is to a large degree actually allocated by economic pressures, according to deals negotiated by buyers and sellers- deals that, somehow, according to academics, “don’t count” as water marketing, deals that lead to entire counties going dead dry in order to satisfy the economic and population growth of distant cities (more about that here).

Now, creating water markets is a lot more complicated than “creating water markets.” The op-ed suggests, among other things,

Creating bigger water markets covering more water users is a critical step toward encouraging smarter use of dwindling water resources, especially in the western United States. Washington must work with the states to create clear and uniform rules to encourage the development of large-scale, interstate water markets (emphasis mine) that cover urban and rural areas, and ensure that water is allocated to the most important uses in times of shortage.

Now suppose I am a farmer with a water right in the South Platte River basin (87% snowpack as of April 2nd!). I see that Central Valley almond farmers are paying tens of thousands of dollars an acre-foot for reliable water. I know I can’t raise a crop that profitable on my own farm, so I go to this mythical new water market and sell my consumptive use (let’s assume I actually know what this is, unlike 90% of the farmers out there) to some poor soul in Merced.

Surely we’ve seen the problem: how on earth is this interstate water market going to move my water from northeast Colorado to the Central Valley?

The steps involved in an interstate water market. Remember that water is really heavy and really expensive to pump uphill.

The steps involved in this supposed interstate water market. It has to cross the Rocky Mountains, the Mojave Desert uplift and the Tehachapi Mountains to get from “where the water is this year” to “where the water needs to be.” Remember that water is really heavy and really expensive to pump uphill.

Obviously, this is an extreme example. But presumably, we want markets so that we can move water from where it is to whoever is willing to pay for it, and this year the only water in the West is in the Central Rockies, and growers of permanent crops like fruits and nuts are probably those most willing to pay. This accords with the theory frequently cited that we just need to create big water markets, represent the price of water accurately and transparently, and our shortage and allocation problems will be solved through market forces.

“Creating water markets” is great in theory. In theory, marketing can allocate water to its highest and best use, including rural and urban areas. But water is not like other marketable goods; you can’t just ship it anywhere at a reasonable cost. You have to have the infrastructure. Even at a smaller scale than my example, you have to have sufficient engineering to move the water from seller to buyer, to store it until it is needed, and to lose as little as possible to groundwater and evaporation. This means you can’t connect every possible buyer and every possible seller. Seeing water allocated as it is drives people to think we need new market institutions. These problems are not institutional. We trade in water rights all the time. These problems are physical. Buyers and sellers of water need to be connected not by a new market concept, or a new regulatory regime, but by physical infrastructure that enables them to trade. If economists and “international affairs fellows” want to improve the problems of Western water users, they should focus on creating a system that accords with the physical realities of water delivery. Prior appropriation does that (and even allows trading!). “Large-scale interstate water markets” do not.

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4 thoughts on “The Problem with Water Markets

  1. Brian:
    I have enjoyed discussing this with you in the past. So, if water markets can’t help drought-stricken California farmers without engineering infrastructure which doesn’t currently exist, then I suggest this market-driven solution instead: (1) The price of almonds continues to rise until one-of-two things happens: (2a) Almond-lovers suddenly see their craving as a luxury and stop buying the high-priced nut with an ensuing market collapse; farmers go broke and sell their lands; these lands are bought and used for crops or other purposes more suited to their physical environment. (2b) Almond-lovers continue to see their craving for a luxury item as a real necessity providing growers with the profits needed to build whatever engineering infrastructure (pipelines, desalinization, other?) is needed to maintain their very valuable enterprise. Either way, the “invisible hand” has guided the solution to an appropriate end. Aren’t the market forces already at work here?
    Regards,
    PD

    • Certainly market forces are already at work at the appropriate scale. Almond farmers buy water to maintain their crops (which, unlike field crops, cannot be fallowed without killing the trees) on an open market when they are short. They just do it at an appropriate scale- within a river basin, for example, where you can physically get the water to its buyer. Considering how expensive water infrastructure is, I doubt these markets will ever expand beyond basins.

      There are markets in every river basin. Economists just don’t seem to “count” them because prior appropriation still exists, or because there’s no central “water exchange,” or maybe because they aren’t aware of the trading that goes on. I dunno.

  2. Thank you for pointing out what should be obvious even to those who hover above us in places like think tanks and Washington in general. I like your blog. Subscribing now.

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