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  • Writer's pictureEric Edwards

Water Markets are Essential to Address California’s Drought

Last week, Governor Jerry Brown issued an executive order requiring cities to reduce water use by 25 percent. But the urban sector uses less than one-fifth of California’s water; much of the rest is in agriculture. Meanwhile, the state and its cities are considering major investments in infrastructure, such as desalinization plants and diversion canals, which could cost taxpayers billions. Will these measures help? Probably not a lot, because the underlying problem is not so much a lack of water as it is a lack of water markets. The principle behind a water market can be illustrated by a family in Orange County that is willing to pay thousands of dollars per year to the local water utility to have a green lawn, while that same amount of water used on a farm to grow something like alfalfa generates only $60 in revenue. If the farmer were to sell some of his “low-value” water to the family, both parties would be better off.

While water is essential to life, we use it for more than bathing and drinking, and in that sense, water is no different from gasoline and food — essential but still subject to the law of supply and demand. We don’t have statewide crises when milk or diesel are in short supply because markets adjust; prices rise and people economize. We recently published an economic analysis of why water prices don’t adjust in the same way and found the primary factors to be constraints on the voluntary transfer of water out of agricultural use and into other uses where the water has a higher value.

If they could, farmers would voluntarily sell or lease some of their water. If just 5 percent of the water currently in agriculture were moved to California’s cities via market transfers, rural California farmers would earn tens of millions of additional dollars each year while urban water supplies would increase substantially, more than will be generated by the mandated 25-percent cut in urban water use. This is the type of win-win scenario that markets can provide and that political mandates fail to create.

There are several reasons why California farmers have not been active in water markets, as, for example, farmers in Colorado are: (1) Water rights are commonly controlled by the local irrigation district, which responds to political demands to keep the water, rather than transfer it, even if transfers could better serve its members. (2) Many rural counties in California have ordinances making it illegal to transfer water out of the county. (3) Farmers fear that if they transfer water, even temporarily, they will forfeit their right to it in future drought years. (4) Rules issued by providers of agricultural water, like the Bureau of Reclamation, can impede transfers to cities.

Here is what politicians, state water agencies, environmental advocates, and water management organizations could work together to do: (1). Develop simple rules to allow water transfers while ensuring adequate water to protect other rural water users and the environment. (2) Smooth the regulatory process by making the approval of transfers the norm rather than the exception. (3). Promote water banks. Farmers could agree to become potential sellers by placing some water in the “bank” to be sold or leased at a price of their choosing. If cities or other farmers offer to pay more than this price, a water transfer beneficial to both parties would occur. The water bank is an institutional arrangement to bring sellers and buyers together, much like the New York Stock Exchange brings investors together.

It is understandable why farmers are worried about their water rights. Mandating reductions from them without compensation will bring only legal and political challenges, not a solution. Water markets offer a voluntary mechanism for responding to short-term drought and long-term water management challenges. Transfers of water to cities need not cause large-scale changes to California’s rural counties. Water markets allow for win-win solutions, which would be a nice alternative to political finger-pointing and neighborhood “water policing.”

Eric Edwards is an assistant professor in the Department of Applied Economics at Utah State University Gary Libecap is a professor at the Bren School of Environmental Science and Management at the University of California, Santa Barbaa

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