Monday, March 31, 2014

Water Subsides Are a Drain on California and on Economies in General

California has been dealing with drought for quite some time. I'm not going to go as far and say that it hasn't been this bad since the Great Depression, but it's still bad. The water situation in the country is bad enough where the population has doubled, yet the water consumption has tripled. There are those on the Left who would like to blame the drought on climate change because obviously, any climatological phenomenon is caused by our carbon output, right? Although record low rainfalls are not helping, you know what is making it worse? Ill-informed government policies, specifically in the form of water and irrigation subsidies.

The United States Bureau of Reclamation (USBR) oversees water management, particularly in the West. Even thought the USBR has multiple reclamation projects, it can be summarized by saying that the USBR sells water to farmers for a fraction of the cost. In economic terms, this subsidy is artificially depressing water prices (see below).

It wouldn't be the first time that subsidies caused unintended consequences (see here, here, and here). Unsurprisingly, these subsidies create a deadweight loss. More importantly, by keeping prices low, it increases the quantity of the water consumed, which leads to shortages. The underpricing, which does not factor in the real-life costs of storing, pumping, and diverting water via dams, leads to inefficient usage and overuse, which is unfortunate considering how rare of a commodity water is. These subsidies also harm developing countries. Developing countries are more reliant on their agricultural output than developed countries. By distorting the markets to make American agricultural goods artificially cheap, developing countries lose out on agricultural output that a more liberalized market would have offered, which makes it more difficult for developing countries to climb out of poverty. This is not mere theoretical griping. In addition to California, this is also adversely affecting places such as Egypt, India, and Las Vegas.

One can argue for better-targeted subsidies, which I'm sure some would, but I feel more than my fair share of skepticism of allowing for a water allocation system that is based on political whims, not on who needs the water the most. Instead of having the government subsidize and allocate water, let's create water markets. With a water market, we can remove distortions so this rare resource can be used more efficiently, we can conserve a rare resource, and we can make water rights well-defined, enforceable, and transferable because market prices are a successful mechanism to determine supply and demand of resources. Although there is some government regulation, allowing water markets in such places as Chile and Australia works (Grafton et al, 2010).

Proponents of these subsidies would argue that agricultural markets would take a hit. So what if food prices go up a bit? Those prices should not have been that low in the first place. It does not do much good if the subsidies deplete the water while lining the pockets of Big Agriculture. If you're worried about low-income households, provide tax credits, but let's not throw more money at the problem thinking that will help because that's how California got itself in this mess in the first place. Are water markets the silver bullet to California's water woes? A silver bullet in public policy is more theory than anything else. Nevertheless, water markets can be the mechanism implemented in concert with other policy alternatives to mitigate California's water shortage.

4-8-2015: The people over at Vox wrote a good piece on water markets. Also, the Public Policy Institute of California put out a policy analysis on the drought of California, which includes policy alternatives, including strengthened water markets.

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