Dirk Yandell is Associate Professor of Economics at the University of San Diego. Michael Paganelli is a student of business and economics at the University of San Diego.
Californians and other Westerners are feeling the effects of a fifth year of drought. Reservoirs are at record lows, river levels have dropped significantly, and the Sierra Nevada snow-pack has been well below normal. Water has become an everyday topic, and emotions are strong.
The shortage has led to a number of proposals to promote conservation and regulate water use. Mandatory cutbacks and master plans for conservation have been implemented or are being considered by water districts throughout California.
Water-use controls include bans on the operation of large fountains and decorative water displays, restrictions on serving water in restaurants unless requested by the customer, and bans on hosing down driveways and sidewalks. Limits on using sprinkler systems to water lawns and shrubs have been imposed, and washing cars at home and filling swimming pools and spas have been forbidden. The most severe proposals call for an outright ban on all outdoor residential water use.
Households have been warned of impending mandatory cutbacks of 30 to 50 percent from average water usage in prior years. The imposition of this severe rationing was postponed in many dis-trim after heavy rains fell in March, but planning for such rationing continues. In San Francisco, private homes and businesses have been budgeted only 75 percent of their usual consumption. Santa Barbara households and businesses were ordered to cut water usage by 45 percent.
Many cities are using “water-waste compliant investigators” to root out water-wasting customers. People found wasting water are first issued a series of warnings, but ultimately face fines. Unrepentant “water hogs” have flow restrictions put in place to reduce water pressure and limit usage.
The problem is that all rationing plans ignore the natural forces of the marketplace. All users do not place the same value on water, but all are asked to curtail usage by the same percentage.
A Market for Water
The efficient solution is to allow a water market to develop so that allocations can be made in a competitive environment. The way to get consumers voluntarily tO use less water is to allow the market price to rise to reflect its decreased availability. At higher prices, consumers will have an incentive to conserve. Water will be demanded only for its most highly valued uses. An efficient allocation results, and no regulatory intervention or costly policing is needed.
Consumers complained when the price of gasoline rose during the U.S. buildup in the Persian Gulf, but most understood that the price increase reflected the expectation of reduced availability and the uncertainty of future supplies. Shoppers understand that cold weather has a direct influence on the prices of many fruits and vegetables. Consumers regularly see prices adjust in response to changes in market forces, and yet the idea of allowing water to be allocated by the same market forces is ignored in the current debate.
The focus on residential rationing is curious when one considers that only about 15 percent of the water used in California goes to household and industrial sectors. The remaining 85 percent is used by agriculture. In fact, 40 percent of the state’s water is used to grow rice, alfalfa, and cotton, and to irrigate pasture land for grazing by cattle and sheep. These uses combined produce only about 0.2 percent of total state income.
Water for agricultural uses often is sold at prices well below the price to residential customers. Prices charged to some agricultural users are as low as $8 per acre-foot (one acre-foot of water is the amount needed to cover one acre to a depth of one foot), compared with those to some urban users who are charged well over $200 per acre-foot. The focus of the water debate shouldn’t be on the regulation of water use, but on means for efficiently allocating existing supplies.
The current allocation of water is determined by historical water rights. Such rights follow the legal concept of “first in time, first in right.” This means that those who first claimed the right to a source of water may use it as long as they and their descendants live. Unfortunately, the right is simply to use the water, not to sell it.
To discourage hoarding, most Western states require that the water be applied to some “beneficial use.” If not, water rights can be lost. Because of this requirement, water is used in such historically defined “beneficial uses” as irrigating acres of alfalfa or other grasses for grazing cattle or sheep, or for growing cotton or flooding rice paddies in semi-arid regions.
Farmers and ranchers with water rights have no incentive to save water. Excess water cannot be sold to eager urban consumers, and conservation techniques are many times more costly than the cost of the water saved. Farmers often get the blame for urban water shortages, but they are simply responding to incentives that government policies place before them.
Current policies have kept the price of water from reflecting its true value. One acre-foot of water contains about 326,000 gallons. A price of $200 per acre-foot is equivalent to about 6.1 cents per 100 gallons. A few cents per day to keep thousands of dollars of landscaping alive is an expense that most homeowners are happy to pay. The pleasure that a pool or spa provides is well above the cost of the water needed to fill it. Water for cooling or lubrication in a manufacturing process may be much more valuable than as an agricultural input. Mutually beneficial exchanges, made in a functioning water market, would allow farmers to sell excess water to the users who most highly value the scarce resource.
It is impossible for a central planning body to calculate all the efficient uses of a particular resource. As F. A. Hayek put it, central planners cannot compute “the infinite variety of different needs of different people which compete for the available resources . . . .”
The rational approach is to design policies that allow the marketplace to efficiently allocate water to the uses that provide the best economic return. Water markets need to be developed to allow water transfers. This doesn’t mean that those with rights need lose them, but only that they face the full market costs of using water. As the price rises, some farmers may find it most profitable to leave their fields fallow and sell their water to others.
A water market will allow those with the most highly valued uses to obtain the water they need. Prices will adjust to reflect the relative scarcity of water. In periods of drought, the price will rise, which will discourage residential water use. Consumers will find it desirable to switch to brooms and low-flush toilets, just as higher beef prices encourage consumers to eat more chicken and fish. The advantage is that consumers will be free to choose how they use water, and no rationing policy need be put in place.
We all watch the disaster of economic planning in the Soviet Union and Eastern Europe and applaud their movement to a more market-oriented economy. We recognize that their chronic shortages of products from apples to automobiles are a direct result of the failure of a command economy. Somehow most policy makers don’t realize that the current water shortage is the result of the same anti-market philosophy.