All Commentary
Tuesday, June 21, 2016

California’s Water Economy Is Thirsting for Prices

Resource allocation goes awry without markets


Donald Trump believes he can solve California’s water problems; he even went as so far as to claim, “There is no drought.” If elected, he promised, he would solve the water problem by reducing the water that flowed into the ocean, thereby increasing the amount appropriated by municipalities and businesses. For a political outsider, Mr. Trump has mastered the politicians’ habit of promising solutions that actually worsen the fundamental problem.

Water Econ 101

The most charitable interpretation of Trump’s remarks is that California is experiencing a drought not because of bad weather but because of bad political institutions. All climates contain natural variability. That is a fancy way of saying that some years are wet while others are dry. It is because of these dry years that there are over 1400 named dams and why 1300 named reservoirs were constructed in the state. If the weather doesn’t cooperate and you want the taps to work, you need a permanent stock of water.

In Los Angeles, some home owners are being paid to tear out their lawns in the aptly named cash-for-grass program.

This stock of water is a renewable resource. When rain falls or snow melts, water flows into the system and is stored in these same reservoirs for later use. If water is continually being consumed at a rate faster than it is being renewed, that is prima facie evidence that the system is being mismanaged. Hoping for a wet year is simply irresponsible because the entire point of building these canals and reservoirs is to ensure access to water without needing to rely on the weather’s cooperation.

Trump’s promise to “start opening up the water” only postpones the problem for a future date as it does not fix the imbalance between the water demanded and the water supplied.

From the perspective of an economist, when the quantity demanded exceeds the quantity supplied, the price is too low. This is the fundamental characteristic of all shortages. If you doubt this, just look at the store shelves that remain empty in Venezuela while eggs go for $150 a dozen on the black market. Legislating a low price does nothing to either increase production or discourage consumption.

California Streaming

For years, water was abundant in California because it was relatively easy for water managers to increase water supply by constructing new water projects. The population of California is more than three times larger today than it was in the 1950s and 35 times larger than it was in 1900. When it comes to water use, industry and agriculture are more important than Hollywood or Silicon Valley, so the state faces a strong temptation to lower the reservoir levels even if demand is outstripping supply.

Market prices coordinate economic activity. Water managers cannot indefinitely increase supply so they instead rely on demand management. This is why, in Los Angeles, some home owners are being paid to tear out their lawns in the aptly named cash-for-grass program. This is also why Governor Jerry Brown threatened to fine people for taking long showers. They have yet to set up a hotline so you can snitch on your neighbors. All of these policies are failed attempts to achieve the results of higher prices.

We should embrace higher prices because they are an incentive-compatible solution to this problem. We turn off lights when we leave a room because electricity is expensive. The governor can use the bully pulpit all he wants, but if individuals do not care about the water going down their drains because the price they pay is kept so low, then all the talk about conservation is just more hot air.