Distributional Implications of Supply Constraints in Water Markets

Abstract

In California, after three decades of water market development, volume of water traded in the market remains lower than desired. Total volume of water traded annually accounts for just around 2%–5% of total water used. Vast difference in the marginal values of water in agriculture and urban or environmental uses suggest that significant economic gains can be achieved by easing the barriers to trading water across sectors. This paper draws attention to the role of state and local policies in restricting water transfers. Using novel, purpose-built, satellite-mapped data of a sample of water-trading irrigation districts in California, this paper shows how districts’ water transfer decisions are made in response to conflicting pressures of drought-induced high-water demand against the need to support the agricultural economy and the environment in water-exporting areas. The time period under study is 1991–2019, which spans the entire history of water market activity in California from inception to maturity, and helps illustrate the role of changing local and state policies on irrigation districts’ water market participation. Despite policy-induced restrictions, this paper shows that sample irrigation districts are highly responsive to demand in water-buying areas, have increased the volume and frequency of water transfers, particularly in the last decade. This paper highlights important research and policy questions about the distribution of economic and environmental effects of water transfers in source area communities that could affect the future potential of water markets in easing structural and drought-induced water scarcity in California.