Water Markets for California

California is parched.  There is little water and all the forecasts indicate that there will be even less of it later in summer.  What are the options to ameliorate the situation?

There is one obvious reform that has not received much public attention: introducing water-markets.  I do not understand why is the market solution almost universally overlooked.  I am even willing to argue that water market is the solution, it may be supplemented with other means but those will remain supplements, adjusting the market where it cannot get it right.

This is not the first dry spell in California.  Dry riverbed in 2009.  By NOAA, [Public domain], via Wikimedia Commons

Instead of markets, we hear about different ad-hoc measures.  But how much can a state save if the restaurants are forced not to serve water to the customers unless they ask for it? Who is going to control whether lawns are watered 2 or 3 days a week?  Why do we need rules that only permit to fill covered pools?  The list goes on-and-on, garden fountains can only be used in case they work on a closed circulation, cars can only be washed with hoses with shutoff nozzles, new developments cannot irrigate with potable water unless drip irrigation systems are used, agricultural water users have to report more water use information to regulators...

There are several issues with such measures.  First, these may not be effective for saving water.  The problem is not washing streets or watering lawns after rain.  The problem is that the population as a whole uses more water than what is available.  It is the total quantity, not the way water is used.  We may prescribe what is the "fair" use but wasteful usage remains an issue even when only spending water in "acceptable" way—we cannot check how many minutes people take shower.  Second, the government cannot decide what is the best use.  Water consumption does not have noteworthy externalities, so it should be left to the individual users to decide what to do with it.  Third, such measures may target the straw-man while leaving the main culprits untouched.  The little data I have suggests that more than 3/4 of water in California (out of what humans are using) goes for irrigation.  As a rule of thumb, agricultural water need is around 1000 times the final mass of the harvest.  So, the "water-tag" of a restaurant meal amounts to 300-1000kg, out of which less than 1/1000 is served in glass...  Maybe we should ban restaurants to serve Californian rice instead?

Markets help to settle all these issues.  Here is a number of steps one has to take to reach fully functioning water markets.

• Clear water property rights.  The water ownership must be unambiguous, both for reservoirs and groundwater. 
• Extraction quota for different water sources, set each year by a public institution.  Up to the quota, the owners can sell water to any user.  This amounts to a "cap-and-trade" system.
• The quota must be tradable.
• "Pipe-neutrality".  The price must be associated with quantity,  quality, and location of the water, but not how it is used.  If you pay the price, feel free to drink, water your lawn, or wash the car.  Note that this is exactly how the electricity market works.
• Every household and farm must have water meters.  This also applies to irrigation water.
• There may be a need for a (temporary) support for those who loose as a result of the new system.  The support must be in the form of cash, not water!

Water meters are simple and ubiquitous.  Photo: André Karwath aka Aka [CC BY-SA 2.5], via Wikimedia Commons

Who are the loosers?  Many will point to farmers but that depends on who will obtain the water rights.  If the farmers will be entitled to a large endowment as they have historically been, they may be the winners instead—selling that water may bring more income than using it on fields.  If, however, the rights are given to someone else, many farms will be immediately out of business.  It is expensive to farm in arid climate.

Finally, I stress here that this reform does not amount to a tax hike.  First, the money for water goes to the government only if the government gets the water rights.  Second, if this is the case, the government should lower taxes, such as income or property tax.  It amounts to shifting government revenues from property and income tax to natural resources.