How market design can help solve problem of water allocation

Nice article by Paul Milgrom and Silvia Console Battilana:

Misallocation of scarce resources too often deprives users of them even as others waste their supply. Well-designed markets can overcome such problems by enabling voluntary transactions that allow existing users to retain their allotments while enabling higher-value uses.

Market design will also play a critical role in solving the problem of water allocation. Many of the world’s existing rights to fresh water – both surface water and groundwater – have already been granted and grandfathered in complex ways to cities, farmers, and industrial users. In some cases, each individual trade of these rights requires governmental approval; other jurisdictions prohibit such trading entirely.

These restrictions and historical rules have led to highly inefficient allocations. Water may be unavailable to towns that require more of it as they grow, even when those urban and residential uses are a hundred times more valuable than the rural ones they would supplant. Certain industrial firms whose rights are based on historical use may have an incentive to overuse water, even during droughts, to retain their rights to future allotments. Where trading of rights is limited or prohibited, poor price signals make it difficult even to assess which uses are most valuable. And water demand will increase and shift as climate change continues to upend historical usage patterns.

The success of the US radio spectrum auction points to a solution. Instead of revoking incumbents’ spectrum rights unilaterally, Congress redefined them in a way that made trading them possible and simple, and then allowed TV broadcasters to decide for themselves whether to continue their previous uses or decline to participate. The rights that were sold were then reconfigured to be suitable for new uses and efficient trading, while those that were unsold remained fit for existing purposes.

A similar reorganization of water rights could protect existing users not wishing to sell, while creating tradeable rights for others that would allow water to flow to its most valuable use. Any attempt to compel all current users to participate will likely be thwarted by legal and political opposition, but a fully voluntary market styled on the same principles as the one for radio spectrum could accommodate resisters while drastically improving the allocation of water rights. Moreover, policymakers could use a portion of the value freed by any reallocation to offset inequities – for example, by granting credits to rural towns or small agricultural producers so that they receive the water resources they need.

Allocating water efficiently and fairly will require innovation, collaboration, and regulation. In this and other domains, market design puts practical economic theory in the service of establishing rights and introducing effective rules and algorithms. That way, we can accommodate diverse market participants, harness new technologies, and maximize the public good.

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