Wednesday, October 29, 2014

The Economics of Water in the American West

Fresh water doesn't get used up in a global sense: that is, the quantity of fresh water on planet Earth doesn't change. But the way in which the world's fresh water is naturally distributed--by evaporation, precipitation, groundwater, lakes, and rivers and streams--doesn't always match where people want that water to be. The man-made systems of water distribution like dams, reservoirs, pipelines, and irrigation systems can alter the natural distribution of water to some extent. But the American West is experiencing a combination of drought that reduces the natural supply of water and rising population that wants more water. Even with drought, population pressures, and environmental demands for fresh water, there is actually plenty of water in the American Southwest--at least, if the incentives are put in place for some changes to be implement by urban households, farmers, water providers, and legislators.

For an analysis of the issues and options, a useful starting point is a set of three papers published by the Hamilton Project at the Brookings Institution:

Here's a figure from Culp, Glennon, and Libecap showing the U.S. drought situation, concentrated in the southwestern United States: 

These southwestern states have also experienced dramatic population growth in recent decade. Of the regions of the United States, these are the states with the highest population growth and the lowest annual rainfall even in average times. Here's a figure from Kearney, Harris, Hershbein, Jácome, and Nantz:

Here's my master plan for how to address the water shortfall, drawing on discussions in the various papers. 

1) Reduce the incentives for outdoor watering by urban households in dry states. 

If  you had to guess, would you think that urban households in dry states of the American southwest use more or less water than other states? In general, these households tend to be heavier users of water. Here's a figure from Kearney et al., who report (citations omitted):
Outdoor watering is the main factor driving the higher use of domestic water per capita in drier states in the West. Whereas residents in wetter states in the East can often rely on rainwater for their landscaping, the inhabitants of Western states must rely on sprinklers. As an example, Utah’s high rate of domestic water use per capita is driven by the fact that its lawns and gardens require more watering due to the state’s dry climate. Similarly, half of California’s residential water is used solely for outdoor purposes; coastal regions in that state use less water per capita than inland regions, largely because of less landscape watering . . .

There are a variety of ways to reduce outdoor use of water: specific rules like banning outside watering, or limiting it to certain times of day (to reduce evaporation); the use of drip irrigation and other water-saving technologies; and so on. For economists, an obvious complement to these sorts of steps is to charge people for water in a way where the first "block" of water that is used has a relatively low price, but then additional "blocks" have higher and higher prices. 

Here's a figure showing average monthly water bills across cities. Los Angeles and San Diego do rank among the cities with higher bills, although the absolute difference is not enormous. But again, the point here is not the average bill, but rather that those who use large amounts of water because they want a green lawn and a washed-down driveway should face some incentives to alter that behavior. 

2) Upgrade the water delivery infrastructure. 

One hears a lot of talk about the case for additional infrastructure spending, but much of the focus seems to be on fixing roads and bridges. I'd like to hear some additional emphasis on how to fix up the water infrastructure system. As Ajami, Thompson, and Victor note: 
"Water infrastructure, by some measures the oldest and most fragile part of the country’s built environment, has decayed. ... Water infrastructure—including dams, reservoirs, aqueducts, and urban distribution pipes—is aging: almost 40 percent of the pipes used in the nation’s water distribution systems are forty years old or older, and some key infrastructure is a century old. On average, about 16 percent of the nation’s piped water is lost due to leaks and system inefficiencies, wasting about 7 billion gallons of clean and treated water every day .... Metering inaccuracies and unauthorized consumption also leads to revenue loss. Overall, about 30 percent of the water in the United States falls under the category of nonrevenue water, meaning water that has been extracted, treated, and distributed, but that has never generated any revenue because it has been lost to leaks, metering inaccuracies, or the like ... " 

3) Let farmers sell some of their water to urban areas. 

For historical reasons, a very large proportion of the water in many western states, but especially California, goes to agricultural uses. Some of these uses combine relatively high market value and relatively low use of water, like many fruits (including wine grapes), vegetables, and nuts. But the use of water for other crops is more troublesome.  Culp, Glennon, and Libecap go into these issues in some detail. As one vivid example, they write: "In 2013, Southern California farmers used more than 100 billion gallons of Colorado River water to grow alfalfa (a very water-intensive crop) that was shipped abroad to support rapidly growing dairy industries, even as the rest of the state struggled through the worst drought in recorded history ..." 

There are a substantial number of legal barriers to the idea of farmers trading some water to urban areas, but the possibilities are quite striking. Here's a figure showing that 80% of California's water use goes to agriculture, with a substantial share of that going to lower-value field crops like alfalfa, rice,  and cotton. In agricultural areas, as in urban ones, there is often considerable scope for conserving water in various ways,  like targeting the use of irrigation more carefully, making sure that irrigation ditches don't leak while carrying water, and the like. 

Imagine for the sake of argument that it was possible with a comprehensive effort that combined shifting to different crops and water conservation efforts to reduce agricultural water use in California by one-eighth: that is, instead of using 80% of the available water, agriculture would get by with using 70% of the available water. The amount available for urban and/or environmental uses would then rise by half, from 20% to 30% of the available water. 

One approach they describe, implemented starting in 2002 in Santa Fe, New Mexico, required that any new urban construction had to find a way to offset water that would be used in that construction. 
As an example, developers could obtain a permit to build if they retrofitted existing homes with low-flow toilets. Residents of these homes welcomed the chance to get free toilets, and Santa Fe plumbers jumped at the opportunity for new business. Within a couple of years plumbers had swapped out most of the city’s old toilets with new high-efficiency ones. Water that residents would have flushed away now supplies new homes.  ... In short order, a market emerged as developers began to buy water rights from farmers. Developers deposited the water rights in a city-operated water bank; when the development became shovel-ready, the developer withdrew the water rights for the project. If the project stalled, the developer could sell the rights to another developer whose project was farther along. Santa Fe also enacted an aggressive water conservation program and adopted water rates that rise on a per unit basis as households consume additional blocks of water. Thanks to the innovative water-marketing measures, the conservation program, and tiered water rates, water use per person in Santa Fe has dropped 42 percent since 1995 ... 
4) Set up groundwater banks. 

Historically, most western states have allowed any property owner to drill a well and use groundwater without limit. But the groundwater reserves are slow to recharge, and with the drought and population pressures, they are under severe stress. Culp, Glennon, and Libecap explain (citations omitted):
Groundwater has been the saving grace for many parts of the water-starved West. Following the advent of high-lift turbine pump technology in the 1930s, many regions had access to vast reserves of water in underground aquifers that they have tapped to supply water when surface water supplies were inadequate. A recent study looked at data on freshwater reserves above ground and below ground across the Southwest from 2004 to 2013. It found that freshwater reserves had declined by 53 million acre-feet during this time—a volume equivalent to nearly twice the capacity of Lake Mead! The study also found that 75 percent of the decline came from groundwater sources, rather than from the better-publicized declines in surface reservoirs, such as Lake Mead and Lake Powell. Much of this decline occurred because some Western states, including California, have historically failed to regulate, or do not adequately regulate, groundwater withdrawals. As a result, groundwater aquifers are effectively being mined to provide water for day-to-day use. In response to the ongoing drought, California farmers continue to drill new wells at an alarming rate, lowering water tables to unprecedented depths ...In the San Joaquin Valley of California, excessive groundwater pumping caused the water table to plummet and the surface of the earth to subside more than twenty-five feet between 1925 and 1977 ..." 
Arizona has already been taking steps toward groundwater protection, both by limiting what can be taken out and by providing incentives to save water in the form of recharging groundwater (which avoids the problem of evaporation). 

Although not yet developed into a formal exchange, Arizona has been at the cutting edge in developing groundwater recharge and recovery projects and a supporting statutory framework to help enhance the reliability of water supplies. Arizona allows municipal users, industrial users, and various private parties to store water in exchange for credits that they can transfer to other users. Because water stored underground in aquifers is not subject to evaporation, groundwater that is deliberately created through recharge activity can be stored and recovered later. This recharge and recovery approach is facilitated by Arizona laws that restrict the use of groundwater in several of the state’s most important groundwater basins; these restrictions prevent open access to the resource. Restrictions on open access, combined with statutory and regulatory provisions that allow for the creation and recovery of credits, created the essential conditions for trade in stored groundwater. As a result, numerous transactions have occurred between various municipal interests, water providers, and private parties. 
California passed legislation last month to regulate groundwater pumping for the first time. 

5) More research and development on water-saving technologies. 

As Ajami, Thompson, and Victor discuss at some length, there is relatively little innovative activity in water conservation and purification, as opposed to, say, energy conservation and new sources of energy. They argue that part of the reason is that energy-providing companies compete against each other, while most water companies are sleepy publicly-run local monopolies. Potential entrepreneurs have the ability to look at a lot of ways of producing and using energy, confident that if they come up with something useful, their invention will find a ready market. But entrepreneurs looking at various methods of water conservation will often find that their ideas apply only locally, or are hard to patent, or are hard to sell to water companies and users. Here's their figure comparing spending for energy and water innovation at a global and U.S. level. 

Drought is a natural problem. But the factors that determine how water is available get used represent an economic problem of the incentives and constraints that determine the allocation of a scarce resource.  In the American West, the institutional problems of water allocation seem to me even more severe than the natural problem of drought. 

* Full disclosure: I did comments and editing on the paper by Culp, Glennon, and Libecap, and was paid an honorarium for doing so.