Matt Kahn:
Adam Nagourney appears to be an adherent of the ideas of the Club of Rome. In his NY Times front page piece today, he worries that California cities that encourage growth are exacerbating the "water crisis" by increasing demand during a drought that is likely to persist. What is the fallacy in his logic?
He implicitly assumes that policy reform will not take place in California. Farmers consume roughly 80% of the state's water. According to this article, farmers now pay $.0033 per gallon. Yes, that's .3 cents per gallon. Residential households such as myself pay .5 cents per gallon. A gallon of water is a gallon of water. Suppose that the Water Authorities raised the price of water for farmers so that it equals the price that urbanites pay. Or, allow the farmers to sell their water allocation to urbanites. This 66% increase would incentivize the sector that consumes 80% of the water to be more efficient and to substitute away from water intensive agricultural output that yields a low market price.
If the state's farming sector could figure out a way to reduce its water consumption by 25%, how many urbanites could move to California? For a 66% price increase to induce a 25% consumption decline implies a price elasticity = -.38 which strikes me as quite plausible in the medium term and perhaps too inelastic.
34.1 million acre-feet is used by California agriculture each year. A 25% reduction in CA agriculture water consumption = roughly 8 million acre feet = 8 million *326,000 = 2.6 trillion gallons of water not used.
Suppose that 10 million new people moved to California's cities (so this is a 25% increase in the state's population). The 2.6 trillion/10 million = 260000 gallons per new person per year = 712 gallons per new person per day.
See how we adapt by introducing market incentives to allocate scarce resources? The challenge of adaptation is mainly political (not economics). Allow free markets to operate and the NY Times will have to find new doom and gloom headlines.
via greeneconomics.blogspot.com
I only have one quibble. The water market will never be a "free market" in the true sense of the word. A plea to the water authority (i.e., government) to price water more rationally is a plea for policy reform (the term Matt uses earlier) towards a better use of incentives. Free markets only exist when there is no government regulation of buyers and sellers, no taxes, no subsidies and no nothing. An efficient free market for water is a difficult thing to pull off since it is a common-pool resource. It is easier for the pizza market to operate efficiently since pizza is a private good.
I don't think adaption to climate change can be accomplished efficiently by government taking a hands off approach. You can't privatize much of the natural environment.
Matt also said this the other day:
Terry Anderson's book Free Market Environmentalism played a key role in my early thinking about Coase and environmental economics. For years, Terry was in charge of PERC and I greatly benefited from my first visit to PERC in Bozeman MT a few years ago. Today, some very serious economists will be meeting at Stanford for a 1.5 day conference on the economics of climate change adaptation. The broad themes of this PERC conference are listed here.
Free Market Environmentalism played a key role in my early thinking about Coase and environmental economics too. My conclusion was that free market solutions wouldn't work. Call me an unserious (inserious?) economist.
