What can economic history tell us about the future of water policy?

Auction-based water markets, which distribute the greatest amount of water to the highest bidders, have been lauded for their ability to meet demand efficiently. Amid increasing threats of water scarcity, they have become a favored approach in countries like the United States and Australia. However, analyses of water auctions’ efficiency have typically omitted key factors, such as rainfall volatility, sustainability of water supply, and farmers’ liquidity constraints (limitations on their cash to purchase water). In certain contexts, however, other water distribution systems may be more effective. 

Analyzing one of the oldest water markets in the world – the 700-year old auction system in Mula, Spain – Yale economic historian José Antonio Espín-Sánchez found that a recent shift to quotas increased revenues for poor farmers.  To understand why, Espín-Sánchez and his co-author Javier Donna designed a model that could account for the factors typically omitted from similar studies – and then applied their model to Mula.  Delving into the town’s history, including its punishment of water theft and irrigation misuse, and analyzing the effects of the recent shift from auctions to quotas, the findings shed light on water distribution’s local dynamics – and offers lessons for the future.

Results at a Glance

• In the Spanish municipality of Mula, the switch from a 700-year old auction-based water market to a quota system provided 8% more revenue for farmers. 
• The results suggest that optimal water policy should be guided by a region’s local characteristics.
• Auction-based water markets are most effective in regions with heterogeneous demand (varying levels of demand for water), low aggregate rain volatility (where rainfall is consistent from year to year), and high idiosyncratic rain volatility (varies between different farms or sub-regions). 
• Quota systems are most effective in small regions where crop diversity and water demand are both relatively homogenous, where farmers’ liquidity constraints are high, and where there is high aggregate rain volatility. 
• Mula’s centuries-old criminal justice system, with flexible punishments for water theft, functions as social insurance for vulnerable farmers; judges concentrated harsh punishments on wealthy recidivists.