25 July 2008

What is a Market?

Various commentors claim that "water markets cannot work" until issues of monopoly power, the poor, inappropriate rights, etc. are solved.

Maybe and maybe not.

In a market, price signals matter. (In non-market settings -- e.g., bureaucracies -- prices may exist but people do not use them to make decisions or allocate resources.)

So, when I say that water should be allocated "by a market," I do not necessarily mean that companies will be able to enter and compete (overcoming a monopoly on supply) or that the poor will be shafted (because they cannot afford to buy water at market-clearing prices), or that farmers' rights should be taken away.

What I do mean is that price is meaningful to participants, i.e., that they will look at the price and then decide how much water to use. This event can happen with a monopoly selling the water, the poor also consuming water (because everyone gets a basic entitlement of water), and farmers using water in any which way they want. (Other issues -- infrastructure, quality, environment, wasteflows, etc. -- can be integrated into the price-rationing mechanism.)

Also note that politicians and bureaucrats like to intervene in markets, to redistribute rights to their friends, lobbyists and bribers -- and sometimes even to the People. Since their interventions change the rules of the game and prevent markets from functioning, "markets" do not deserve the blame for the outcomes that result.

Bottom Line: In a market for water, prices rise when there is less water and fall when there is more. Because prices are meaningfully high, people use less water when its more expensive (and more when it is not). The overall result is that the quantity demanded will equal supply -- and neither shortage nor surplus results.

Does this make sense? Please comment.

12 comments:

Silas Barta said...

Yes, it makes perfect sense. Unfortunately, looking at it from the other side of the spectrum, people equate "market" with "100% free libertarian market that I like". We saw that with Bob Murphy's shameful op-ed where he said (once you get past the tremendous fluff) that, because of some imperfections and that -- gasp! -- government sets the limits, it's "not a market".

Markets can also, as you note, recognize other valid claims to resources and hold them off the market. For example, the baseline subsistence water right. (Though would that be alienable in your ideal system?) As long as there are still alienable, well-defined rights, it's a market.

When talking about this, our moral intuitions can blur the semantic distinctions. While I find slavery abhorrent, a slave auction is, undeniably, a "market solution" to the allocation of scarce slave labor.

Francis said...

No, not really. The West was settled based on a particular value judgment expressed in law: First in time, first in right.

That value judgment has lead to any number of consequences that, depending on your viewpoint, are either positive or negative.

It appears to me that you are looking at a subset of the consequences and imposing your own value judgment that those consequences are bad (eg, alfalfa farming in Imperial Valley). In order to reverse those particular consequences you've expressed a desire to uproot the original value judgment, using language that carries strong positive connotations (eg, market).

I have a number of basic problems with this approach. On a purely linguistic level, I think you're misappropriating language that has strong positive connotations and using it to mean something it has never meant. Even your all-in auction does not give rise to a "market" in any sense of the word that an average American would appreciate.

I also don't think that you've adequately established that the consequences of the original value judgment are so severe as to justify ripping out 150+ years of legal precedent and starting over.

Many people actually like the consequences of the original decision and it's not just the farmers. If you haven't noticed, food prices are skyrocketing around the world. One possible allocation of the People's water could be to actually increase the amount of low-cost water available to California farmers.

It's also worth noting that urban districts and urban users both are terribly wasteful. Many urban districts have staggering loss rates due to leakage. Even if that water ends up back in a groundwater basin that's being pumped from, someone still pays the energy cost of lifting that water a second time. Parks and school fields are over-watered. Showers don't have flow restrictors. Many toilets could be far more efficient. etc.

Allowing urban districts to keep their costs low by acquiring ag. water simply allows them to perpetuate their waste, while diverting water away from beneficial uses.

It's also not clear what new value judgment you're looking to put in place of First in time, first in right. Free transferability of water rights? Water and water rights are transferable (see Water Code 1700 et seq., and the Monterey Amendments). One of the major impediments to more water transfers is infrastructure, not law.

You're not alone in having problems with the idea that a farmer receiving a BuRec allocation that's below even BuRec's cost can then resell the allocation and pocket the difference. Lots of people have problems with, for example, what it appears that Sen. Feinstein is trying to do for Westlands Water District.

So, at the end of the day, I guess these are my concerns:

I'm not sure what problem you're trying to solve.
I'm not sure that the identified means will actually solve the apparent problem.
I think you're misusing language to create a positive impression about your preferred side of what's really a public policy dispute.
I'm concerned that there will be huge adverse unintended consequences from uprooting a system that's deeply entrenched in law and practice.
I suspect that there are much less disruptive alternatives to solving mutually agreed-upon adverse consequences of the current system.

Philip said...

The place the water market works best right now is at the margin, where, for instance, water districts with relatively abundant water supplies can (and have) agree(d) to furnish a quantity of water, either on a contingent or contractual basis to other users in exchange for money. There are still issues to work through, like the brain-dead and economically damaging, but legally favored, requirement that land be fallowed if its allocated water is sold or leased.
Markets are brilliant, but can also be stupid. Today's best poets probably earn a tiny fraction of what even a sub-par hedge fund manager makes. Does that mean writing good poetry is a "low value" activity (like growing the hated alfalfa), and that the hedge fund manager's greater "value" makes him a more productive and worthy consumer of resources?

Bob Murphy said...

Philip said:

Markets are brilliant, but can also be stupid. Today's best poets probably earn a tiny fraction of what even a sub-par hedge fund manager makes. Does that mean writing good poetry is a "low value" activity...and that the hedge fund manager's greater "value" makes him a more productive and worthy consumer of resources?

Yes, it does, depending on what we mean by "worthy." If your definition of "worthy" includes not stealing from people, then it does.

People have property. They can exchange it with whom they wish. (I'm abstracting away from regulations etc. because they aren't really affecting your point or my response.)

If people want to spend more on hedge fund managers' services, then hedge fund managers will make more than poets. That's what economists mean by saying something is high valued.

If you want, I guess you can say that what the market values highly, you don't yourself. Fair enough. But I wonder, how much did you spend on poetry last year? Do you call up the people running your retirement account (assuming you have one, I don't know) and say, "Hey! Stop trying to earn high returns!" ?

Bob Murphy said...

Well, since you asked for comments David, let me give the "shameful" view here. I think you are going to tie yourself up in knots with all of your caveats. In an effort to not sound heartless or "extreme," you are going to concede the basic premises of your critics, and then all you're left with is arguing over details.

You don't really want to eliminate bureaucracy, you just want to change the bureaucrats' orders. You don't really want to let market prices allocate resources; you still have a zero price for the first x gallons (even though that's not the true price), etc.

I still love your work, and I'm glad you're making this case, because your views are way more sensible than most of the resource economists I've read on this stuff. But if someone wanted to implement the analog of your plan in an area where we already had a relatively free market--like in computers--then I think it would be crazy. E.g., everybody gets the first megabyte of memory free, then pays for marginal memory according to a schedule drawn up by the city council. And then we call that a "market solution"? Nah.

Beyond the purity of whether or not your position is right in the grand scheme, there is the rhetorical issue. I think your opponents will more easily back you into a corner because you are afraid to really let private property rights allocate water. You might end up sounding like people who defend waterboarding etc. but say, "Now come on, no one here supports torture. What we are defending is enhanced interrogation techniques..."

(I'm not saying you are torturing property rights.)

David Zetland said...

@Silas -- agreed.

@Francis -- you're off topic.

@Philip -- marginal decisions? good. Poets? Not for me to judge. Bob's reply is good.

@Bob -- I agree that I may get backed into a corner on particulars, but those particulars (e.g., farmers' water rights-- right Francis?) need to be recognized. The "water as human right" aspect also tends to trump both economic logic and facts on the ground, but it can't be ignored. Ask the voters. (Right Francis?)

Bob Murphy said...

David,

Again, I want to emphasize that I'm not trying to "make the perfect the enemy of the good," to use that overused phrase.

However, why not say something like, "Yes, completely privatize it to get rid of absurdities in allocation, but then give government assistance to poor people if you're afraid of them dying of thirst."

This bogey of, "Poor people won't be able to afford water" is crazy. If you really let the market take over, water would be way cheaper, and it's not exactly expensive right now to get enough to live.

Pepe said...

"Maybe and maybe not".

I believe this is my answer to climate change and to the government solutions cost benefit.

"Also note that politicians and bureaucrats like to intervene in markets, to redistribute rights to their friends, lobbyists and bribers -- and sometimes even to the People. Since their interventions change the rules of the game and prevent markets from functioning, "markets" do not deserve the blame for the outcomes that result."

David, wasn't this your definition of a market when we were discussing China?

Philip said...

Bob and David, I am not scandalized that poets make less than hedge fund managers. I was trying to point out the wisdom in Wilde's comment about people who know the price of everything and the value of nothing.

David Zetland said...

@Bob -- If you really let the market take over, water would be way cheaper, and it's not exactly expensive right now to get enough to live. Your first statement is a hypothesis (and falsified, according to some people). Your second statement means there's no reason to privatize! People are wary of change, so my "free 75" idea is a way of alleviating that fear when moving to a new price structure -- not necessarily privitization.

@Pepe - China? Where?

@Philip -- I am always wary of "poets" who claim to be worth more than they are paid. My dad thinks I am a pretty good poet, but that doesn't give me any claim on a higher salary.

Francis said...

David, you wrote: So, when I say that water should be allocated "by a market" ... [w]hat I [] mean is that price is meaningful to participants. ... In a market for water, prices rise when there is less water and fall when there is more

By your definition, a "market" in urban water exists so long as the retail provider, even if the provider is a government agency, adopts a rate structure that (a) imposes high marginal rates for high levels of consumption and (b) varies depending on the amount of water in storage.

That seems odd.

Not holding a PhD in economics, I guess I have to defer to your definition, but it's certainly not one used by anyone I know in the water business. Can we get a third-party referee? Brad Delong has a post of top econ. bloggers here.

David Zetland said...

@Francis -- that "market" would work just like any other (bananas, etc.) and FAR better than the current bureaucratic, command and control system.

Feel free to ask those other bloggers.