California: Muddy Waters

California's severe drought reminds some observers of the oil shortages of the 1970s. Government regulations combine with natural forces to create a shortage of a valuable resource. But the market for water in California in the 1990s is probably even more distorted and irrational than was the market for oil in the 1970s.

If a drought of this severity had occurred during the Jerry Brown years (the drought of 1977 was mild by comparison), there would have been calls for a "new water policy," complete with a "water czar" to regulate the whole scene. Instead, policy makers in 1991, prodded by a surprising coalition of environmentalists and free-market economists, are groping for market-based policies to deal with the crisis. Thus the drought provides a good test of how much the public and politicians truly believe in the market. In California, the picture is muddy.

State law actually enables Gov. Pete Wilson to become a "water czar." By declaring an official "drought emergency," Wilson could allocate water without regard to contracts, water permits, or water rights. Instead, Wilson has given a nod toward market incentives by creating the California Drought Emergency Water Bank, which is buying water—albeit at a fixed price—from farmers who agree to let some or all of their land lie idle. "The year 1991 may be a turning point in California's transition to water trading," says economist Rod Smith, publisher of the quarterly Water Strategist.

The drought in California has lasted five years. In January, after it became clear that rainfall would again be well short of normal, state water officials announced drastic cutbacks for agricultural users—who consume 85 percent of the state's, water—and for municipal users. The State Water Project suspended all deliveries for agricultural use and cut municipal deliveries by 90 percent. The federal Central Valley Project cut water to agricultural customers by 75 percent and to municipal users by 50 percent. Together these two projects deliver nearly 30 percent of California's water.

Meanwhile, state and local governments have subjected consumers to the "moral equivalent of war" bunkum that characterized the energy crisis. A widescale conservation blitz is on throughout the state, and areas with skimpy water supplies, such as Marin County (where no-growthers have for years blocked the construction of new water storage facilities), limit users to 50 gallons per person per day. That's about enough for one five-minute shower, one toilet flush, and brushing your teeth with the tap running. Several municipalities have uniformed "drought police" who try to catch people watering lawns or washing their cars in the middle of the night. It isn't unusual to see people spray-painting their dead lawns green.

To their credit, some hard-hit areas, such as Santa Barbara County, are using an escalating price scale, rather than outright rationing, to encourage conservation. But even if every household in the state cut water use by 25 percent, overall consumption would drop by only 2 percent.

The intense focus on household conservation is straining at a gnat. The real problem is inefficient and extravagant use of water by California agriculture. Agricultural water users pay far below the true cost for most of their water. For example, a 1989 General Accounting Office study showed that farmers get water from the Westlands Water District near Fresno—one of the largest federal water contractors—for $17 an acre-foot (about 326,000 gallons), while the full cost of the water is about $42 an acre-foot. Farmers commonly get water for as little as $5.00 an acre-foot, while the Metropolitan Water District, which serves Los Angeles and much of Southern California, pays as much as $500 an acre-foot wholesale.

 "As long as farmers are buying subsidized water that's almost free," says Marc Reisner, author of Cadillac Desert: The American West and Its Disappearing Water, "they'll go on doing what they've always done: waste it." Rice farmers, among the leading water consumers in the state, have come in for special criticism. It can take as much as 7.5 acre-feet of water for each acre of rice—enough to supply about 50 people for a year.

Says Reisner: "It's crazy to grow a crop that needs 80 inches of water in a semi-desert with subsidized water, glut the market, and then give the farmers price subsidies as well as water subsidies. But that's what we do." One rice grower told a television interviewer that it costs him 10 cents a pound to produce rice. The world market price is about 3 cents a pound. Despite the subsidies, the total cash value of the California rice crop was only $244 million in 1989.

Rice farming is far from an isolated example of egregious water consumption. The Central Valley beef industry, which relies on water-intense alfalfa and grass, requires about 5,000 gallons of water to produce one pound of meat. The value of agricultural production in California last year was $17.8 billion, or less, than 3 percent of California's $730-billion economy.

Still, farmers have reacted defensively to talk of water pricing. The California Farm Bureau Federation says the case for farm-water profligacy is exaggerated and the extent of subsidy overstated. (The Farm Bureau appears well qualified to spot exaggeration: It also claims that agriculture accounts for one in three jobs in California.) Farmers, with a few exceptions, haven't embraced a true market for water, even though a variety of water-efficiency technologies, such as drip irrigation and lined irrigation canals, would allow most farmers to grow the same crops with far less water.

Although some state politicians have said that "we might need to look at" regulating the kinds of crops farmers grow, market-based solutions have led the efforts to deal with the crisis. Wilson's Water Bank is the first market-oriented effort to be put in place. The Department of Water Resources pays about $125 an acre-foot and guarantees sellers that the transactions won't be regarded, now or in the future, as evidence of available surplus water or of wasteful or inefficient use on the part of the seller. The DWR has already exceeded its target of 500,000 acre-feet for the Water Bank. Water in the bank, however, will be allocated according to "extreme critical needs" determined by the bank itself.

Because the Water Bank is the only authorized buyer in the state, as well as the arbiter of who gets to buy its water, it has been criticized for not facilitating a true market that would allow farmers and water districts to trade among themselves at freely negotiated prices. Tom Graff of the Environmental Defense Fund has expressed concern about whether state policy will help develop a "true marketplace." The EDF also found troubling the announcement that the DWR will "monitor prices and report any signs of price-gouging." "Sounds just like Gorbachev," says Graff.

Other market-oriented proposals are similarly encumbered by government regulation. Water from the federal Central Valley Project by law can't be sold outside of the Central Valley. Neither Los Angeles nor San Francisco can tap into this supply, which could meet the needs of 70 million people in a year of normal rainfall.

A bill sponsored by Sen. Bill Bradley (D–N.J.) would change this, but the bill, S. 489, would also require either that 25 percent of the proceeds from any sale be diverted to a "Central Valley Project Restoration Fund" to benefit fish and wildlife or, alternatively, that 25 percent of the purchased water be dedicated directly to fish and wildlife purposes. Rod Smith comments, "Central Valley Project water users may find the environmental package too dear of a price to pay for the opportunity to trade water."

Just as California was about to hit the panic button, heavy March rains arrived. The "March Miracle," as the rainfall was quickly dubbed, filled most state reservoirs only to about 75 percent of capacity. Still, it eased the crisis enough to lessen pressure for more water reform, showing that the survival of even the reforms that have been enacted is tenuous. Says Smith: "Proponents of water trading should delay declarations about a new era in California water policy."

Contributing Editor Steven Hayward is director of the Claremont Institute's Golden State Project.