A Tale of Two Countries: Markets and Transboundary Water Governance Between the United States and Mexico

Abstract

While there is a robust literature about using tradeable permits as a solution to pollution externalities, less work has applied these principles to the area of transboundary water management. This article proposes the use of transboundary water banking as a means for addressing issues of water externalities, conflict over water resources, and incentive compatibility. First, the article provides clarity to this discussion by synthesizing relevant literature over transboundary water governance, focusing on the experience between the United States and Mexico over the Colorado River. Second, the article formalizes the idea of a transboundary water bank and the efficiency of an auctioned versus grandfathered permit program. Third, the article provides a brief formulation of the market design elements of such a scheme, namely four conditions that enable a sort of Nash Equilibrium among agents. The article concludes by alluding to the parallels between energy and water markets. While only a start, this article seeks to catalyze more formal mathematical modeling of solutions to transboundary water governance.

Keywords:

• transboundary
• tradeable permits
• economic analysis
• water management

Notes

¹See Hanemann (2006) for a thorough discussion of water's differentiating elements.

²See Dosi and Easter (2003) for a comprehensive review.

³See the Appendix for a GIS mapping of the region.

⁴In Mexico, IBWC is known as the Comision Internacional de Limites y Agua (CILA). IBWC/CILA (IBWC henceforth) is the official agency for managing transboundary water issues between the United States and Mexico.

⁵See Lloret (2011) for a game theoretical approach modeling the benefits of informal agreements.

⁶For a more detailed treatment of this history and legal dispute, see Mumme and Lybecker (2006) [p. 180] and Department of Interior (2010).

⁷Furthermore, this short synthesis of MDB is not meant to be comprehensive, but rather emphatic of a salient advantage of risk-diversification under climatic volatility.

⁸See Dosi and Easter (2002) for a review of the shortcomings of markets and the possibility that incentives result in overexploitation of the environment and further policy hostility.

⁹This does not equate water lending with water banking, but rather seeks to provide context for current water transfers around the world.

¹⁰“Companies” includes profit-maximizing governmental agencies, landowners, and other entities that control water rights (Anderson & Landry, 2001). Insofar as profit-motives exist, Weisbrod (2004) suggests that the assumption holds for non-profit companies too, for example.

¹¹One important abstraction in the model is that, in reality, a sufficiently large number of market participants would be required to make the water bank an effective means for improving water supply and diversifying risk. Because the proposed water bank is purely voluntary, it is not clear whether there would be sufficient size absent exogenous incentives or requirements for participation.

¹²The only relevant decision that is a prerequisite is a pre-specification of land to centralize the common pool consumptive resource over. However, this is less of a theoretical issue for economic analysis and more of an international relations and sociology issue.

¹³It is possible that there is no functional binding cap in reality; that is, as long as total output , there are no technical problems with the analysis. However, it is also possible the regulator wants to begin with a relatively small quantity at the start date and then auction more permits based on the water bank's success. In either case, the initial quantity of permits for a given water quality are allocated based on a pre-specified environmental quality target.

¹⁴However, an important caveat is characterized as the “rebound effect.” Davis (2008) shows that conservation and efficiency measures may in fact increase consumption of water because the marginal cost decreases. The sign ultimately depends on whether the substitution or income effect dominates. Nevertheless, the direction is not of significance here, as the article only argues that social forces have a non-zero effect on water resources.

¹⁵That is, suppose there exists homogeneous regulation that mandates a fixed level of water quality. Water types j are pooled and an average is calculated. This parallels the CAFE standards for fuel efficiency in that automobile makers are required to have a final average fuel efficiency for cars.

¹⁶Although initially one may think that water quality would not be binding, companies do not necessarily want to meet only the minimum water quality. Certain water utilities may try to attract different customer bases.

¹⁷At first, this seems to contradict the well known “independence property” that is considered to generally hold for quantity instruments. However, this result is not necessarily inconsistent with the independence property because, in the current setting, there are effectively two externalities: political (transboundary governance) and environmental (water quality). Therefore, the current result suggests that there is an important interaction between the two externalities, so the equilibrium outcomes of a grandfathered versus auctioned permits can differ.

¹⁸See Baliga and Maskin (2003) for the full discussion of the model.

¹⁹Abstract from heterogeneous quality in commodities, as it will not change the basic theme.

²⁰Other costs that typically fall under this category are search and information costs, and monitoring and enforcement costs. Neither are expected to be serious issues in this case, so they are not given much attention in the article.

²¹A crucial issue that will need more examination in this regard is the time consistency effects in this sort of tradeable permit scheme. If marginal damages vary over time due to climatic conditions and the number of permits in the system changes recurringly, time inconsistency will be a drawback.

²²Carbon taxes are a salient policy instrument for addressing environmental externalities and achieving a weak double dividend. However, in this case, it is unclear how they would function. In particular, it is not clear what action would be taxed. The issue this article considers is more about property rights and incentives than it is about externalities in the conventional climate economics sense.

²³Specifically, Fernandez (2002) discusses that cooperation must occur over water pollution. This supports the simulation of a water market with tradeable permits, since water quality and quantity are ultimately traded.

²⁴For example, see MBD http://mdba.gov.au/ for information on MDB's trading rules in their water market.