Using Tradable Water Permits in Irrigated Agriculture

Abstract

The present paper examines, both theoretically and empirically, the environmental and economic benefits of introducing a policy to optimally manage groundwater used in irrigated agriculture and the efficiency potential of allowing trading of water permits. We confirm the results appearing separately in the literature on optimal resource management and tradable permits, that both tradable water permits and non-tradable quotas provide the basic mechanism for sustainable water use and yield substantial economic benefits and that allowing trading of water permits improves efficiency. In order to derive the above results we develop a discrete time model to realistically describe farmer’s myopic behavior, while using a continuous time model to describe optimal management. We also incorporate into the analysis the economic effect of sea water intrusion in the aquifer and we estimate the cost of water overexploitation under myopic behavior. The empirical part of the paper is based on simulations using data from an agricultural region in Northern Greece. The main contribution of the paper is the introduction of heterogeneity in crops’ production and market characteristics. We show that the more diverse are the crops, in technology and market prices, and the stricter is the water constraint, the higher are the benefits from using a tradable water permit system.