Governor Newsom’s Water Plan Represents Progress, But Misses The Power Of Markets

In mid-August, California Governor Gavin Newsom announced plans to tackle the state’s ongoing water crisis. California is in the midst of a drought, which some are now referring to as “the end of the dream.” Water shortages in the West are unfortunately becoming part of everyday life, thanks in large part to climate change.

Newsom’s plan appears to be moving the state in the right direction by focusing on increasing the supply of water available for residents’ wide-ranging purposes. However, his administration should be doing more to leverage the power of markets and market pricing, strategies noticeably absent from new proposals.

California’s problem is that over the coming 20 years, the state stands to lose 10 percent of its water supplies. This is primarily due to water evaporating at a higher rate, due to increased temperatures, and drier soils that are able to retain more runoff.

Newsom’s response is to institute a four-point plan, which involves developing new water supply through recycling and desalinization efforts, creating more above- and below-ground storage capacity to hold storm runoff, as well as adopting additional water conservation efforts in cities and on farms.

Environmentalists, who one might expect to support such efforts, have homed in on two main criticisms of the plan. First, they attack it for not focusing more on conservation. Second, they criticize desalinization as a means to increase the state’s limited supply of fresh water.

Desalination can be controversial since, although it creates water that is safe enough to drink, it can also have environmental side effects. For example, facilities can harm sea life as saltwater is pulled out of the ocean or when leftover brine is pumped back into the sea. Moreover, desalinization can be expensive and itself an energy-intensive process.

Roadblocks to the governor’s new plan should be anticipated. Back in May, California regulators blocked an attempt to build a plant in Huntington Beach, not far from Los Angeles, in part at the urging of NIMBYs and environmentalists. Similar projects like it are likely to also face opposition, potentially getting bogged down in the thick expanse of state and local regulations.

The Newsom Administration shouldn’t be deterred, however. They are right to focus on an abundance agenda. In the years ahead, even as some of California’s population moves to other states, attempting to close the water gap by limiting demand alone is a Sisyphean task and a band-aid at best. Pragmatic solutions are going to have to focus on creating more supply.

For this reason, it is surprising that the words “price,” “pricing,” and “market” appear nowhere in the governor’s 19-page plan. Market prices do two things: first, their adjustment signals to would-be entrepreneurs when a resource is in high demand. Second, they provide an incentive to entrepreneurs to provide more of the resource at times, as well as to direct resources to where they are most valued.

California policymakers have experimented with water markets in the past. But according to Nobel Laureate Paul Milgrom, prices aren’t operating as they should in this market. “Less than 5% of water is reallocated, even in the most severe drought,” Milgrom stated in a recent interview. “The prices adjust [water gets more expensive], but the reallocation doesn’t adjust even when there is insufficient water.”

Milgrom recommends water auctions as a potential solution. Free-market environmentalists have long argued that “market failures” are really just cases of “market opportunities” representing untapped profit opportunities. It’s no wonder desalinization is a booming industry right now, and the California government could be participating by auctioning off newly-desalinized water, benefiting taxpayers and water users alike. Revenues can even be reinvested back into making water desalinization more environmentally friendly, or, used to fund other state priorities.

The Newsom plan does include language about plans to “modernize water rights administration” but this seems to have less to do with facilitating new markets and more to do with digitizing records, collecting data, and improving modeling at California agencies. Further, the Administration is also considering “adopting regulations that would allow for curtailments of water rights in years when there is not a declared drought emergency,” which sounds counterproductive to say the least.

Newsom’s plan is a step in the right direction, but it’s not going to fundamentally change California’s water problems. California, like the nation as a whole, is hampered by its own unwieldy bureaucracies and special interest groups. Politicians may have an aversion to market-based solutions, but at the end of the day markets may be the best hope they’ve got.