Essays on the Economics of Water by Nicholas W. Hagerty Sc.B., Brown University (2010) Submitted to the Department of Economics in partial fulfillment of the requirements for the degree of Doctor of Philosophy at the MASSACHUSETTS INSTITUTE OF TECHNOLOGY June 2018 c 2018 Nicholas W. Hagerty. All rights reserved. The author hereby grants to MIT permission to reproduce and to distribute publicly paper and electronic copies of this thesis document in whole or in part in any medium now known or hereafter created. Author............................................................................. Department of Economics May 15, 2018 Certified by . Esther Duflo Abdul Latif Jameel Professor of Poverty Alleviation and Development Economics Thesis Supervisor Certified by . Benjamin Olken Professor of Economics Thesis Supervisor Accepted by. Ricardo Caballero Ford International Professor of Economics Chairman, Departmental Committee on Graduate Studies 2 Essays on the Economics of Water by Nicholas W. Hagerty Submitted to the Department of Economics on May 15, 2018, in partial fulfillment of the requirements for the degree of Doctor of Philosophy Abstract This thesis studies three questions in the economics of water resource management. Chapter 1 estimates the economic gains available from greater use of large-scale water markets in California. I develop a revealed-preference empirical approach that exploits observed choices in the existing water market, and I apply it to comprehensive new data on California’s water economy. This approach overcomes the challenge posed by transaction costs, which insert an unobservable wedge between observed prices and marginal valuations. First, I directly estimate transaction costs and use them to recover equilibrium marginal valuations. Then, I use supply shocks to estimate price elasticities of demand, which govern how marginal valuations vary with quantity. I find even a relatively modest market scenario would create additional benefits of $480 million per year, which can be weighed against both the benefits of existing market restrictions and the setup costs of larger-scale markets. Chapter 2 estimates the possible costs of industrial water pollution to agriculture in India, focusing on 63 industrial sites identified by the central government as “severely polluted.” I exploit the spatial discontinuity in pollution concentrations that these sites generate along a river. First, I show that these sites do in fact coincide with a large, discontinuous rise in pollutant concentrations in the nearest river. Then, I find some evidence that agricultural revenues may be substantially lower in districts immediately downstream of polluting sites, relative to districts immediately upstream of the same site in the same year. These results suggest that damages to agriculture could represent a major cost of water pollution. Chapter 3, co-authored with Ariel Zucker, presents an experimental protocol for a project that pays smallholder farmers in India to reduce their consumption of groundwater. This project will test the effectiveness of payments for voluntary conservation – a policy instrument that may be able to sidestep regulatory constraints common in developing countries. It will also measure the price response of demand for groundwater in irrigated agriculture, a key input to many possible reforms. Evidence from a pilot suggests that the program may have reduced groundwater pumping by a large amount, though confidence intervals are wide. Thesis Supervisor: Esther Duflo Title: Abdul Latif Jameel Professor of Poverty Alleviation and Development Economics Thesis Supervisor: Benjamin Olken Title: Professor of Economics 3 4 Acknowledgments I owe tremendous gratitude to my advisors, Ben Olken, Esther Duflo, and Chris Knittel, for their guidance, insight, and wisdom. Through generous time, attention, support, and mentorship, they have kept me inspired, open-minded, on track, and reaching high. I also thank Michael Greenstone, my advisor earlier in graduate school, who gave me crucial opportunities and kept my focus on the big picture. This thesis benefited dramatically from the comments and feedback of other MIT Economics fac- ulty members, who view graduate education as a collective responsibility. I am particularly grateful to Abhijit Banerjee, Amy Finkelstein, Dave Donaldson, David Autor, David Atkin, Jim Poterba, and Simon Jäger. Thanks to Clay Landry and WestWater Research, LLC, for sharing the data that made the first chapter possible, and Divyang Waghela and the staff of the Coastal Salinity Prevention Cell for making the third chapter possible. For excellent research assistance I thank J-PAL staff mem- bers Neha Doshi, Gokul Sampath, Aditya Madhusudan, and Suresh Bharda, and MIT undergraduate student Kavish Gandhi. Throughout graduate school, I may have learned the most from my fellow Ph.D. students. For years of collaboration, camaraderie, and friendship, I want to especially thank Arianna Ornaghi, Ariel Zucker, Donghee Jo, Gabriel Kreindler, Jack Liebersohn, John Firth, Josh Dean, Matt Lowe, Michael Abrahams, Peter Hull, and Rachael Meager. I am also grateful for funding from the MIT Energy Initiative, the MIT Tata Center for Technology and Design, the Abdul Latif Jameel World Water and Food Security Lab (J-WAFS) at MIT, the Weiss Fund for Research in Development Economics, and the International Growth Centre. I am beyond fortunate to have benefited from a long line of extraordinary mentors who helped me reach this point. To name a few standouts: Arik Levinson encouraged me and helped confirm my decision to pursue a Ph.D. Sri Nagavarapu indulged my undergraduate overeagerness and inspired me to think of economics as a potential career path. Amit Kobrowski first taught me to truly read and think critically. Derek Stein, Holly Simon, and Antonio Baptista introduced me to scientific research and were generous with their time and patience to a degree that in retrospect I can scarcely comprehend. Finally, I thank my good friends, my partner Ann, my brother Steve, and my parents for constant love and support. My parents gave me my intellectual curiosity, my sense of justice, and my care for the natural environment – and no matter what I get myself into, they always know exactly the right thing to say. I dedicate this thesis to them. 5 6 Contents 1 Liquid Constrained in California: Estimating the Potential Gains from Water Markets 15 1.1 Introduction . 15 1.2 Background on Water in California . 21 1.2.1 Water is initially allocated by fixed rules and environmental conditions . 22 1.2.2 Secondary markets are inhibited by transaction costs . 24 1.3 Theoretical Framework . 26 1.3.1 Simplified graphical model . 27 1.3.2 Model of an exchange economy with transaction costs . 28 1.3.3 From theory to estimation . 31 1.4 New Data on California’s Water Economy . 37 1.4.1 Water transactions . 37 1.4.2 Water entitlements . 38 1.4.3 Crosswalk file and user locations file . 39 1.5 Step 1: Estimating Transaction Costs from Observable Factors . 39 1.5.1 Selecting cost factors . 40 1.5.2 Econometric specification . 40 1.5.3 Results . 42 1.5.4 Discussion . 44 1.6 Step 2: Recovering Equilibrium Marginal Valuations of Water . 45 1.7 Step 3: Estimating Demand Elasticities . 46 1.7.1 Empirical strategy . 47 1.7.2 Results . 51 1.8 Step 4: Simulating the Gains from Trade . 52 1.8.1 Setting up simulations . 53 1.8.2 Results . 54 1.9 Conclusion . 56 1.10 Figures . 58 1.11 Tables . 67 1.12 Appendix: Validating Low Marginal Values of Water in Agriculture . 73 1.12.1 Data . 73 1.12.2 Outcome variables . 74 1.12.3 Empirical strategy . 75 1.12.4 Results . 76 1.13 Appendix: Market Power as an Alternative Explanation for Price Gaps . 80 1.13.1 Model of spatial trade with market power . 80 7 1.13.2 Deriving the estimation procedure . 82 1.13.3 Empirical implementation . 84 1.13.4 Results . 85 1.14 Appendix: Nash-in-Nash Bargaining as an Alternative Model . 89 1.14.1 Basic bilateral negotiation . 89 1.14.2 Nash equilibrium in simultaneous bilateral negotiations . 90 1.14.3 Small transaction quantities . 91 1.14.4 Fixed costs . 92 1.15 Appendix: Supplementary Tables . 94 1.16 Data Appendix . 96 1.16.1 Transactions . 96 1.16.2 Entitlements and Deliveries . 98 1.16.3 Quantity consumed . 104 1.16.4 Crosswalk file . 104 1.16.5 User location file . 105 2 The Costs of Industrial Water Pollution to Agriculture in India 107 2.1 Introduction . 107 2.2 Background . 109 2.2.1 Industrial water pollution and crops . 109 2.2.2 Welfare measures . 110 2.3 Data . 111 2.3.1 Sources . 111 2.3.2 Matching pollution data to industrial sites . 113 2.3.3 Matching agricultural data to industrial sites . 114 2.3.4 Covariate balance . 114 2.4 Empirical strategy . 115 2.4.1 Regression discontinuity in pollution . 115 2.4.2 Spatial matching in agricultural outcomes . 116 2.5 Results . 117 2.5.1 Pollution . 117 2.5.2 Agricultural outcomes . 118 2.6 Conclusion . 120 2.7 Figures . 121 2.8 Tables . 123 3 Measuring Demand for Groundwater Irrigation: An Experimental Protocol Using Con- servation Payments 127 3.1 Introduction . 127 3.2 Background . 130 3.2.1 Optimal groundwater policy: A framework . ..