# **1. Introduction**

The purpose of this note is to consider certain analytical aspects of optimal, and sub-optimal, management of groundwater in a water basin, where groundwater is pumped to the surface using electrical pumping equipment, and subsequently utilized as an input in agricultural production. We ask the following questions:

- 1) What are the characteristics of socially optimal water management for such a basin?

- 2) What are the characteristics of privately optimal groundwater extraction behavior?

- 3) Can the socially optimal allocation be implemented, and what electricity price must then be charged to farmers for this purpose?

- 4) What is the value of the standing groundwater as such, in both an overall optimal allocation, and when the groundwater allocation is not optimal (the water table is too low)?

The concrete reference and background for our interest in this issue is the serious problem of excessive groundwater extraction facing a number low-income and emerging economies. Recent prior analyses of the problem include World Bank (2010); IFPRI (2010); and Msangi (2010). Excessive groundwater extraction can involve serious negative externalities due to the common-pool nature of groundwater: When a given groundwater basin is exploited by a large number of independent farmers, each farmer has little incentive to conserve the groundwater stock, since such conservation confers future benefits largely upon other farmers, and not oneself. This general topic has recently been studied extensively inside and outside of the Bank, by Briscoe and Malik (2006), Dubash (2005), Ray (2008), Reddy (2005), Shah et al (2000), Shah (2009), World Bank (2005, 2010), Vaidyanathan (2006), Jessoe (2010), and Birner et al (2010), among others.

The overall consensus from this literature is that the current situation is non-sustainable in many countries and regions, in the sense that the amount of extracted groundwater is greater than the water replenishment, with falling water tables as a consequence. A leading prevailing view is that a main factor contributing to excessive groundwater extraction in many locations is low-priced electricity to farmers, given that this electricity is largely used for pumping from common-pool groundwater basins. When farmers pay little (or in some cases, even zero) at the margin for electricity used for pumping, basically all available electricity will be expended for groundwater pumping, and pumping is done regardless of the water table level and thus the distance any unit of water must be pumped (which in turn defines the electricity cost of pumping per water unit).<sup>1</sup> The problem can however be said to be two-pronged. Since basic electricity consumption is not charged at the margin, there is the potential for excessive pumping even if groundwater had no standing value. This amplifies the problem that the value of standing groundwater is not priced nor charged. In principle, in the absence of direct pricing of groundwater to

> 1 Note that while this is the main view, it is not the only view of the current groundwater situation in many locations. Some observers take an alternative view, that even when electricity prices are low, rationing of electricity supply to farmers can be sufficient to constrain agricultural water use to a level that would have been experienced, had farmers faced “correct” electricity and water prices, in the absence of rationing. This would in case imply that it is the basic increasing demand for water from agriculture that is the main culprit, not low electricity prices. See, in particular, the extensive discussion in Birner et al (2010).