Markets, Contracts, and Uncertainty in a Groundwater Economy

Groundwater is a vital yet threatened
resource in much of South Asia. This paper develops a model
of groundwater transactions under payoff uncertainty arising
from unpredictable fluctuations in groundwater availability
during the agricultural dry season. The model highlights the
trade-off between the ex post inefficiency of long-term
contracts and the ex ante inefficiency of spot contracts.
The structural parameters are estimated using detailed
micro-data on the area irrigated under each contract type
combined with subjective probability distributions of
borewell discharge elicited from a large sample of
well-owners in southern India. The findings show that, while
the contracting distortion leads to an average welfare loss
of less than 2 percent and accounts for less than 50 percent
of all transactions costs in groundwater markets, it has a
sizeable impact on irrigated area, especially for small
farmers. Uncertainty coupled with land fragmentation also
attenuates the benefits of the water-saving technologies now
being heavily promoted in India.