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The Illiquidity of Water Markets


There is ample evidence that institutions governing human relationships are persistent over time. We explore a particular historical episode, self-governed communities in Southern Spain, that went from a market institution (auctions) to a non-market institution (fixed quotas) in the 1960s. By focusing only on the distribution of power or the efficiency of each available institution, we are unable to explain the institutional change. One institution is a market mechanism while the other requires a ban on trading. Depending on the parameters of the model one mechanism is more efficient than the other. Moreover, each mechanism could achieve full efficiency under some parameters. The non-market mechanism requires an egalitarian distribution of property rights. We use this fact to show that a transition to a more efficient (and more equal) institution may not happen because of commitment problems when the new institution requires the owners of property rights to sell them to other agents with limited liability. Hence, the model predicts that an existing institution may persist, even though the new institution could be adopted without any cost, and the old institution is both less efficient and less egalitarian. We show how a temporary increase in payoffs, which increased collateral, solved the commitment problem and lead to a change to a more efficient institution. We use a dynamic discrete choice model to structurally estimate the parameters characterizing demand. We show that the non-market institution is more efficient than the market institution. To do that we jointly estimate the willingness to pay and the ability to pay of the farmers.