July 2021

July 2021
Groundwater Use in California Agriculture


Economic Update: Inflation in a Rebounding Economy

with Leo Feler, Senior Economist, UCLA Anderson Forecast
  • Inflation: In June, the consumer price index increased 5.4% year-over-year and 0.9% month-over-month. Core inflation, excluding food and energy, increased 4.5% year-over-year and 0.9% month-over-month. Over the past three months, vehicle-related inflation (new vehicles, used vehicles, parts, and rentals) and pandemic-affected services inflation (airfare, hotels, and admissions to events) have accounted for more than half of the increase in monthly headline inflation. In other words, inflation is currently not broad-based; it is concentrated in sectors experiencing supply constraints (vehicles) and pandemic-affected services with pent-up demand (leisure and travel). See Exhibit 1.
  • Retail sales: The economy is rebounding, and the inflation we’re experiencing is a side-effect of that rebound. Advance estimates of U.S. retail and food services sales for June increased 18.0% year-over-year and 0.6% month-over-month, following a decline of 1.7% month-over-month in May. The increase in retail and food services in June is a positive sign that the recovery has momentum even as the impulse from fiscal stimulus wears off. Related to supply constraints, declining auto sales again pulled down retail sales.
  • Employment: Payroll employment growth accelerated to 850,000 jobs in June (following growth of 583,000 in May and 269,000 in April), with notable gains in leisure and hospitality, public and private education, professional and business services, retail trade, and other services. Job openings at the end of May were 9.2 million versus 9.5 million people who were unemployed. The ratio of job openings per unemployed person is now 0.97, compared to 1.23 right before the pandemic. See Exhibit 2.

Exhibit 1: Inflation is currently not broad-based; it is concentrated in sectors experiencing supply constraints (vehicles) and pandemic-affected services with pent-up demand (leisure and travel)

Source: Bureau of Labor Statistics and Council of Economic Advisors, July 13, 2021, available at: https://twitter.com/WhiteHouseCEA/status/1414940727088402438.

Exhibit 2: Number of job openings per unemployed person, 2007–June 2021

Source: Bureau of Labor Statistics and St. Louis FRED, available at: https://fred.stlouisfed.org/graph/?g=Ft4T.

Groundwater Use in California Agriculture

A Conversation with Leila Bengali, Fiona Burlig, Louis Preonas, and Matt Woerman

This month, our podcast features a conversation with UCLA Anderson Economist, Leila Bengali, and Professors Fiona Burlig, Louis Preonas, and Matt Woerman, regarding their recent paper on groundwater use in California agriculture. Below is an edited transcript of their conversation. Click here for full audio and video.


Leila Bengali: Our topic is the economics of groundwater in California agriculture: how the cost of groundwater affects its use and why this is important for the California economy and water policy. Let’s start with some general background. When you talk about groundwater use, what does that mean? Why is groundwater important for agriculture in California?

Fiona Burlig: As a residential water user, I don’t think about where my water comes from – I just turn the tap on. When we’re thinking about where our water typically comes from in California, it’s going to come from two main sources. One is surface water that comes from when it snows in the Sierras and eventually melts, then that comes down throughout the rest of the state. The other source is that the state sits on a large aquifer – you can think about it as a big bathtub of water underneath the ground. There’s a big groundwater aquifer that sits right under the Central Valley. You can drill a well just like you might drill an oil well to extract that water. Farmers are heavily reliant in California on both of these sources of water. Almost everything we grow that’s delicious in this country comes from California. In order to support that agriculture – it doesn’t rain enough in the state to fully support those farms, so farmers need to get water from other sources, and they tap into both the surface water resources and the groundwater resources to water their crops. It turns out that farmers use a lot of groundwater. Around 4 million acres in the state is irrigated with groundwater. Somewhere between 40%-60%, depending on whether it’s a drought year, of the agricultural water use in California comes from these underground aquifers. Understanding how farmers interact with these aquifers and what types of policies we want to put in place to conserve the sustainability of these aquifers is an increasingly interesting policy question.

Leila Bengali: This podcast is based on a paper that the three of you wrote recently. I think there were some pretty amazing statistics in your paper – California produces 18% of total US crop value. So, we’re talking about a really big and important industry here. This provides some context for how important groundwater is for the California economy and for the US overall. As I understand it, one of the big issues with groundwater is overdraft: the aquifers you mentioned are being depleted. This is a problem, given the importance of groundwater for California agriculture. To me, overdraft implies that something’s not working, that markets are not getting us to the optimal level of groundwater use. Why is it that markets aren’t working here?

Louis Preonas: You would think that if it is known that we should have about this much groundwater left after each season for the aquifer to recharge and be sustainable, that farmers figure it out. One of the problems has to do with this fundamental feature of groundwater – it’s like many other things that we study as environmental economists – it is a common-pool resource. There are certain types of private goods where we can think about market mechanisms being more likely to work. So, if I make pizzas, I can enter the market of pizzas, and I have my pizzas, and I compete with other firms that also make pizzas. With groundwater it’s not as simple because it is rivalrous. That means in “econ-speak,” that if I pull up groundwater, that’s going to interfere with somebody else’s ability to pull up the same groundwater, because both people sit atop the same aquifer, and are sucking with straws out of the same source. So, that’s one feature. Another thing that’s an inherent part of the problem is it’s not excludable. There’s no way for me, feasibly, as a farmer to say, “Hey, neighbor, I don’t want you to pump groundwater. In fact, I would even be willing to pay you not to pump groundwater,” because it’s difficult for me to observe how much water my neighbor takes out. So this is really a problem that requires government intervention to allocate it, as in many such markets for common-pool resources. You can think about fish, you can think about forestry, you can think about other types of renewable or non-renewable goods we use. Groundwater is really a classic example of that. It is really interesting, to us especially, thinking back historically – why hadn’t California figured this out until recently? In the state constitution there are provisions on how to govern surface water rights, and irrigation districts, which are pretty common parlance in California. Different areas like Fresno, Madera, Pajaro Valley, have irrigation districts that govern the use of surface water, and govern how much of that water farmers are allocated per acre. For groundwater, until recently, these institutions have not existed in California. It’s kind of been the Wild West, where if you own the land, you have the right to drill downward and pull up as much water as you see fit.  But that’s been changing recently. In 2014, the government under Jerry Brown passed the Sustainable Groundwater Management Act, which is basically three laws that are governing or putting a structure on the regulation of groundwater to make it more sustainable in California to introduce the sort of regulation to mitigate issues that cause overdraft.

Leila Bengali: We talked a little bit about markets and prices. Prices are generally in economics thought of as being important for getting us to the optimal amount – in this case, of groundwater. It’s helpful to know how people respond to prices. In your research, you determined how farmers’ use of groundwater responds to the price of groundwater. So, why is this question so hard to answer?

Matt Woerman: One of the issues is that, in California, groundwater is not typically priced in the first place. It’s this open-access resource that anyone who owns some land has the legal right to drill a well and pull up the water from the aquifer underneath. First of all, there’s typically no explicit price here, which goes back to the issue of why markets don’t work. And then the other issue is that if you can just drill a well and pull up as much water as you want, that’s typically not metered, it’s not reported to anyone, so there’s a fundamental data issue – which is, we don’t generally even know how much groundwater farmers are extracting. Ultimately, if we want to know how groundwater consumption responds to price, and we don’t know either of these things – price and quantity – that makes it a challenging problem to tackle. What’s really nice about our setting is, in California, the vast majority of groundwater pumps are run by electricity. It turns out that if you know how much electricity these pumps are using, and you know some characteristics of the pumps and the depth of the water that they are trying to pull up, there’s a simple physics relationship between the amount of electricity that goes in and how much water comes out. We’re able to solve that fundamental problem of not observing water quantities or prices by looking at the electricity side of things instead, and then translating that to water usage. Our study is really the first large-scale study of California agriculture – all those fruits and vegetables and nuts that we eat – and how farmers are responding to changes in their cost of pumping groundwater.

Leila Bengali: It sounds like the key issues were that this question is hard to answer because we have to know prices and quantities, and prices and quantities of groundwater use in California are not generally known. I want to note how much work you three had to do in this project to get those prices and quantities. Now I want to get to some of your findings. You found that farmers are actually pretty responsive to the cost of extracting groundwater. You looked at the responsiveness to the cost of the electricity to pump the water out of the ground. Could you tell us, what did you find? How did your results compare to what other researchers have found before?

Louis Preonas: Our first set of results look at how farmers’ electricity use responds to changes in the electricity price – basically estimating electricity demand response. There are many different applications of electricity demand response – for example, regressions that other energy economists have done that typically focus on residential consumers, how households respond if their price goes up on peak energy days. But not as much has been on the commercial and industrial side, other sectors of the economy, and very little on agriculture. By isolating agriculture, we found a segment of the electricity portfolio that is extremely responsive to price, relatively speaking. Our estimates are that if there’s a 10% increase in farmers’ pumping costs, or their electricity costs, for using that energy to pull up groundwater, then they actually decrease their consumption by about 11%. So, elasticity is greater than 1. Just to give a little context here, residential households usually have an elasticity around 0.2. Commercial and industrial – thinking about small businesses or factories, those estimates tend to be around 0.4 to 0.6. So, our estimates are much more elastic than that, which suggests that farmers are actually behaving in a way that seems pretty sophisticated in terms of their response to the electricity price that is going into their groundwater use. And then we can do some physics to convert these estimates into the responsiveness to the cost of pumping groundwater. The big thing here is that when you put electricity into your motor to pump up groundwater, the amount of groundwater you get will change if the motor is more efficient, and it will also change if the water is further below the surface. So, if the water level drops by 10%, it gets 10% more expensive to the farmer to pull that water up. We find really similar responses to the cost of groundwater itself, which combines both the change in the electricity price as well as changes in the depth of the groundwater. Whether the cost increase comes from higher electricity prices or from the groundwater level dropping, farmers are going to be really responsive to the cost shock they face. We’re finding more responsive groundwater use than previous estimates in previous papers that have studied farmers extracting groundwater. Part of that might have to do with the fact that our measurement is quite good, relative to previous work, because we do observe really accurate electricity pricing information. That allows us to be really precise here.

Leila Bengali: So when the cost of using groundwater increases, do farmers just water their crops less, or is it something else?

Matt Woerman: We explore four different options for how it is that farmers are reducing their groundwater extraction. The first one is exactly what you say: do they just water less – do they just put a little less water on their crops? We can test that empirically. It turns out that most of the farmers in our sample face electricity prices that vary throughout the day, just as a lot of residential consumers in California do. So you might expect if you’re going to water your crops less, the first thing you’ll do is wait during really high priced hours and make sure to turn off your water because that’s when it’s really expensive to pump. We just don’t find that effect at all. There is no effect where farmers are going out in the middle of the day when it’s particularly expensive and reducing their groundwater consumption during those hours, which suggest to us that that is probably not the margin on which they are making an adjustment if they’re not taking advantage of those really high priced hours to reduce their water use. Another option is that farmers might be investing in groundwater pumps that are more efficient at pumping water. If they did that, then we might see less electricity consumption but the same amount of groundwater usage. We do some empirical tests here too and find that this doesn’t appear to be the mechanism that farmers are using. We also look into the possibility that farmers are using less groundwater but using more surface water instead (or one of these other water sources for example), and we find that’s not true. Our final option is that farmers are actually changing the kind of crops they are growing in response to changing groundwater pumping costs. We estimate a model where we look at how farm crop choice responds to changes in groundwater pumping costs. We consider four broad categories. First, we’ve got fruit and nut perennial trees (so citrus fruits, almonds, and walnuts). Second, we look at hays and other kinds of alfalfa. Third, we look at annual crops, which are mostly vegetables. And fourth, we consider fallowing and not planting anything at all. What we find is that as groundwater pumping costs increase, farmers are more likely to grow fruit or nut perennials or they’re more likely to grow nothing at all. They are less likely to grow hay and alfalfa kinds of crops or annual crops like vegetables. So farmers are seeing in advance that their costs are going to be changing, and they reoptimize what kind of crops it would be best for them to grow as they anticipate costs in the next growing season.

Leila Bengali: What are the policy implications of your work, as they’re related to some of the rules, regulations, and policies that have been proposed or discussed in California?

Fiona Burlig: There’s the SGMA – the Sustainable Groundwater Management Act – and the goal of that legislation is to try and make aquifer use sustainable. What that means is that the aquifer is part of a natural process. When it rains in the spring, some water comes back into the aquifer. It’s not something that gets depleted and never recharged. There is this natural recharging process. The problem that’s happening at the moment in California is that we’re taking water out of aquifers much more quickly than the natural recharge puts water back in. If we don’t do something, we’ll eventually end up at a point where we have completely depleted these aquifers. What SGMA is trying to do is slow down or halt extraction so that we can bring this natural system back into balance. In order to do that, what SGMA does is empower local agencies with the ability to try out a whole bunch of different options for curtailing water use. That can be a local price or a tax, that can be a local quantity restriction, that can be bans on a particular type of crop being grown in the region, etc. Local policy makers have a large amount of flexibility to decide exactly how to achieve sustainability targets. The key thing is that different parts of the aquifers have different basins in California, which have different targets for how much of a reduction in extraction needs to occur. In certain basins, you might want to reduce extraction by 50%. If that’s the case, then it’s going to be really important to know how farmers respond to different policy instruments in terms of their reductions in consumption. Taking the most basic kind of economic policy instrument, which is imposing a price, if you have an elasticity of 0.5, from an older estimate, versus an elasticity of 1, from our paper, that suggests it’s actually much easier to achieve the state’s sustainability goals than would have been thought based on prior estimates. Comparing a low elasticity to a high elasticity, if the elasticity is in fact high, which is what we are finding, that suggests that farmers are actually going to be quite responsive to local policies, which is actually great news from an aquifer sustainability standpoint. We can get a large amount of change in farmer behavior for a relatively small change in price or in the cost of groundwater extraction. That’s the optimistic part of what we’re finding. Of course, since we’re economists, you have the one hand and the other hand. So on the other hand, the implication of what we’re seeing is that farmers appear to be changing their water use by changing what they’re growing. This also has potentially larger scale impacts on agricultural markets as a whole. If farmers are really switching out of growing things like lettuce or strawberries and really putting energy into almonds and oranges, that might be great for the delicious fruit and nut market, but it definitely has implications on what we eat more broadly. I would say that this is great news on the sustainability front, but it doesn’t come for free. There is something else that is going on in the background to enable these reductions in water usage to happen.

Leila Bengali: And that’s even more prominent because California, as we talked about at the beginning, is such a large producer of many of these food crops that we eat in the U.S. and even across the world.

Fiona Burlig: Exactly. While it may be a bit uncomfortable for us to think about a particular vegetable becoming more expensive in the market, in some sense, what we’ve been doing all along by having groundwater be an unpriced resource, is we’re subsidizing the consumption of a particular product. What these types of regulations have the potential to do is actually bring us back into a world of sustainability that we never lived in. While it sounds like that’s a bad thing, to potentially reallocate crop land, from an economist’s perspective, it’s actually probably really good: we’ve been doing a lot of waste because the groundwater has been way too cheap relative to its actual value to society. By increasing the cost of water and having farmers reallocate what they’re growing, that means, from a societal perspective, we’ll have a better overall mix of crops on the market that take into account what the land and what the climate can sustain.

Leila Bengali: That sounds like a perfect place to end. I want to thank you for sharing your research based on your recent paper called “Energy, groundwater, and crop choice.” Thank you very much.