Can Expansion of Markets for Groundwater Decelerate the Depletion of Groundwater Resource in Rural India?∗

The development of markets for natural resources can help to ensure that individual users appropriately internalize the opportunity cost of these resources and thus can decrease resource use. However, expansion of markets also makes it possible to sell these resources, which may lead to more rapid extraction. A simple model of markets for groundwater suggests that the latter effect dominates and that water transactions should be increasing in the fixed costs of pumping water. We construct an alternative model in which there are non-convexities with respect to water in the agricultural production process and there are important externalities arising from well interference. We then examine these predictions using a data set from northern India that integrates farm-level information on the buying and selling of water and village-level panel information on water table depths in an instrumental variable framework. As predicted by the alternative model, we find that water transactions are decreasing in the level of fixed costs and that increased market breadth results in lower levels of aquifer depletion. JEL Classifications: L25, O13, P11, Q01, Q13, Q25 ∗This paper has benefitted from suggestions and comments by Jillian Berk, Kaivan Munshi, David Weil, Nicholas Wilson, and numerous participants of Brown Applied Micro Lunch. The support provided by Ministry of Water Resources, Government of India is greatly appreciated. We also wish to thank the residents of the two villages from the study area for providing in-depth contextual information. †Brown University; Email: [email protected] ‡Brown University; Email: [email protected]