Markets, Contracts, and Uncertainty: A Structural Model of a Groundwater Economy

Access to groundwater has been a key driver of agricultural productivity growth and rural poverty reduction in south Asia. Yet, markets for groundwater have not developed everywhere. We develop a contract-theoretical model of groundwater transactions under payoff uncertainty, which arises from unpredictable fluctuations in groundwater availability during the agricultural dry season. Our focus is on the tradeoff between the ex-post inefficiency of seasonal contracts and the ex-ante inefficiency of more flexible water-selling arrangements. We structurally estimate the model using micro data on area irrigated under each transaction type combined with subjective probability distributions of end-of-season borewell discharge collected from over 1,600 well-owners across four districts in southern India. We use the estimates to quantify the contracting distortion and its impact on the development of groundwater markets. ∗Development Research Group, The World Bank, 1818 H St. NW, Washington DC, 20433. Giné: [email protected]; Jacoby: [email protected]. We owe a particular debt to K.P.C. Rao for his efforts in managing the field work associated with this study, and to his survey team. We also thank Mark Gersovitz for extraordinarily useful comments on an earlier draft, as well as seminar participants and several discussants for their ideas and suggestions. Financial support for this project was provided by the Research Committee of the World Bank. Views expressed in this paper are those of the authors, and do not necessarily reflect the opinions of the World Bank, its executive directors, or the countries they represent.